Question

The state of Georgia is considering the construction of a high-speed rail system to alleviate traffic congestion, especially across the Atlanta Metropolis at a cost of $45 billion. Some of the funding will come from the Deutsche Bank financial institution, while most of it will be through the issuance of state bonds, with the rest financed by private investors who will own shares in the rail system. Explain how financial intermediation is necessary to make this project a reality. Why couldn’t the state use the tax revenues it collects during the current year to pay for it?

Answer 1

Financial intermediation is the procedure performed by banks of taking in reserves from an investor and after that loaning them out to a borrower. The saving money business blossoms with the financial intermediation capacities of financial foundations that enable them to loan out cash at generally high rates of premium while accepting cash on store at moderately low rates of premium.

Coordinate loaning amongst savers and borrowers resembles bargain, wasteful. All together for financial exchanges to be finished there must be a twofold occurrence of needs.

Individuals with reserve funds will have a given measure of assets that they will need to loan for a specific day and age.

They should discover somebody to loan to with coordinating conditions, the same surmised measure of assets and a similar day and age.

Coordinate loaning will require an agreement or some likeness thereof which should be arranged. Consequent exchanges including reimbursements of intrigue and rule should be represented.

Another issue experienced by banks is that they will have restricted capacity to expand and limit their presentation to default chance. Financial intermediation settle this issue.

A financial go-between offers an administration to help an individual or firm to spare or get cash.

A financial go-between encourages the distinctive needs of loan specialists and borrowers. For instance, on the off chance that you have to obtain $1 000 – you could endeavor to locate a person who needs to loan £1 000.

Yet, this would be extremely tedious and you would think that its hard to know how dependable the bank was.

Subsequently, as opposed to search for people to get a total, it is more productive to go to a bank (a financial middle person) to acquire cash.

The bank raises reserves from individuals hoping to store cash, thus can bear to loan out to those people who require it. A portion of the parts played by banks as financial middle people are as per the following.

1. Pooling the assets of little savers: Many borrowers require extensive entireties, while numerous savers offer little totals. Without middle people, the borrower for a $100 000 home loan would need to discover 100 individuals willing to loan him or her $1 000. That is not really productive. Banks, for instance, pool numerous little stores and utilize this to make vast advances.

2. Activating Wholesale back and Lines of Credit: Banks will likewise assemble extensive entireties of cash from the discount markets for on-loaning to numerous little borrowers crosswise over different profitable segments. Such offices can be activated seaward, where a littler organization would not have the capacity to arrange great terms independent from anyone else. Cases of such offices are seaward credit offices raised by banks to support SMEs or home loans locally.

3. Giving care, bookkeeping, and installments systems for assets: Banks are a conspicuous case for the care of cash in accounts, the records of installments, stores and withdrawals and the utilization of charge/ATM cards. Financial mediators can do the greater part of this significantly more economically than people since they exploit economies of scale. These administrations are institutionalized and computerized on a vast scale, so per unit exchange costs are limited.

4. Providing liquidity: Financial intermediaries make is easy to transform various assets into a means of payment through ATMs, credit cards, debit cards, etc. In doing this, financial intermediaries manage many short-term outflows and investments with long-term outflows and investments in order to meet their obligations while profiting from the spread between long and short term interest rates

5. Diversifying risk: Financial intermediaries’ help investors diversify in ways they would be unable to do on their own. Banks spread depositor funds over many types of loans, so the default of any one loan does not put depositor funds in jeopardy.

6. Collecting and processing information: Financial intermediaries are experts at collecting and processing information in order to accurately gauge the risk of various investments and to price them accordingly. Individuals do not likely have to tools or know-how to do the same, and certainly could not do so as cheaply as financial intermediaries (once again, economies of scale are important here). This need to collect and process information comes from a fundamental asymmetric information problem inherent in financial markets.

The process of financial intermediation is a very important role in an economy like ours. The majority of economic agents are in need of resources which they cannot generate on their own while some have surplus resources.

The ability of the two economic agents can be quickened by a financial intermediary. Some of the advantages of having financial intermediaries include the following:

(i) Lower search costs: You don’t have to find the right lenders; you leave that to a specialist.

(ii) Spreading risk: Rather than lending to just one individual, you can deposit money with a financial intermediary who lends to a variety of borrowers — if one fails; you won’t lose all your funds.

(iii) Economies of scale: A bank can become efficient in collecting deposits, and lending. This enables economies of scale — lower average costs. If you had to sort out your own saving, you might have to spend a lot of time and effort to investigate best ways to save and borrow.