The key principles of financial intermediation are:
1. Risk-sharing: Financial intermediaries take on risk by lending funds to borrowers. They earn a return on this risk by charging a higher interest rate than they pay for deposits.
2. Liquidity transformation: Financial intermediaries provide liquidity by transforming short-term deposits into long-term loans. This makes it easier for borrowers to access capital.
3. Maturity transformation: Financial intermediaries match the maturities of assets and liabilities. This reduces liquidity risk and helps to ensure that they can meet the needs of depositors and borrowers.
4. Diversification: Financial intermediaries achieve diversification by investing in a large number of assets. This reduces the risk of the portfolio and increases the likelihood that the intermediary can generate a return.
These principles impact the economy in several ways. Financial intermediation helps to allocate capital to productive uses, which leads to economic growth. This is because financial intermediaries can provide funding to small businesses and startups that may not have access to traditional capital markets. Additionally, financial intermediation provides a way for individuals and institutions to save and invest. This helps to increase savings and investment rates, which can boost economic growth over the long term. Furthermore, financial intermediaries help to ensure that credit risk is spread across a broad network of borrowers, which reduces the likelihood of systemic risk in the economy.
