Loan advice

Financial intermediaries obtain funds by issuing financial claims against themselves to market participants and then investing those funds. The investments made by financial intermediaries—their assets—can be in loans and/or securities. These investments are referred to as direct investments. As just noted, financial intermediaries play the basic role of transforming financial assets that are less desirable for a large part of the public into other financial assets—their own liabilities—which are preferred more by the public. This transformation involves at least one of four economic functions: (1) providing maturity intermediation; (2) risk reduction via diversification; (3) reducing the costs of contracting and information processing; and (4) providing a payments mechanism.
Maturity intermediation involves a financial intermediary issuing liabilities against itself that have a maturity different from the assets it acquires with the fund raised. An example is a commercial bank that issues short-term liabilities (i.e., deposits) and invests in assets with a longer maturity than those liabilities. Maturity intermediation has two implications for financial markets. First, investors have more choices concerning maturity for their investments; borrowers have more choices for the length of their debt obligations. Second, because investors are reluctant to commit funds for a long period of time, they will require that long-term borrowers pay a higher interest rate than on short-term borrowing. In contrast, a financial intermediary will be willing to make longer-term loans, and at a lower cost to the borrower than an individual investor would, by counting on successive deposits providing the funds until maturity (although at some risk as discussed below). Thus, the second implication is that the cost of longer-term borrowing is likely to be reduced.
To illustrate the economic function of risk reduction via diversification, consider an investor who invests in a mutual fund. Suppose that the mutual fund invests the funds received in the stock of a large number of companies. By doing so, the mutual fund has diversified and reduced its risk. Investors who have a small sum to invest would find it difficult to achieve the same degree of diversification because they would not have sufficient funds to buy shares of a large number of companies. Yet by investing in the investment company for the same sum of money, investors can accomplish this diversification, thereby reducing risk. This economic function of financial intermediaries—transforming more risky assets into less risky ones—is called diversification. While individual investors can do it on their own, they may not be able to do it as cost effectively as a financial intermediary, depending on the amount of funds they have to invest. Attaining cost-effective diversification in order to reduce risk by purchasing the financial assets of a financial intermediary is an important economic benefit for financial markets.
Investors purchasing financial assets should develop skills necessary to understand how to evaluate an investment. Once those skills are developed, investors should apply them to the analysis of specific financial assets that are candidates for purchase (or subsequent sale). Investors who want to make a loan to a consumer or business will need to write the loan contract (or hire an attorney to do so). While there are  some people who enjoy devoting leisure time to this task, most of us find that leisure time is in short supply, so to sacrifice it, we have to be compensated. The form of compensation could be a higher return obtained from an investment. In addition to the opportunity cost of the time to process the information about the financial asset and its issuer, there is the cost of acquiring that information. All these costs are called information processing costs. The costs of writing loan contracts are referred to as contracting costs. Another dimension to contracting costs is the cost of enforcing the terms of the loan agreement. There are economies of scale in contracting and processing information about financial assets, because of the amount of funds managed by financial intermediaries. The lower costs accrue to the benefit of the investor who purchases a financial claim of the financial intermediary and to the issuers of financial assets, who benefit from a lower borrowing cost.
While the previous three economic functions may not have been immediately obvious, this last function should be. Most transactions made today are not done with cash. Instead, payments are made using checks, credit cards, debit cards, and electronic transfers of funds. These methods for making payments are provided by certain financial intermediaries. The ability to make payments without the use of cash is critical for the functioning of a financial market. In short, depository institutions transform assets that cannot be used to make payments into other assets that offer that property.