Functions of Financial Intermediaries

A financial intermediary is an entity that acts as the
middleman between two parties in a

financial transaction, such as a commercial bank, investment banks, mutual funds and pension
funds. Financial intermediaries offer a number of benefits to the average consumer, including
safety, liquidity, and economies of scale involved in commercial banking, investment
banking and asset management.
A non-bank financial intermediary does not accept deposits from the general public. The
intermediary may provide factoring, leasing, insurance plans or other financial services.
Financial intermediaries have emerged as a useful tool for the efficient market system as they
help channelize savings into investment. However, they can also be a cause of concern, as the
sub-prime crisis shows. Often, there is a need to regulate the activities of these intermediaries.
FUNCTIONS OF FINANCIAL INTERMEDIARIES
Financial intermediaries move funds from parties with excess capital to parties needing funds.
The process creates efficient markets and lowers the cost of conducting business. For example,
a financial advisor connects with clients through purchasing insurance, stocks, bonds, real
estate, and other assets. Banks connect borrowers and lenders by providing capital from
other financial institutions and from the Federal Reserve. Insurance companies collect
premiums for policies and provide policy benefits. A pension fund collects funds on behalf of
members and distributes payments to pensioners.
 As said before, the biggest function of these intermediaries is to convert savings into
investments.
 Intermediaries like commercial banks provide storage facilities for cash and other liquid
assets, like precious metals.
 Giving short and long term loans is a primary function of the financial intermediaries.
These intermediaries accept deposits from the entities with surplus cash and then loan them to
entities in need of funds. Intermediaries give the loan at interest, part of which is given to the
depositors, while the balance is retained as profits.
 Another major function of these intermediaries is to assist clients to grow their money
via investment. Intermediaries like mutual funds and investment banks use their experience to
offer investment products to help their clients maximize returns and reduce risks.
BENEFITS OF FINANCIAL INTERMEDIARIES
Through a financial intermediary, savers can pool their funds, enabling them to make large
investments, which in turn benefits the entity in which they are investing. At the same time,
financial intermediaries pool risk by spreading funds across a diverse range of investments and
loans. Loans benefit households and countries by enabling them to spend more money than
they have at the current time.
Financial intermediaries also provide the benefit of reducing costs on several fronts. For
instance, they have access to economies of scale to expertly evaluate the credit profile of
potential borrowers and keep records and profiles cost-effectively. Last, they reduce the costs
of the many financial transactions an individual investor would otherwise have to make if the
financial intermediary did not exist.
ADVANTAGES OF FINANCIAL INTERMEDIARIES
 They help in lowering the risk of an individual with surplus cash by spreading the risk via
lending to several people. Also, they thoroughly screen the borrower, thus, lowering the default
risk.
 They help in saving time and cost. Since these intermediaries deal with a large number
of customers, they enjoy economies of scale.
 Since they offer a large number of services, it helps them customize services for their
client. For instance, banks can customize the loans for small and long term borrowers or as per
their specific needs. Similarly, insurance companies customize plans for all age groups.
 They accumulate and process information, thus lowering the problem of asymmetric
information.
Let us consider a simple example that will help us understand these advantages better. Suppose
you need some loan, but you don’t know who has enough money to give you. So, you contact a
middleman, who in turn is in contact with those with surplus money.
EXAMPLE OF A FINANCIAL INTERMEDIARY
In July 2016, the European Commission took on two new financial instruments for European
Structural and Investment (ESI) fund investments. The goal was creating easier access to
funding for startups and urban development project promoters. Loans, equity, guarantees and
other financial instruments attract greater public and private funding sources that may be
reinvested over many cycles as compared to receiving grants.
One of the instruments, a co-investment facility, was to provide funding for startups to develop
their business models and attract additional financial support through a collective investment
plan managed by one main financial intermediary. The European Commission projected the
total public and private resource investment at approximately $16.5 million per small- and
medium-sized enterprise.
Bank: These intermediaries are licensed to accept deposits, give loans and offer many other
financial services to the public. They play a major role in the economic stability of a country,
and thus, face heavy regulations.
Mutual Funds: They help pool savings of individual investors into financial markets. A fund
manager oversees a mutual fund and allocates the funds to different investment products.
Financial advisors: Such intermediaries may or not offer a financial product, but advises
investors to help them achieve their financial objectives. These advisors usually undergo special
training.
Credit Union: It is also a type of bank, but works to serve its members and not public. They may
or may not operate for profit purposes.
A POTENTIAL ISSUE WITH INTERMEDIARIES
It is possible that a financial intermediary may not spread risk. They may channel depositor’s
funds to schemes that earn them (intermediaries) more profits. Or, due to poor management,
they may invest money in schemes, which may not be so attractive now.
Such issue (or issues) with the intermediaries, however, are avoidable. Moreover, after the
2008 crisis, financial intermediaries are facing increased regulations to ensure that they don’t
overreach their limits.
Financial intermediaries play a very important role in the economic development of the
country. They play even bigger role in the developing countries, including helping the
government to eliminate poverty and implement other social programs.
FIVE SERVICES PERFORMED BY FINANCIAL INTERMEDIARIES
 They pool individual funds together

 They provide safekeeping, accounting and access to payment systems
 They provide liquidity
 They reduce risk by diversifying their investments.
 They collect & process information, thereby reducing the problem of asymmetric
information.
https://www.investopedia.com/terms/f/financialintermediary.asp
https://efinancemanagement.com/sources-of-finance/financial-intermediaries
https://www.intelligenteconomist.com/financial-intermediaries/

Functions of Financial Intermediaries

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Functions of Financial Intermediaries

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A financial intermediary is an entity that acts as the

middleman between two parties in a

BENEFITS OF FINANCIAL INTERMEDIARIES

ADVANTAGES OF FINANCIAL INTERMEDIARIES

EXAMPLE OF A FINANCIAL INTERMEDIARY

A POTENTIAL ISSUE WITH INTERMEDIARIES

FIVE SERVICES PERFORMED BY FINANCIAL INTERMEDIARIES

 They pool individual funds together

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