Why do Financial Intermediaries Exist?

Whydo Financial Intermediaries Exist?


  • Significant changes in the workings of financial intermediaries have been witnessed in recent years. Emerging markets for financing options and futures have required input from financial intermediaries, as opposed to individuals or firms (Allen and Satomero, 1996).


  • This paper will discuss the role of financial intermediaries today.

FirstSupporting Paragraph

  • Financial intermediaries offer direct financial services (Adrian and Shin, 2010). Direct financing involves developing an exact match between the claims of Deficit Spending Units (borrowers) and Surplus Spending Units (savers) (Shay, n.d.). Thus, financial intermediaries resort to reshaping direct claims sold by DSUs to make them more appealing to SSUs. (University of South Carolina, n.d.).

SecondSupporting Paragraph

  • Financial institutions also solve the problem of information assymerrics. Financial institutions overcome such problems by estimating the capacity of a borrower to repay the outstanding sum or adjusting the interest rate accordingly (Auronen, 2003).

  1. Support

  • Financial intermediaries can apply one of two approaches to risk minimization: adverse selection or moral hazard. In adverse selection, lenders (due to lack of information) cannot make a distinction between projects that pose low risk and those that pose a high risk. On the other hand, borrowers may elect to allocate the funds that have been advanced to them for other purposes, other than those that have been agreed upon: moral hazard (Bebczuk, 2003).

  1. Support

  • Of the two approaches, adverse selection is more efficient (Pauly, 2007).

ThirdSupporting Paragraph

  • Recent decades have witnessed a significant reduction in asymmetric information and transaction costs: the traditional role of banks has declined (Crawford, 2014).


  • In essence, financial intermediaries act as middlemen between the net savers and net borrowers of the economy (Genberg, n.d.: 100). Over the years, however, the role of financial intermediaries become more involved (Cetorelli et al., 2012: 4).


Adrian, T., &amp Shin, H. (2010). Financial Intermediaries and MonetaryEconomics.FederalReserve Bank of New York Staff Reports.Retrieved fromhttp://www.fednewyork.org/research/staff_reports/sr398.pdf

Adrian, T., &amp Shin, H.&nbspS. (2010). The Changing Nature of FinancialIntermediation and the Financial Crisis of 2007–2009.&nbspAnnualReview of Economics.doi:10.1146/annurev.economics.102308.124420

Allen, F., &amp Santomero, A.&nbspM. (1999). What do ®nancialintermediaries do?&nbspJournalof Banking &amp Finance.Retrieved fromhttp://finance.wharton.upenn.edu/~allenf/download/Vita/intermed.pdf

Auronen, L. (2003). Asymmetric Information: Theory and Applications.&nbspHelsinkiUniversity of Technology Department of Industrial Engineering andManagement. Retrieved fromhttp://citeseerx.ist.psu.edu/viewdoc/download?rep=rep1&amptype=pdf&ampdoi=

Bebczuk, R.&nbspN. (2003). Asymmetric Information in FinancialMarkets.&nbspCAMBRIDGEUNIVERSITY PRESS.Retrieved fromhttp://www.beck-shop.de/fachbuch/leseprobe/9780521793421_Excerpt_001.pdf

Cetorelli, N., Mandel, B.&nbspH., &amp Mollineaux, L. (2012). SpecialIssue: The Evolution of Banks and Financial Intermediation.&nbspEconomicPolicy Review,&nbsp18(2).Retrieved from http://www.ny.frb.org/research/epr/2012/EPRvol18n2.pdf

Pauly, M. (2007). The Truth about Moral Hazard and AdverseSelection.&nbspPolicyBrief. Retrieved fromhttps://www.maxwell.syr.edu/uploadedFiles/cpr/publications/pb36.pdf

Shay, R. (n.d.). SOME BASIC CONSIDERATIONS IN AUTOMOBILE FINANCE METHOD OFFINANCE.&nbspNationalBureau of Economic Research&nbsp.Retrieved from http://www.nber.org/chapters/c1880.pdf

Universityof California. (n.d.). An Overview of the Financial System. Retrievedfromhttps://www.unc.edu/~salemi/Econ006/Mishkin_Chapter_Financial_System.