Question

“Financial intermediaries play a crucial role in an economic crisis–they are responsible for both causing the market to crash and then helping it recover from the crisis.” Is this statement true? Discuss with an example in detail please.

Answer 1

Financial intermediaries are channelizing the funds from savers in the economy to the borrowers in the economy.

Financial intermediaries are playing an important role in causing the share market to crash because they are fuelling the liquidity in the market as they are channelizing the funds and acting upon the incentives which are provided by the central banks in order to maximize the benefits to the economy so there is a bullish rally on the upside because there is high liquidity presence and high availability of the credit because credit is having the multiplier effect as availability of credit can feel growth to large extent but financial intermediaries are interconnected with each other and defaulting of even one financial intermediaries can trigger a financial contagion so if the one financial intermediary is defaulting upon its payments or it is having a bad quality of Assets on its books than it can trigger a financial collapse like we saw in case of Lehmann brothers.

financial intermediaries are also important in order to recover from any kind of financial crisis because when the central bank will be stimulating the economy through cutting down of the interest rate and lowering the Reserve requirement ratio,then these financial intermediaries in the form of commercial banks are generally fuelling the economy by easy credit and then they will be trying to provide credit and liquidity to the market as well and it is leading to participation in the market which will be fuelling the growth so it can be said that financial intermediaries play an important role in adaptation of the qualitative and policies of the central bank's in order to support the economy by providing liquidity and credit availability to a large number of customers and it will help the the economic recovery as well as financial market to recover as well.