Financial intermediation FN2029

This is a dynamic subject which aims to provide insights into and understanding of theories and practices relating to financial intermediation and the risk management techniques currently being used in major banks throughout the world.

Prerequisites / Exemptions

If taken as part of a BSc degree, courses which must be passed before this course may be attempted:

  • FN1024 Principles of banking and finance

Topics covered

Section 1: Theories of financial intermediation:

  • Types and characteristics of financial intermediaries
  • Financial intermediation as delegated monitoring
  • Liquidity transformation, bank runs and maturity transformation
  • Financing sources and borrower characteristics
  • Introduction to market microstructure.

Section 2: Risks in banking

  • Investigation of the principal risks in banking, including credit risk, liquidity risk, interest rate risk, market risk, sovereign risk, solvency risk, and operational risk
  • The risk management process
  • Risk measurement
  • Value at Risk techniques.

Section 3: Credit risk

  • Default risk, exposure risk and recovery risk
  • Internal and external credit ratings and the uses of rating systems
  • Principles of credit risk management
  • Credit risk models.

Section 4: Balance sheet management, liquidity risk and interest rate risk

  • Asset and liability management
  • Techniques for managing assets and liabilities
  • The liquidity gap
  • Interest rate gaps.

Section 5: Capital requirements and securitisation

  • Capital adequacy and regulation of financial intermediaries
  • Economic capital
  • Securitisation for capital management
  • The mechanics of securitisation.

Section 6: Analysing bank performance

  • Accounting and market value based performance measures
  • Risk-adjusted performance
  • Risk-adjusted return on capital
  • Economic value added.

Section 7: Risk Management

  • Derivatives pricing and hedging: linkages between the state preference model and arbitrage pricing, between option pricing models and delta hedging, and between forward pricing and hedging.
  • Hedge ratios
  • Managing credit risk with derivatives, including forwards, options, swaps, credit linked notes, and collateralized debt obligations
  • Managing interest rate risk with swaps
  • Managing foreign exchange risk with the forward hedge, money market hedge, and currency swaps.

Learning outcomes

If you complete the course successfully, you should be able to:

  • Discuss and evaluate key theories relating to the role of banks as financial intermediaries
  • Discuss and evaluate the risks which banks face and explain how these risks are managed, with particular focus on techniques of asset and liability management, and credit risk measurement and management
  • Discuss the importance of capital in bank management and the role of securitisation, and explain the importance of capital adequacy within banking regulation
  • Describe and analyse the various means of analysing bank performance
  • Explain the principles and techniques involved in the use of derivative instruments for hedging credit, interest rate and exchange rate risk.


Unseen written exam (3 hrs 15, including reading time).

Essential reading

  • Bessis, J. Risk Management in Banking. Chichester: Wiley.
  • Matthews, K. and J. Thompson The Economics of Banking. Chichester: Wiley.
  • Saunders, A. and M.M. Cornett Financial Institutions Management: A Risk Management Approach. New York: McGraw Hill.

Students are also expected to read journal articles which are available in the Online Library.

Course information sheets

Download the course information sheets from the LSE website.