Banks as financial intermediary-

Financial markets link savers and

borrowers and this link is accomplished
through either direct finance or indirect
finance.
Direct Finance- when savers lend funds
directly to borrowers.
Third party- Facilitator
Indirect Finance- involves a particular
type of middlemen, a third party who
stands between borrower and lender.
Deposit interest rate 6% and loan
interest rate- 9%
Benefits of Financial Intermediary-
1. Banks match up savers who want to
lend funds for short period and
borrowers who want to borrow funds
for long period. “Borrowing short and
lending long”.
If unable to come up with the funds to
redeem the demand deposits, the bank
would be ‘illiquid’.
Ways to avoid illiquidity
(a) seeks a widely diversified set of
depositors
(b) banks keep small amount of
reserves against sudden withdrawls and
establishes several lines of credit with
other banks and with govt regulators.
(c) make long term loan to only a small
fraction of its loan clients.
(d) lending a portion of funds in govt
bonds which are relatively easy to
convert into currency.
SLR.
2. Banks pool many small depositors to
make relatively large loans to
borrowers.
3. Diversification benefits to customers
4. Economize transaction costs