Financial intermediaries vs. financial markets
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Financial Intermediaries
A financial intermediary stands between savers (who have surplus funds) and borrowers or investors (who need funds). It earns a spread or fee for performing this matching role and for bearing risks on behalf of its clients.
Key types: - Banks: accept deposits and make loans. The interest rate on loans exceeds the rate on deposits — the spread is the bank's gross income. - Insurance companies: collect premiums, pool policyholder risk, and invest float in long-dated assets. Policyholders get protection; the insurer earns investment returns on premiums held until claims arise. - Pension funds: pool retirement savings from employees and invest them in equities, bonds, and property over decades, aiming to generate returns that meet future pension obligations. - Mutual funds: pool retail investor money to buy a diversified portfolio. Investors own proportional shares of the fund. Professional management + diversification for amounts too small to achieve it individually.
Worked example
A saver deposits €10,000 in a bank at 2% interest. The bank lends that same €10,000 to a homebuyer at 5%. The bank's net interest spread = 3% — its gross income from intermediating between saver and borrower. The saver never meets the borrower; the bank bears the credit risk that the borrower might default.
Exam strategy
Central bank tools (reserve ratio, discount rate, open-market ops) affect money supply and interest rates in opposite directions.
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