3 - FINANCIAL INTERMEDIARIES

Abstract

This chapter discusses financial intermediaries. One characteristic differentiating developed from underdeveloped countries is the number, range, and diversity of specialized financial institutions. These institutions are known collectively as financial intermediaries. The name intermediary refers to the fact that these institutions stand between the ultimate borrower and the ultimate lender; their function is to expedite the flow of funds from the latter to the former. The fundamental way in which financial intermediaries contribute to economic development is by reducing the costs involved in the lending process. Cost reductions are achieved through three different means. The financial institutions can increase the overall supply of loanable funds. They can reduce the risks involved in the lending process. Many financial institutions are highly specialized lenders; they only make certain types of loans. Through specialization they acquire lending expertise, which enables them to lower the direct cost of negotiating, evaluating, accounting, appraising, and collecting loans. Financial intermediaries fall into two distinct categories. Each of these financial intermediaries tends to specialize in certain types of loans.