What are financial intermediaries? Financial intermediaries are individuals or institutions that act as mediators between two parties to facilitate a financial transaction. They offer a series of benefits to the average consumer, which include security, liquidity, and economies of scale included in commercial banking, investment banking, and asset management.
Financial intermediaries reallocate capital to productive companies that would not otherwise be invested through a variety of debt structures, capital, or hybrid forms.
They allocate the funds of people who have a surplus of capital, called savers, to whom they require liquid funds to be able to carry out some activity, called investors. This can be in the form of loans or mortgages.
Alternatively, the money could be lent directly through the financial markets, thus eliminating the financial intermediary. This is known as financial disintermediation.
The Financial Intermediaries Definition above is the best definition for financial intermediaries you could ever find on the internet, sure these financial intermediaries’ definitions are clear and well understood.
Now that you’ve known what financial intermediaries are or what is financial intermediaries, let us proceed to the importance of financial intermediaries and also the characteristics of Financial intermediaries;
Importance of Financial Intermediaries
Although in certain areas, such as investment, technological advances threaten to eliminate the financial intermediary, disintermediation is a much smaller threat in other areas, such as banking and insurance.
However, in the absence of financial intermediaries, people could not carry out daily transactions, and large companies would have difficulty obtaining funds. That is why it is important to understand how relevant your role is.
Through a financial intermediary, savers can group their funds, allowing them to make large investments.
The general economic stability of a country can be demonstrated through the activities of financial intermediaries.
Characteristics of Financial Intermediaries
Below are the characteristics of Financial intermediaries in bullets and with extensive explanations, get to know the characteristics of Financial intermediaries;
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Reduced risk
Financial intermediaries provide a platform where people with surplus cash can spread their risk by lending to several people, rather than just one. In addition, the borrower is carefully examined and selected, reducing the risk of default.
This same model applies to insurance companies. They collect customer premiums and provide the benefits of the policy if customers are affected by unpredictable events, such as accidents, deaths, and illnesses.
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Regulation
Given the complexity of the financial system and the importance of intermediaries in influencing the life of the public, regulation is necessary. Several past financial crises, such as the “subprime” crisis, have shown that weak regulations could put the economy at risk.
The role of the central bank or monetary authorities is necessary to control dishonest financial intermediaries.
It is the monetary authorities that must ensure that there are adequate balances and controls in the system to avoid losses to investors and the economy in general.
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Scale Economics
Financial intermediaries enjoy economies of scale because they can take deposits from a large number of clients and lend money to multiple borrowers. This helps save time and costs on several fronts.
The practice helps reduce the operating costs incurred in their normal business routines. In addition, they reduce the costs of the many financial transactions that an investor would have to make if the financial intermediary doesn’t exist.
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Economies of scope
Brokers often offer a range of specialized services to customers. This allows you to improve your products to meet the requirements of different types of customers.
For example, when commercial banks lend money, they can customize loan packages to suit large and small borrowers, according to their specific needs.
Similarly, insurance companies enjoy economies of scope by offering insurance packages. It allows products to be improved to meet the needs of a specific category of customers, such as people suffering from chronic diseases or the elderly.
Now we are done with the characteristics of Financial intermediaries, you should note down those points as they are very vital.
Functions of Financial Intermediaries
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Provide loans
Financial intermediaries play the vital role of bringing together those economic agents with surplus funds who wish to lend them, with those entities with a shortage of funds who wish to obtain loans.
In doing so, the manager provides assets to shareholders, capital to companies, and liquidity to the market.
The granting of short and long term loans is one of the main businesses of financial intermediaries. They channel the funds of depositors with surplus cash to entities that are looking for money borrowed.
Borrowers generally apply for loans to buy assets that require a lot of capital, such as commercial premises, cars, and manufacturing equipment.
Intermediaries grant loans at interest, part of which is given to depositors whose funds have been used. The remaining balance of interest is retained as earnings.
Borrowers undergo an evaluation to determine their creditworthiness and their ability to pay off the loan.
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Asset storage
Commercial banks provide facilities for secure storage of both cash (bills and coins) and other liquid assets (precious metals such as gold and silver).
Depositors receive proof of deposit, checks, and credit cards that they can use to access their funds. The bank also provides depositors with the records of withdrawals, deposits, and direct payments that they have authorized.
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Advise on investments
Most financial intermediaries, such as mutual funds and investment banks, employ internal investment specialists who help clients increase their investments.
