Why are economies of scale important in the financial

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Why are economies of scale important in the financial industry? As the number of lenders and borrowers of a financial intermediary increases the cost of serving each new customer will decline. As banks take more deposits the average cost of servicing each deposit will decline. The building, staff, computers, and equipment of the bank all have costs. The more depositors that a bank has, then the lower are the average costs of servicing each deposit. The costs of hiring lawyers to write debt contracts may be high for a single loan. The more loans an institution makes, then the more it can spread out the legal costs of writing debt contracts for these loans. It is likely that the same type of contract can be used over and over again. Similarly, loan officers have to be trained in processing loans. The more loans made the lower will be the average cost of training for each loan. Mutual funds also employ economies of scale to reduce the average costs of investment. By pooling their funds into one institution, they can buy larger quantities of securities, reducing the average costs of researching and purchasing stocks and bonds for the 71
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Econ 350 U.S. Financial Systems, Markets and Institutions Class 8 individual investor. Another way that mutual funds (and other financial intermediaries) can help to reduce transactions costs is through the development of expertise. Expertise: Knowledge gained through experience. Financial intermediaries are able to develop expertise in many ways. Banks may specialize in certain forms of lending, such as consumer loans, or certain types of industry, such as agriculture or maritime. They gain the knowledge to be able to safely and profitably provide financial services to these areas. They can learn to interpret credit scores and bond ratings. Once upon a time, they could gain personal knowledge of their customers through long-term relationships with local residents. They can gain experience in business lending as practice enables them to weed out the best business loans. Mutual funds can develop expertise by hiring analysts and researchers to select the best investments for the risk profiles of their members. Mutual funds often specialize in different instruments or industries, and can gain knowledge of profitable investment opportunities. They also can offer their members information such as investment advice and forecasts, and liquidity services such as check-cashing privileges and savings accounts. These all help to lower the transactions costs of participating in securities markets for small investors. Figure 8-2 Retail Money Funds 1970-2010, Component of M2 Many mutual funds invest in the retail money market. As shown in Figure 8-2, retail money funds did not exist before 1972, and then began to grow quickly in the 1980s and 1990s. During the last two recessions retail money funds declined.
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