Financial cost

There are specific differences between direct finance and indirect finance. There are six main functions of financial intermediaries and they are:

* Size transformation can only be made by financial intermediaries, savers/depositors are prepared to lend smaller amounts of money than the amounts required by borrowers. Banks perform the size transformation function exploiting economies of scale associated with the lending/borrowing function. * Maturity transformation which is that savers generally favour investing their money in safe short-term investment whereas borrowers prefer long-term loans, to finance their projects without the financial intermediaries both ends would not have their needs satisfied. * Risk transformation is when depositors are generally not keen to take great risks when investing their money; however, borrowers often look for funds in order to finance risky projects without the help of financial intermediaries many risky but profitable projects would not be implemented. * Liquidity provision is when surplus agents prefer that the assets they invest in be “liquid”, ie easily convertible into cash; on the other hand, borrowers prefer long-term funding to carry out their projects. If financial intermediaries did not exist surplus agents would not be ready to hold highly illiquid assets to finance borrowers. * Cost reduction is done by financial intermediaries as they are able to reduce costs which are associated with the buying and selling of financial instruments. Due to lower transaction costs financial intermediaries offer lower loan rates relative to direct financing. * Provision of payments system in modern times, financial intermediaries facilitate payments via a number of non-cash means such as cheques, credit/debit cards, electronic transfers and etc, however because of the significance of the payment system for an economy, suitable regulation is needed concerning the activities that financial intermediaries are