<i>Explain how financial intermediation exposes banks to risk and explain what those risks are.</i><br/><br/>Financial <del>intermission</del> <ins>intermediation</ins>involves asset transformation <del>wherepie</del> whereby intermediares mismatch the liabilities owed and assets owned in terms of duration, size and liquidity. This mismatch leads to the intermediary facing several types of risk: interest rate risk, <del>market risk</del>, credit risk and liquidity risk. Two other risks faced by a bank <ins>are</ins>market risk and operational risk but these simply result from trading <ins>and operating</ins>.<br/>Interest rate risk has two effects: the market effect and the income effect. Only the income effect results <ins>from</ins>financial intermediation, which is further broken down into two scenarios: the assets of a bank having a greater duration than its <del>assets</del> <ins>liabilities</ins>or the the liabilities of a bank having a greater duration than its assets. The former results in <del>repotato-ing risk</del> reinvestment risk which is the risk that assets (loans) may be re-invested at a rate <del>higher</del> <ins>lower</ins>than existing liabilities (deposits). The latter results in refinancing risk which is just the opposite.<br/>Credit risk is the risk that a <del>loan</del> borrower defaults and that none <ins>or only a part</ins>of the banks liabilities are recouped.<br/>Liquidity risk is the risk arising from a mismatch in <del>socks</del> <ins>duration</ins>. It is the risk that a bank is not able to liquidify its assets in time to pay its liabilities and <del>will definetely</del> may default.
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