Question

Suppose Eileen comes into a large sum of money and decides to lend the money to earn interest. She realizes that even if she were able to evaluate whether the borrower is creditworthy before making the loan, she cannot ensure that her borrower uses the money as promised once she lends the money. Therefore, because a financial intermediary has the ability to track customers' uses of money more easily and the ability to take action quickly If needed, she decides to lend through a financial intermediary. This is an example of how financial intermediaries can help to solve the problem of:

Moral hazard Insolvency Adverse selection

Answer 1

With the given situation, Eileen might be ready to lend money for a reason but might not appreciate if the money is used for any other purpose. If she lends the money through a financial intermediary, then the financial intermediary will easily make sure that the money is used for the said purpose.

Therefore, financial intermediaries will solve the problem of moral hazard.