Question

Explain, using examples, the importance of financial intermediation to the flow of funds in an economy.

Answer 1

A healthy economic system is the one which has the perfect equilibrium of flow of funds. A financial intermediary is an entity that facilitates transactions between two parties by serving as the middleman to such transactions. Financial intermediaries transfer funds from those who have surplus capital to those who need it. Through this process different kinds of assets i.e. with different duration are converted to assets with a different duration. Example: Banks accept short term deposits and transform these assets to loans. Mutual Funds pool the savings of retail investors and help individuals create savings. Financial intermediaries facilitate circulation of money in the market and help in the growth of the economy. Financial intermediaries help in reducing the risk of individual investors by helping them save. Also provide the advantage of convenience, economies of scale.