(d) Theory on “Finance” and “Financial Intermediaries”

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Reforms in China’s Monetary Policy
funds intermediation, and “financial sector” is the aggregate of institutions 
and individuals that support the flow of funds or serve as intermediaries in 
that process. The funds here can be either real fund (namely the fund in 
lendable funds theory) or nominal fund (the fund referred to by ordinary 
people in daily life) (Luo, 2000). “Financial intermediaries borrow funds 
from lenders—depositors, and then underwrite loans to borrowers—payers, 
serving as an intermediary.” This leads to theories of the direct finance and 
the indirect finance. “Direct financing means that borrowers borrow funds 
from lenders directly in the financial market, and indirect financing means 
that financial intermediaries stands in between, assisting in the fund trans-
fer” (Mishkin, 1995). “The chain of indirect financing consists of three 
parties: the depositor, the financial institutions (banks) and the borrower. 
In deposit transactions, the lenders are people or entities that have extra 
money (depositor) and borrowers are financial institutions (banks). In the 
loan transactions, lenders are banks, and borrowers are people or entities 
that lack money (enterprise)” (Han, 2000). 
For the nonbank public, there are people who have excess funds and those 
who lack money, but the relationship between these two groups of people and 
banks is not as follows:
people with excess money
→ banks → people lacking money
Instead, it should be as Figure 1.2 illustrates.
In “direct financing,” people with excess money lend money to those who 
need it, and banks only serve as payment channels. In the “indirect financing,” 
economic transactions occur among the three parties, but instead of lending 
the deposits of people with excess money to those who lack it, banks make 
loans directly. Bank’s lending activity, which creates money, is only restricted by 
the required reserves and has nothing to do with the balance of deposits held 
by the bank. Therefore banks’ lending activity, which provides money to those 
who lack it, is not constrained by the relationship between banks and those 
who have excess money. At the same time, the deposit asset of those who have 
Banks
people with excess money
people lacking money
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