Question

Explain how the information related problems affect the operation of the financial intermediaries? ( 20 marks) How financial intermediaries managed with the information related problems.( 20 marks)

Answer 1

A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment bank, mutual fund, or pension fund. Financial intermediaries offer a number of benefits to the average consumer, including safety, liquidity, and economies of scale involved in banking and asset management. Although in certain areas, such as investing, advances in technology threaten to eliminate the financial intermediary, disintermediation is much less of a threat in other areas of finance, including banking and insurance.

Information related problem -

Poor information - A financial intermediary may become complacent about spreading the risk and invest in schemes which lose their depositors money (for example, banks buying US mortgage debt bundles, which proved to be nearly worthless – precipitating the global credit crunch.)

Information Asymmetry -  Adverse Selection and Moral Hazard. The primary reason why people give their money to financial intermediaries instead of lending or investing the money directly is because of the risk that is present from the information asymmetry between the provider of funds and the receiver of those funds

2. Financial intermediaries managed with the information related problems

Limited resources for deploying, managing or improving information systems. Lack of enterprise-wide definitions for information types and values (no corporate-wide taxonomy). Large number of diverse business needs and issues to be addressed. Lack of clarity around broader organisational strategies and directions.

Various types of information are needed while buying and selling securities. Much time and money is spent in obtaining the same. The financial market makes available every type of information without spending any money. In this way, the financial market reduces the cost of transactions

Financial intermediaries can manage the problems of adverse selection and moral hazard. a. They can reduce adverse selection by collecting information on borrowers and screening them to check their creditworthiness. ... They can reduce moral hazard by monitoring what borrowers are doing with borrowed funds