BMZ ACADEMY
BMZ ACADEMY
@061 262 1185/068 053 8213/0717 513 144
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
, BMZ ACADEMY
2.01 Explain how financial intermediaries reduce transaction costs thereby
allowing small savers and borrowers to benefit from the existence of financial
markets. [10]
Transaction costs, the time and money spent in carrying out financial transactions,
are a major problem for people who have excess funds to lend. However, financial
intermediaries can substantially reduce transaction costs because they have
developed expertise in lowering them and because their large size allows them to
take advantage of economies of scale, the reduction in transaction costs per dollar
of transactions as the size (scale) of transactions increases. Financial intermediaries
can reduce transaction costs through various means and the specific strategies
employed may vary depending on the nature of the financial intermediary and the
market in which it operates.
One of the primary ways is by exploiting economies of scale. By consolidating the
investments of multiple individuals, financial intermediaries can achieve lower costs
per rand of investment. For example, if 100 investors each with R10,000 were to buy
R1,000,000 of bonds together, they would face lower costs per rand compared to if
they were to buy separately.
Transaction costs are the costs associated with finding a lender or a borrower for this
money. Thus, banks lower transactions costs and act as financial intermediaries—
they bring savers and borrowers together. Along with making transactions much
safer and easier, banks also play a key role in the creation of money.
Those who want to borrow money can go directly to a bank rather than trying to find
someone to lend them cash Transaction costs are the costs associated with finding a
lender or a borrower for this money. Thus, banks lower transactions costs and act as
financial intermediaries—they bring savers and borrowers together.
Another way financial intermediaries reduce transaction costs is by offering
standardized terms on which they are prepared to do business. This reduces the
total number of transactions required and provides a more efficient process for
borrowers and lenders.
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
, BMZ ACADEMY
Financial intermediaries also provide expertise and enjoy economies of scale. By
bundling the funds of many investors together, they can reduce transaction costs and
benefit both small and large investors.
Regarding information costs, as savers and investors, it is important to ask how one
comes to know that the financial system will ensure that their money will go to a
sound company and not some fly-by-night operator. How will you make sure that
once the money has been invested in a good company, the managers will not
misuse money? In the real world, borrowers may have private information (e.g. about
their prospects, what they produce, their technology, their managerial staff etc.)
which may not be available to lenders, thus asymmetric information leading to (i)
Adverse Selection: hard to distinguish good borrowers from the bad (ii) Moral
hazard: hard to monitor borrower after loan has been made. These intermediaries
may manage moral hazard problems by monitoring what the borrowers are doing
with the funds they borrowed. They may also reduce the adverse selection by
collecting borrowers’ information and screening the borrowers to check their
creditworthiness.
For example, a bank knows how to find a good lawyer to produce an airtight loan
contract, and this contract can be used over and over again in its loan transactions,
thus lowering the legal cost per transaction. Instead of a loan contract (which may
not be all that well written) costing R500, a bank can hire a topflight lawyer for
R5,000 to draw up an airtight loan contract that can be used for 2,000 loans at a
cost of R2.50 per loan. At a cost of R2.50 per loan, it now becomes profitable for the
financial intermediary to lend the client.
Because financial intermediaries are able to reduce transaction costs substantially,
they make it possible for you to provide funds indirectly to people with productive
investment opportunities. In addition, a financial intermediary’s low transaction costs
mean that it can provide its customers with liquidity services, services that make it
easier for customers to conduct transactions. For example, banks provide
depositors with checking accounts that enable them to pay their bills easily.
In addition, depositors can earn interest on checking and savings accounts and yet
still convert them into goods and services whenever necessary.
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
BMZ ACADEMY
@061 262 1185/068 053 8213/0717 513 144
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
, BMZ ACADEMY
2.01 Explain how financial intermediaries reduce transaction costs thereby
allowing small savers and borrowers to benefit from the existence of financial
markets. [10]
Transaction costs, the time and money spent in carrying out financial transactions,
are a major problem for people who have excess funds to lend. However, financial
intermediaries can substantially reduce transaction costs because they have
developed expertise in lowering them and because their large size allows them to
take advantage of economies of scale, the reduction in transaction costs per dollar
of transactions as the size (scale) of transactions increases. Financial intermediaries
can reduce transaction costs through various means and the specific strategies
employed may vary depending on the nature of the financial intermediary and the
market in which it operates.
One of the primary ways is by exploiting economies of scale. By consolidating the
investments of multiple individuals, financial intermediaries can achieve lower costs
per rand of investment. For example, if 100 investors each with R10,000 were to buy
R1,000,000 of bonds together, they would face lower costs per rand compared to if
they were to buy separately.
Transaction costs are the costs associated with finding a lender or a borrower for this
money. Thus, banks lower transactions costs and act as financial intermediaries—
they bring savers and borrowers together. Along with making transactions much
safer and easier, banks also play a key role in the creation of money.
Those who want to borrow money can go directly to a bank rather than trying to find
someone to lend them cash Transaction costs are the costs associated with finding a
lender or a borrower for this money. Thus, banks lower transactions costs and act as
financial intermediaries—they bring savers and borrowers together.
Another way financial intermediaries reduce transaction costs is by offering
standardized terms on which they are prepared to do business. This reduces the
total number of transactions required and provides a more efficient process for
borrowers and lenders.
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
, BMZ ACADEMY
Financial intermediaries also provide expertise and enjoy economies of scale. By
bundling the funds of many investors together, they can reduce transaction costs and
benefit both small and large investors.
Regarding information costs, as savers and investors, it is important to ask how one
comes to know that the financial system will ensure that their money will go to a
sound company and not some fly-by-night operator. How will you make sure that
once the money has been invested in a good company, the managers will not
misuse money? In the real world, borrowers may have private information (e.g. about
their prospects, what they produce, their technology, their managerial staff etc.)
which may not be available to lenders, thus asymmetric information leading to (i)
Adverse Selection: hard to distinguish good borrowers from the bad (ii) Moral
hazard: hard to monitor borrower after loan has been made. These intermediaries
may manage moral hazard problems by monitoring what the borrowers are doing
with the funds they borrowed. They may also reduce the adverse selection by
collecting borrowers’ information and screening the borrowers to check their
creditworthiness.
For example, a bank knows how to find a good lawyer to produce an airtight loan
contract, and this contract can be used over and over again in its loan transactions,
thus lowering the legal cost per transaction. Instead of a loan contract (which may
not be all that well written) costing R500, a bank can hire a topflight lawyer for
R5,000 to draw up an airtight loan contract that can be used for 2,000 loans at a
cost of R2.50 per loan. At a cost of R2.50 per loan, it now becomes profitable for the
financial intermediary to lend the client.
Because financial intermediaries are able to reduce transaction costs substantially,
they make it possible for you to provide funds indirectly to people with productive
investment opportunities. In addition, a financial intermediary’s low transaction costs
mean that it can provide its customers with liquidity services, services that make it
easier for customers to conduct transactions. For example, banks provide
depositors with checking accounts that enable them to pay their bills easily.
In addition, depositors can earn interest on checking and savings accounts and yet
still convert them into goods and services whenever necessary.
BMZ ACADEMY 061 262 1185/068 053 8213/0717 513 144
