Question

What are the main effects of High inflation on Financial Intermediations and what are the results?

Answer 1

Answer-

The efficiency of financial sector is lessened  due to the high rate of inflation and the financial market become volatile and we can witness a slowing economy.

Duet to high inflation the financial intermediaries like banks and financial institutions will be lending less and the loan approvals will be less compared to low inflation and good economy. The equity markets will be less active and the liquidity decreases during periods of high inflation. The higher inflation over a prolonged period decreases the investments and slows the growth as many industries decreases the capital allocation and shelve the expansion plans due to credit crunch.

The private sector has linear relation with inflation. The growth of private sector sees a deep cut during periods of high inflation.

During high inflation the financial intermediaries are not able to lend and the activity in various cash intensive businesses like real estate, manufacturing particularly metals like steel slows down dramatically and these companies start defaulting on the loans repayments. This can lead to increase in bad loans in financial intermediaries if the inflationary pressures continues over a prolonged period of time. These bad loans and non performing assets further lowers the performance of financial intermediaries and can further dent their lending capability.