Question

Why might you be willing to make a loan to your neighbor by putting funds in the bank and having the bank lend her the funds at 10% interest rate, rather than lend her the funds yourself?

Answer 1

Solution

Because there are other costs of making the loan to your neighbor including high (legal fees, fees for a credit check, and so on), you will probably not be able earn 5% on the loan after your expenses even though it has a 10% interest rate. You are better off depositing your savings with a financial intermediary and earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank rather than lending them to your neighbor.

The costs of writing up the loan contract might exceed the​ 5% difference between your deposit rate and the bank lending rate.