Answer to Question 1
Depository institutions create liquidity, lower costs of obtaining funds, lower costs of monitoring borrowers, and pool risk. They create liquidity because they create assets that can be easily converted into money. Indeed, some of their deposits are money itself They lower the costs of lending and borrowing funds. If you have funds to loan, rather than searching for a borrower, you can simply deposit the funds in a financial firm. Similarly, if you want to borrow funds, rather than searching for someone with funds to loan, you can simply borrow from a financial firm. Depository institutions also lower the cost of monitoring borrowers because these firms specialize in this activity. Finally, depository institutions pool risk and thereby lower the average risk of loaning funds. In other words, by lending to a large number of firms and individuals, a bank lowers the average risk it faces because it knows that only a small fraction of the large number of loans won't be repaid.
Answer to Question 2
C
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