How do Moral Hazard, Adverse Selection and Asymmetric Information help to explain
Why banking institutions and other financial intermediaries exist?
Introduction:
The character of financial intermediation: a firm that wanted to invest in new scheme or project may not be able to fund all investment from her own resources and in order to solve this issue it will has to resort to borrow to get all or part of needed funds. And also an investor or an individual with excess finance out of his/her current revenue may wish to give as loan these funds so that he|she may gain a benefit.
It would hence sound like logical for corporation or company wishing to get funds try to find the investors who wanting to loan their funds, and vice versa. A bank institution and other financial intermediary usually do this job, I mean the financial intermediaries channel fund from those who have surplus to those who have shortages funds.
Why do people give their money to financial intermediaries to invest it on behalf of them? And why financial intermediaries exist?
http://www.londonexternal.ac.uk/current_students/programme_resources/lse/lse_pdf/foundation_units/prinbank/prinbank_chapter2.pdf
The main aim why investors give their finance or money to financial intermediaries instead of investing the fund by themselves is the risk that they are exposure to from the information asymmetry between the demander of funds and the supplier of those fund (provider and receiver)
It is obvious that a seller knows better about trade item than the buyer does.
Therefore the risk would be taken by the buyer.
Similarly the borrower knows better about his financial circumstances than the lender, for example a firm that sells equity or stock may not put the money invest it in appropriate way.
There are some types of risks which are existing when there is information asymmetry, adverse selection and moral hazard
Adverse selection
Moral hazard
As example, investors...