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Role of Transaction Cost in Intermediation Process
Finance & Accounting
Pages 6 (1506 words)
A financial intermediary is a financial institution that brings together an entity with surplus funds with an entity with deficit funds. Such intermediary serves the purpose of proper channelling of funds in the economy.
For instance, when the bank acts as intermediary it connects individuals with different needs, financial inputs at different point of time. It allows people to save money into various accounts like savings account, time deposits, salary account, pension funds, and so on. After the bank accepts deposits from an individual it invests that sum into projects which have returns greater than or equal to the cost of investment which is also the bank’s liability. Now, if any corporate or individual approaches the bank for loan, the bank will charge interest on that loan. This interest will increase the transaction cost of the individual or corporate. The interest charged on loans by the bank on the borrower will obviously higher than what the bank has to pay to the depositors. This is because in order to operate in the market and serve the community it has to maintain a profit margin for all transaction which otherwise would lead to collapse of business. The advantage that an individual or a corporate will get from an intermediation process is that the credit risk is transferred from individual borrower to the bank. This is because when a corporate raises funds from market directly without any intermediation, the credit risk of parties to transaction has to be evaluated personally. ...
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