FINANCIAL INTERMEDIARIES IN ISRAEL, 1950-54*

Abstract

THIS STUDY IS an investigation into the structure of the financial intermediaries in operation in Israel in 1950-54 and the factors that affected the development of the various specific groups of intermediaries. First, the role of financial intermediaries in an economic system is discussed in general terms: What are the variables that determine the level of funds demanded by economic units from financial intermediaries? Under what conditions will ultimate owners of funds hold financial assets? Can these assets be acquired directly as claims on the ultimate users of funds or indirectly as claims on the financial intermediaries? The effect of financial intermediaries in the economy is also analyzed: the operation of these organizations reduces the demand for cash holdings as an asset by substituting financial earning assets (claims on themselves) which are nearly as riskless and liquid as money but which pay a positive rate of interest. The framework in which financial intermediaries operate is applied to the specific experience of the Israeli economy. It is shown that, since real national output grew rapidly and the general price level rose even faster, there was no scarcity of opportunities to channel funds to ultimate users of funds. However, the inflation prevented financial assets from being acquired voluntarily by potential savers because of the decline in the purchasing power of these assets. Funds were made available for development either involuntarily, i.e., through the inflationary process which led to the expansion of the banking organizations, or through increased dependence on the international flow of capital. The import surplus which assisted in developing the Israeli economy was channeled through the government and Jewish Agency development budgets, and, as a result, the importance of the public and the quasi-public sectors in the economy increased. The effect of funds obtained from the government development budget led to a rapid growth of finance companies of the public and quasi-public sectors and was also felt on the development of other types of financial intermediaries.