Lecture Notes on Banks as Financial Intermediaries

Introduction

• Some individuals aim to save and invest, while others seek to borrow.
• Typically, savers and borrowers do not know each other directly.
• Financial institutions, such as banks, act as intermediaries to connect savers with borrowers.

Role of Banks

• Banks attract savings by paying interest on deposits.
• They provide loans and charge interest, earning a profit from the difference in interest rates.
• Banks function as middlemen, linking savers to borrowers and assessing borrower quality.

Example of Lending

• Scenario: Howard Schultz seeking a $1 million loan to buy Starbucks.
  • Direct lending by a single rich individual poses high risk.
  • Collective lending by 100 people (e.g., $10,000 each) shares the risk.
  • Banks perform due diligence on behalf of depositors, leveraging expertise.

Functions of Banks

• Coordinate the lending of pooled deposits.
• Have specialized personnel and systems for evaluating loan applications.
• Assess and select qualified businesses and individuals for loans.
• Spread risk across a portfolio of loans, minimizing impact of defaults.

Operational Details

• Deposits are actively lent out, not stored in vaults.
• Banks maintain a balance of cash reserves to handle withdrawals.
• Reserves are crucial for bank stability and depositor confidence.
  • Insufficient reserves could lead to bank instability.

Conclusion

• Banks simplify financial transactions and minimize saver risk.
• They facilitate the flow of savings into productive loans, promoting economic growth.
• Upcoming topics include the role of stock markets as financial intermediaries.

Additional Resources

• Visit MRUniversity.com for further videos and resources.