Financial intermediaries as facilitators of information exchange between lenders and reputation formation by borrowers

This paper argues that financial intermediation can facilitate exchange of information between lenders which may lead to more efficient credit markets. The idea is that effective exchange of information is impeded if the number of lenders is too large, as is the case if households lend directly. Financial intermediation gets around this difficulty by separating the identity of capital ownership from the identity of lenders. Since each intermediary represents many capital owners, the number of direct lenders (the intermediaries) can be kept small enough for them to share information effectively even when the number of indirect lenders (depositors) is very large.