Financial intermediation

    2. Financial intermediation.

    Financial intermediation is an activity of financial intermediaries.  A
financial intermediary is an institution that links lenders with  borrowers,
by obtaining deposits from lenders and then re-lending  them  to  borrowers.
The role of financial intermediaries  in  an  economy,  such  as  banks  and
building societies, is to provide means by which funds  can  be  transferred
from surplus units in the economy to deficit units. Surplus units are  those
economical  agents,  which  have  more  money,  than  they  need  for  their
immediate needs. Deficit units are those, which have less money,  than  they
need in order to fund their current activity.
    Financial intermediaries help to reconcile  different  requirements  of
borrowers and lenders.
    They provide obvious and convenient ways in which  a  lender  can  save
money. Instead of having to find a suitable  borrower  for  his  money,  the
lender can deposit his money with a bank etc. All the lender has  to  do  is
decide for how long he might want to lend money, and what sort of return  he
requires, and choose a  financial  intermediary,  that  offers  a  financial
instrument of the fitting conditions.
    They can package up the amounts lent by savers and lend on to borrowers
in bigger amounts.
    They  provide  for  a  risk  reduction.  Provided  that  the  financial
intermediary is itself financially sound, the lender would not run any  risk
of losing his  investment.  Bad  debts  would  be  borne  by  the  financial
intermediary in its re-lending operations.
    They provide a ready source of funds for borrowers. Even when money  is
in short supply, a borrower  will  usually  find  a  financial  intermediary
prepared to lend some.
    Most importantly they provide maturity transformation, i.e. they bridge
up the gap between the wish of most lenders for liquidity and the desire  of
most borrowers for loan over longer  periods.  They  do  this  by  providing
investors with financial  instruments,  which  are  liquid  enough  for  the
investors’ needs, and by providing funds to borrowers in a different longer-
term form.