Financial intermediation facilitates efficient allocation of capital from "summary" of The Economics of Money, Banking and Financial Markets, eBook, Global Edition by Frederic S. Mishkin
Financial intermediation plays a crucial role in the economy by connecting savers and borrowers. When individuals have excess funds that they want to invest, they can deposit their money in financial institutions such as banks. These institutions then lend out these funds to businesses and individuals who need capital for investment or consumption purposes. In this way, financial intermediaries help to channel funds from those who have a surplus to those who have a deficit, facilitating the efficient allocation of capital in the economy. Without financial intermediaries, the process of transferring funds from savers to borrowers would be much more complex and inefficient. Savers would have to search for borrowers on their own, evaluate the creditworthiness of potential borrowers, and monitor the performance of their investments. On the other hand, borrowers would have a hard time accessing the funds they need for their projects or purchases. Financial intermediaries simplify this process by pooling funds from many savers and making loans to a diverse set of borrowers, thus spreading risk and reducing transaction costs. Moreover, financial intermediaries play a crucial role in screening and monitoring borrowers. By evaluating the creditworthiness of potential borrowers and monitoring their performance over time, financial institutions help to reduce the information asymmetry between savers and borrowers. This, in turn, lowers the risk of lending and allows funds to flow to the most productive and efficient investment opportunities. As a result, financial intermediation helps to promote economic growth and development by ensuring that capital is allocated to its most productive uses.- Financial intermediation is essential for the efficient functioning of the economy. By connecting savers and borrowers, pooling funds, reducing transaction costs, and screening and monitoring borrowers, financial intermediaries play a critical role in facilitating the efficient allocation of capital. Through these activities, financial intermediaries contribute to economic growth, development, and prosperity.
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