A loan is a
for the borrower.
is a financial claim
owed by a person or a business.
The purpose of the Financial System is to match savers and borrowers through two channels:
Banks and other financial intermediaries
is a financial firm that borrows funds from savers and lends them to borrowers,
during this process increased capital is created in the system through the form of interest, and other
mechanisms. A bank is an example of a financial intermediary, and the most important financial
intermediary is a commercial bank.
To be a bank, the financial institution must perform two functions:
must take deposits, and make loans.
National Banks in the U.S. receive a 'charter' f
rom the Comptroller
of the Currency to function as a bank.
are the place where buyers and sellers, lenders and borrowers come together to facilitate
a transaction involving money.
There are two types of cash flows, or flow of funds that are characteristic
of financial markets:
Indirect Finance and Direct Finance.
is an easier concept to understand, so let's start there.
Your author tells you that direct finance is where funds flow directly from savers to borrowers, but what
does that really mean?
Your next-door neighbor comes to you and asks to borrow money to start a landscaping business.
of all the reason you should or should not lend your neighbor the money.
In Finance, the biggest reason is
the uncertainty of the outcome.
Will you get the money back? When? How much interest should you
charge? Can you get more interest if you invested somewhere else? What happens if your neighbor defaults
and does not pay you back?
The risk of loss falls on you
are you able to bear that risk?
you put the money in a bank or other financial intermediary, and you earn interest
because you are lending money into the Financial System through an intermediary, a bank.
The risk of loss
if your next-door neighbor does not pay the money back remains with the bank.
While the bank uses your
money as a lender, and everyone else's money that is deposited in their bank to make the loan to your
neighbor, the bank receives the interest, because they took the risk of loss, and your money is secure.
Figure 1.1 Moving Funds through the Financial System illustrates the concepts of direct and indirect
Also, read the 'Making the Connection: The Rise of Peer to Peer Lending and Fintech' and ask yourself the
who bear the risk of loss, and how do we as lenders identify the risks.
IIB. Nonbank Financial Intermediaries
Nonbank financial intermediaries are financial institutions that do not perform the two functions to be
classified as a bank.
Thrift institutions are an example of a nonbank financial intermediary, included in this
category are savings and loan associations, savings bank, and credit unions.
While thrift institutions appear