Show How a Financial Intermediary Can Solve Problems That Ultimate Savers and Borrowers Cannot Easily Solve When Dealing Directly with Each Other

2381 WordsMay 10, 200810 Pages
As Bain (1992; p.5) states, ‘Financial intermediaries are institutions which attempt to serve the needs of both lenders and borrowers and are often able to reconcile the divergent requirements of borrowers and savers.’ It is important to highlight that there are several different financial intermediaries; banks, building societies, insurance companies and pension scheme companies, but in this case the role of the bank as an intermediary will mostly be considered. In everyday lending transactions the use of the direct method (ultimate savers and borrowers dealing directly with each other) is uncommon. It has now become widely accepted that the existence of financial intermediaries actually makes direct contact unnecessary. It is true…show more content…
Intermediaries benefit from economies of scale and being able to find out information quickly and cheaply. They benefit from economies of scale because intermediaries are able to realise significant cost savings from working with a high number of customers therefore are researching about their borrowers and lenders on a wider scale. Due to the large numbers involved intermediaries can afford to employ researchers to carry out the specific job of finding out information about individual borrowers and lenders. It is deemed too expensive for individuals to monitor each other therefore it is easier to pay the bank to do it on their behalf; this is one of the main reasons why people lend and borrow via banks. Llewellyn (1999) and Heffernan (1996) explain that verification costs are also minimal as banks have access to privileged information about borrowers, especially where the bank holds the prospective borrower’s current account. Visibility of current accounts allows the bank to build up a picture of individuals owing to bank statements and specific account details. The bank will be able to identify income, spending behaviour, transactions: the car they drive, if they have a pension, if they have life insurance. This means that when transactions are completed via intermediaries the asymmetric information problems are easily solved. Administration costs Administration costs associated with the direct route are very high. Processing all

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