Explain what is meant by the term intermediation and identify two types of intermediation that financial institutions utilize.

Financial institutions are intermediaries who act between lenders and borrower. Savings can be moved between investors and savers. In providing this service intermediaries ensure that the resources used are most effective while also earning income for their financial institution.

Financial institutions use two different types of intermediation: direct lending, and indirect lending. Direct lending is when the intermediary gives a loan directly to the borrower, without involving a third-party. The interest rate will be higher than it would be if they were given through another channel such as capital or credit markets. Direct lending involves the intermediary pooling funds together from several savers and depositors, before they are loaned out to a borrower. This method reduces risk because losses in the event of default can be distributed across many parties.