Financial intermediation is the process by which financial institutions such as banks, credit unions, insurance companies, and mutual funds channel funds from savers to borrowers. These intermediaries act as middlemen, connecting those who have excess funds with those who need capital to finance their business activities or personal consumption.
In financial intermediation, the intermediary assumes the risk of lending money to borrowers, while simultaneously offering interest on deposits held by savers. The difference between the interest rate paid on deposits and the rate charged on loans is known as the spread, which represents the profit for the intermediary. This spread is usually wider in situations where the intermediary faces higher risk.
Financial intermediation plays a crucial role in economic development by promoting savings and investment, and by providing credit to individuals and businesses that would not otherwise have access to capital markets. It also helps to improve the allocation of resources within the economy, by directing capital to its most productive uses.
