An In-Depth Framework of Financial Intermediaries
Table of Contents
Introduction 2
Functionalities of Financial Intermediaries 3
Maturity Transformation 3
Risk Transformation 4
Convenience Denomination 5
Advantages of Financial Intermediaries 6
Reconciling Conflicting Preferences of Lenders and Borrowers 7
Spreading and Reducing Investment Risks 8
Economies of Scale Reduces Costs 8
Economies of Scope Reduces Cost 9
Summary and Conclusion 10
Introduction
Financial markets can often be considered as the collection of all potential buyers and sellers of various types of financial products or/and services along with the specific transactions between them. In particular, they provide a safe and regulated platform for borrowers and lenders to conduct trades between them that would be mutually beneficial to both parties. One might then anticipate, with basic understanding of how economy works, that borrowers and lenders in a financial market would not trade with each other directly but rather do so through an agent of a certain form and functionality; much in the same way that a person typically purchases their weekly grocery at a high street retailer rather than from the original producers in this modern age.
Financial intermediaries are financial institutions operating in financial markets as such agents, for borrowers and lenders to trade through them indirectly. In other words, regarding a much simplified case of transferring funds, a financial intermediary provides means to connect surplus agents (lenders) and deficit agents (borrowers). A typical example of a financial intermediary would be a commercial bank that draws surplus in the form of customer deposits and use these funds to issue all kinds of loans to those with deficits. In this scenario the lenders are effectively people who save with the bank and they benefit from earning interests for their deposits; meanwhile the bank acts on behave of its customers to deal with borrowers.
Despite the fact that we are all accustomed to the existence of financial
Introduction 2
Functionalities of Financial Intermediaries 3
Maturity Transformation 3
Risk Transformation 4
Convenience Denomination 5
Advantages of Financial Intermediaries 6
Reconciling Conflicting Preferences of Lenders and Borrowers 7
Spreading and Reducing Investment Risks 8
Economies of Scale Reduces Costs 8
Economies of Scope Reduces Cost 9
Summary and Conclusion 10
Introduction
Financial markets can often be considered as the collection of all potential buyers and sellers of various types of financial products or/and services along with the specific transactions between them. In particular, they provide a safe and regulated platform for borrowers and lenders to conduct trades between them that would be mutually beneficial to both parties. One might then anticipate, with basic understanding of how economy works, that borrowers and lenders in a financial market would not trade with each other directly but rather do so through an agent of a certain form and functionality; much in the same way that a person typically purchases their weekly grocery at a high street retailer rather than from the original producers in this modern age.
Financial intermediaries are financial institutions operating in financial markets as such agents, for borrowers and lenders to trade through them indirectly. In other words, regarding a much simplified case of transferring funds, a financial intermediary provides means to connect surplus agents (lenders) and deficit agents (borrowers). A typical example of a financial intermediary would be a commercial bank that draws surplus in the form of customer deposits and use these funds to issue all kinds of loans to those with deficits. In this scenario the lenders are effectively people who save with the bank and they benefit from earning interests for their deposits; meanwhile the bank acts on behave of its customers to deal with borrowers.
Despite the fact that we are all accustomed to the existence of financial