Financial intermediation

2. Financialinterme diation is an activity of financial intermediaries. A financialintermediary is an institution that links lenders with borrowers, by obtainingdeposits from lenders and then re-lending them to borrowers.The role of financial intermediaries in aneconomy, such as banks and building societies, is to provide means by whichfunds can be transferred from surplus units in the economy to deficit units.Surplus units are those economical agents, which have more money, than theyneed for their immediate needs.

Deficit units are those, which have less money,than they need in order to fund their current activity.Financialintermediaries help to reconcile different requirements of borrowers andlenders. Theyprovide obvious and convenient ways in which a lender can save money.Insteadof having to find a suitable borrower for his money, the lender can deposit hismoney with a bank etc. All the lender has to do is decide for how long he mightwant to lend money, and what sort of return he requires, and choose a financialintermediary, that offers a financial instrument of the fitting conditions.They canpackage up the amounts lent by savers and lend on to borrowers in biggeramounts.Theyprovide for a risk reduction.

Provided that the financial intermediary isitself financially sound, the lender would not run any risk of losing hisinvestment. Bad debts would be borne by the financial intermediary in itsre-lending operations.Theyprovide a ready source of funds for borrowers.

Even when money is in shortsupply, a borrower will usually find a financial intermediary prepared to lendsome.Mostimportantly they provide maturity transformation, i.e. they bridge up the gapbetween the wish of most lenders for liquidity and the desire of most borrowersfor loan over longer periods.They do this by providing investors withfinancial instruments, which are liquid enough for the investors needs, and byproviding funds to borrowers in a different longer-term form.