Question

Can you please explain the following topics?

MACROECONOMICS 1010

BANKS / BANKING SYSTEM

Role of banks as financial intermediaries

Meaning of asymmetric Information

The meaning and operation of fractional reserve banking

Answer 1

Role of banks as financial intermediaries

• They act as a middle person between the financial transaction between two parties
• Mainly in commercial banks and mutual funds
• It moves fund between the parties
• benefit of reducing costs on several fronts
• They provide factoring, leasing, insurance plans

Asymetric information

• It is also called information failure
• In the economic transaction, this could occur when there is one party having better material knowledge than the other
• Example is the seller having greater knowledge than the buyer, then they can cheat the buyer

Fractional reserve banking

• In this banking sheme, only the fraction of money is available in the form of cash in hand for the withdrawal
• This is done to expand the economy
• if a person deposit money, the bank keep some amount of money in bank for withdrawal and rest is lend out
• Majority of banks keep 10% of deposit
• The question arises what if the deposit ask to withdraw more amount which is not held by the bank currently
• This may cause bank run
• To overcome bank run , The govt had given a bank insurance which is called the lender of last resort
• That means if bank is out of money they can take it from commercial bank
• Because of this, the banks usually insure with deposit some funds to comercial banks yearly

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