ABSTRACT This paper compares the optimal lending decisions of financial intermediaries that differ in their risk exposure. All intermediaries are assumed to face a loan demand described by a random applicant arrival process with each applicant offering a unique risk‐adjusted rate of return; loan demand is therefore uncertain in both quantity and quality. The intermediaries differ in terms of their risk exposure because of disparate funding practices. Intermediaries functioning as brokers minimize their exposure by borrowing funds only as demand is realized, whereas those behaving as asset‐transformers borrow in advance of realizing loan demand, thereby maintaining a loanable funds inventory and sustaining the related exposure. The optimal sequential lending policy is shown to involve setting a credit standard that becomes stricter with the length of the intermediary's planning horizon and the volume of loans outstanding. Most importantly, it is shown that brokers adopt stricter credit standards than asset‐transformers and therby reduce their volume of lending.

ABSTRACT The financial intermediary's choice of operating as a broker with minimal risk exposure or as an asset‐transformer with interest rate risk is modeled as a funds inventory decision made prior to the resolution of uncertainty regarding the borrowing or lending interest rates. It is shown that an increase in the interest rate uncertainty leads the intermediary to reduce its exposure, thereby offering decreased asset‐transformation and more brokerage services. However, a stochastic increase in the interest rates leads to greater asset‐transformation and less brokerage services.