Banks and other financial intermediaries channel capital from savers, who often have short-term liquidity demands, into productive investments that typically require stable, long-term funding. Financial intermediaries work with one another because no single institution can hope to access the full range of available capital and investment opportunities in our complex economy.
Connections among market actors also facilitate risk sharing, which can help minimize (though not eliminate) the uncertainty faced by individual agents. Yet experience – most importantly, our recent financial crisis – as well as a growing body of academic research suggests that interconnections among financial intermediaries are not an unalloyed good.