Question

Discuss this concept: "In an economy without FIs, the level of fund flows between household savers and the corporate sectors is likely to be quite low." In your discussion, be sure to describe what you think is "low"- and what main effects that would have on the economy.

Answer 1

Financial Intermediaries (FIs) plays a key role in moving funds smoothly from the household sector to the corporate sector. In an economy without FIs, the corporate fund users would have to directly approach the savers in the household sector in order to satisfy their borrowing needs. This is a costly process because of up-front information cost faced by the potential lenders in the household sector.

This leads to cost inefficiencies in the market with - Identification of borrowers, pooling the small savings into loans of sufficient sizes to finance corporate activities, assessing the risk involved and investment opportunities. Also, lenders would be required to monitor the activities of the corporate borrowers over each loan's life span. The net results would be a lesser level of fund flow between household and corporate users and also the imperfect allocation of resources in the economy.

This is likely to keep household savings idle and corporates with a very low level of investments resulting in a lower level of income and output in the economy.