The Financial System

Abstract

In a primitive economic world those who have saved part of their income and who wish to onlend their savings (the ultimate lenders), will meet together with those who wish to borrow for various reasons (the ultimate borrowers) and arrange a mutually agreeable price for the transfer of funds between them. However, in a sophisticated world such transfers are beset with difficulties. The lenders and borrowers may be geographically dispersed; the amounts which lenders wish to make available may not match the amounts which borrowers wish to borrow; and the term to maturity of funds on offer may not match borrowers’ requirements. In principle, the price charged for transfers of funds — the interest rate — can be adjusted to overcome most of these difficulties, but in many cases a mutually agreeable interest rate will not be forthcoming, and the transfers will not take place even though lenders wish to lend and borrowers wish to borrow. Financial intermediaries are needed to overcome this problem.