Companies leverage their experience in the industry and in dozens of investment portfolios to find the right investments that maximize return and reduce risk.
The types of investments range from stocks and real estate to treasury bills and other financial derivatives. The intermediaries invest the funds of their clients and pay them an annual interest for a period of time previously agreed.
In addition to managing client funds, they also provide financial and investment advice to help them choose ideal investments.
Types of Financial Intermediaries
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Banks
Banks are financial intermediaries because they grant loans and have much to do with finances. They are the most popular financial intermediaries in the world. The oldest way in which these institutions act as intermediaries is by connecting lenders and borrowers.
They are licensed to accept deposits, grant loans, and offer many other financial services to the public. They play an important role in the economic stability of a country. Therefore, they face strong regulations.
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Investment funds
They provide active capital management collected by shareholders. They help invest the savings of individual investors in financial markets.
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Pension funds
This type of intermediary is the one used by millions of workers to invest their savings for retirement.
When someone signs up, choose how much will be saved from your salary. All that money is used to buy assets that will perform well.
Once the employee retires, he will get all his contributions, along with any gain earned.
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Insurance companies
Almost all operate in the same way. First, they find a large number of customers who need to obtain some type of coverage, be it automobile, home, or health. Once those customers buy insurance coverage, those funds are added to a large set of money.
When someone needs to make a claim to request a payment, the intermediary will access that set of money.
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Financial advisors
They offer particular advice. They save having to understand all the complexities of financial markets to find the best investment.
They advise investors to help them achieve their financial goals. These consultants generally receive special training.
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Credit cooperatives
They are a type of bank created by a community to provide banking services specifically to that community. They work to serve their members and not the public. They may or may not operate for profit.
They offer personal credit terms using the money that other people deposited as savings. When someone needs a loan, they will receive it, because there are funds that other people made available to the cooperative.
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Stock exchanges
Simplify the long process of buying corporate shares. They act as large platforms where people can place stock orders.
After paying those orders, the stock exchange will use that money to buy the shares of the corporations.
The client obtains his desired assets, while the corporations obtain the funds. They are considered the financial intermediary of the investment world.
Examples of Financial Intermediaries
Below we’ve listed financial intermediaries examples to make this easier to digest, these examples of financial intermediaries are well said;
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Commercial banks
When someone gets a mortgage from a bank, they are being given the money that another person deposited in that bank to save.
Suppose Mrs. Andrea is a housewife, and she deposits her savings in her XYZ bank account every month. On the other hand, Boris is a young entrepreneur who is looking for a loan to start his business. Boris has two options to avail a loan.
The first is to be able to find and convince people who are looking for investment opportunities. The second is to approach the XYZ bank to request a loan.
It can be seen that the first option is uncertain since it will take a long time to find investors. However, the second option is faster and more convenient.
Therefore, the financial intermediary facilitates the processes of lending and borrowing large-scale funds.
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Lenders
Suppose you want to start a textile business and you need $ 20,000 to pay the initial costs. All acquaintances could be asked to lend the money, but there will probably be a few people who would be willing to disburse that amount.
In addition, the process of seeking a random loan consumes both time and energy. It is best to go to a lender to access the funds needed to start the business.
That’s why there are lenders: to help connect those who have money with those who need it.
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European Commission
In July 2016, the European Commission acquired two new financial instruments for investments of the European structural and investment fund.
The objective was to create easier access for financing to developers of urban development projects.
Compared to receiving subsidies, financial intermediation is better as a source of public and private financing, since it can be reinvested for many cycles.
The European Commission projected total investment of public and private resources at $ 16.5 million for small and medium enterprises.
References
- James Chen (2019). Financial Intermediary Investopedia. Taken from: investopedia.com.
- Wikipedia, the free encyclopedia (2019). Financial intermediary Taken from en.wikipedia.org.
- Prateek Agarwal (2019). Financial Intermediaries Intelligent Economist Taken from intelligenteconomist.com.
- Sanjay Borad (2019). Financial Intermediaries – Meaning, Functions, and Importance. Efinance Management Taken from: efinancemanagement.com.
- Top Accounting Degrees (2019). 5 Types Of Financial Intermediaries. Taken from: topaccountingdegrees.org.
- IFC (2019). What is a Financial Intermediary? Taken from: corporatefinanceinstitute.com.
- Chelsea Levinson (2018). What Is the Role of a Financial Intermediary? Bizfluent Taken from: bizfluent.com.
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