Intermediation is the process of channeling funds from savers to borrowers through financial intermediaries. Financial intermediaries, like banks and savings and loan associations (S&Ls), play a crucial role in the economy by facilitating the flow of funds, thereby supporting investment and consumption. This mechanism ensures that idle savings are transformed into productive investments, facilitating economic growth and stability.
- Commercial Banks: A commercial bank collects deposits from individuals and entities and lends these funds to businesses and individuals seeking loans for various purposes like buying a home, expanding a business, or personal consumption.
- Savings and Loan Associations (S&Ls): S&Ls focus primarily on accepting savings deposits and providing mortgage loans to consumers.
- Mutual Funds: These entities pool funds from many investors to purchase a diversified portfolio of securities, providing a return to investors and funding for companies and governments.
Frequently Asked Questions
Q1: What is the difference between intermediation and disintermediation?
A1: Intermediation involves financial intermediaries facilitating the flow of funds between savers and borrowers. Disintermediation, on the other hand, occurs when borrowers and savers bypass financial intermediaries and deal directly with each other, often through new digital platforms or direct investment methods.
Q2: Why is intermediation important for the economy?
A2: Intermediation promotes economic growth by ensuring that funds are effectively allocated from savers to borrowers who can invest in productive ventures. This process increases investment, drives consumption, supports business expansion, and maintains financial stability.
Q3: Can intermediation occur in non-traditional financial systems?
A3: Yes, intermediation can occur through non-traditional financial systems like peer-to-peer lending platforms and crowdfunding, which connect savers and borrowers without conventional financial institutions.
Q4: How do financial intermediaries benefit savers?
A4: Financial intermediaries offer savers a safer and more efficient way to earn returns on their funds through interest and dividends. They also provide liquidity, allowing savers to withdraw funds as needed.
Q5: How do financial intermediaries benefit borrowers?
A5: Financial intermediaries provide borrowers with access to capital at reasonable terms, which is essential for purchasing homes, investing in businesses, or personal financial needs. This supports growth and economic expansion.
- Disintermediation: The process by which borrowers and savers bypass financial intermediaries and interact directly with each other to complete financial transactions, often facilitated by technological advances.
- Liquidity: The ease with which an asset can be converted into cash without significantly affecting its price.
- Interest Rate Spread: The difference between the interest rate paid by banks on deposits and the interest rate they charge on loans.
- Financial Institution: Entities such as banks, credit unions, and insurance companies that provide financial services to consumers and businesses.
- Peer-to-Peer Lending: A method of borrowing and lending money among individuals through online platforms, bypassing traditional financial intermediaries.
Online Resources
References
- Mishkin, Frederic S. “The Economics of Money, Banking, and Financial Markets.” Prentice Hall, 2012.
- Cecchetti, Stephen G., and Kermit L. Schoenholtz. “Money, Banking, and Financial Markets.” McGraw-Hill Education, 2014.
Suggested Books for Further Studies
- “Modern Banking” by Shelagh Heffernan
- “Financial Institutions, Markets, and Money” by David S. Kidwell, David W. Blackwell, and Angela L. Sanders
- “Financial Intermediation and Deregulation” by Morten Balling, Elizabeth C. Nelson, and Andy Haldane
### What is the primary role of financial intermediaries in intermediation?
- [ ] To increase fees and charges for transactions
- [x] To facilitate the flow of funds between savers and borrowers
- [ ] To hoard financial assets and limit market access
- [ ] To regulate the overall economy
> **Explanation:** Financial intermediaries facilitate the flow of funds between savers (who provide capital) and borrowers (who need capital), helping to allocate resources efficiently and support economic growth.
### What is an example of a financial intermediary?
- [ ] A retail store
- [ ] A construction company
- [ ] A tech startup
- [x] A commercial bank
> **Explanation:** A commercial bank collects deposits from savers and provides loans to borrowers, acting as a key financial intermediary in the economy.
### Which of the following is NOT a type of financial intermediary?
- [ ] Mutual funds
- [ ] Savings and Loans associations (S&Ls)
- [ ] Commercial banks
- [x] Grocery stores
> **Explanation:** Grocery stores are not financial intermediaries; they are retail sellers of goods. Financial intermediaries include entities like mutual funds, S&Ls, and commercial banks that deal with the transfer of funds.
### What happens during disintermediation?
- [ ] Use of middlemen is increased.
- [ ] Interest rates on loans are markedly reduced.
- [x] Borrowers and savers connect directly, bypassing intermediaries.
- [ ] Financial intermediaries increase their presence.
> **Explanation:** Disintermediation refers to situations where borrowers and savers interact directly with each other, often using digital platforms, minimizing the role of traditional financial intermediaries.
### What benefits do financial intermediaries offer to savers?
- [ ] Guaranteed fixed returns regardless of market conditions
- [x] A safer way to earn returns and an added benefit of liquidity
- [ ] Large spreads between deposit rates and loan interest rates
- [ ] Involuntary high-risk investments
> **Explanation:** Financial intermediaries offer savers a safe way to earn returns such as interest or dividends and provide the added benefit of liquidity, making it easier to access funds when needed.
### Which financial intermediary primarily focuses on mortgage lending?
- [ ] Mutual funds
- [ ] Hedge funds
- [x] Savings and Loan associations (S&Ls)
- [ ] Insurance companies
> **Explanation:** Savings and Loan associations (S&Ls) focus primarily on accepting savings deposits and providing mortgage loans to consumers looking to buy homes.
### How can intermediation influence economic growth?
- [x] By ensuring funds are effectively allocated to productive investments
- [ ] By collecting higher fees and reducing capital flow
- [ ] By maintaining fixed income returns regardless of economic changes
- [ ] By limiting the number of participants in the financial market
> **Explanation:** Intermediation promotes economic growth by ensuring that savings are efficiently allocated to productive investments, supporting business expansions, infrastructure projects, and consumer spending.
### Why is liquidity important in financial intermediation?
- [ ] It limits the number of transactions possible.
- [ ] It complicates the process of accessing funds.
- [x] It allows savers to withdraw funds or make transactions easily.
- [ ] It hinders borrowers' ability to get loans.
> **Explanation:** Liquidity is important because it provides savers with the flexibility to access their funds easily, enhancing the attractiveness and stability of saving through financial intermediaries.
### What is one effect of technological advancements on financial intermediation?
- [ ] Decrease in number of intermediaries.
- [x] Facilitation of disintermediation.
- [ ] Complete elimination of peer-to-peer transactions.
- [ ] Complete reliance on traditional banks.
> **Explanation:** Technological advancements facilitate disintermediation by enabling direct connections between savers and borrowers through digital platforms, reducing the reliance on traditional financial intermediaries.
### How do intermediaries benefit borrowers?
- [ ] By charging higher interest rates.
- [ ] By reducing access to necessary funds.
- [x] By providing reasonable loan terms that support business and personal growth.
- [ ] By avoiding any form of financial regulation.
> **Explanation:** Financial intermediaries provide borrowers with access to capital at reasonable terms, which is essential for various needs like purchasing homes, investing in businesses, and personal financial growth, supporting overall economic stability.
