Financial Intermediaries — Meaning, Functions and Importance
Financial intermediation is an asset that facilitates financial transactions between two parties. Such an intermediary or intermediary could be a firm or an institution. Some examples of financial intermediaries are banks, insurance companies, pension funds, investment banks and more.
It can also be said that the main purpose of financial intermediaries is to direct savings to investment. These brokers charge a fee for their service.
Financial intermediaries emerged as a useful tool for an efficient market system as they help channel savings into investment. However, these can also be a cause for concern, as the sub-prime crisis shows. Usually there is a need to regulate the activities of these intermediaries.
What are Financial Intermediaries?
- Bank: These intermediaries are authorized to accept deposits, lend loans and provide many other financial services to the public. They play an important role in the economic stability of a country and therefore face heavy regulation.
- Mutual Funds: They help pool the savings of individual investors in the financial markets. A fund manager oversees a mutual fund and allocates the funds to different investment products.
- Financial advisors: These types of intermediaries may or may not offer a financial product, but advise investors to help them achieve their financial goals. These consultants usually undergo special training.
- Credit Union: It is also a type of bank, but works to serve its members and not the public. It may or may not work for profit.
Functions of Financial Intermediaries
- As mentioned earlier, the biggest function of these intermediaries is to turn savings into investments.
- Brokers such as commercial banks provide storage facilities for cash and other liquid assets such as precious metals.
- Giving short and long term loans is a fundamental function of financial intermediaries. These intermediaries accept deposits from organizations with cash surplus and then lend to organizations in need of funds. Brokers, some of which give the loan to depositors with interest, while the balance is kept as profit.
- Another important function of these brokers is to help clients grow their money through investment. Brokers such as mutual funds and investment banks use their experience to offer investment products to help their clients maximize their returns and reduce risks.
Advantages of Financial Intermediaries
- By lending the risk to a few people, they help reduce the risk of an individual who has a cash surplus. They also lower the default risk by thoroughly scanning the borrower.
- They help save time and money. Because these brokers deal with a large number of customers, they benefit from economies of scale.
- As they offer a large number of services, it helps them customize the services for their customers. For example, banks can customize loans for small and long-term borrowers or to their specific needs. Similarly, insurance companies customize plans for all age groups.
- They collect and process information, thus reducing the problem of asymmetric information.
Let’s give a simple example to help us better understand these advantages. Let’s say you need some credit, but you don’t know who has enough money to give you. This means that you are contacting an intermediary who is in contact with those with supplementary benefits.
Possible Problem with Agents
It is possible that a financial intermediary does not spread risk. They can redirect depositors’ funds to programs that provide them (intermediaries) with more profits. Or they may invest money in programs due to mismanagement, which may not be very attractive at the moment.
However, such problems (or problems) can be avoided by intermediaries. Also, after the 2008 crisis, financial intermediaries are faced with increased regulation to ensure they do not exceed their limits.
Reading the above points, it is clear that financial intermediaries play a very important role in the economic development of the country. They play an even greater role in developing countries, including helping the government eradicate poverty and implement other social programs.
However, given the complexity of the financial system and the importance of intermediaries in affecting the public’s life, they are tightly regulated. Several past financial crises, such as the sub-prime crisis, have shown that loose or unbalanced regulations can put the economy at risk.