With financial intermediation net lenders can earn a higher

“With financial intermediation, net lenders can earn a higher return on their surplus funds, and net borrowers can acquire funds at a lower cost.” Explain how this seemingly contradictory statement can be true (Hint: Consider a risk-free return).

Solution

Financial intermediation helps decrease the risks connected with lending and borrowing money. Since the financial intermediaries offer more safety and security, the lenders will not have to give up on safety for higher returns and the reduction in risks will thus lower the borrowing rates for the borrowers.