Financial Intermediaries: Definition, Importance & Function
Financial intermediaries are the middlemen of the financial world. In this guide, we’ll discuss everything you need to know about them.
If you send a payment or get paid, you’ll encounter a financial intermediary of some kind. Unless someone is directly paying you with cash in hand, there’s always a middleman.
The financial intermediary is that middleman. It’s an important accounting concept to understand.
Here’s What We’ll Cover:
What Is a Financial Intermediary?
A financial intermediary is an institution that acts as the go-between for financial transactions. This could be a bank, pension fund or mutual fund. The term “financial intermediary” is often more commonly used when speaking about lenders and borrowers. The lender has a cash surplus. The borrower has a cash deficit. The financial intermediary stands in between facilitating the financial transactions between the two.
What Do Financial Intermediaries Do?
There are financial intermediaries that aid with investments. These are mostly mutual funds, pension funds and investment banks. They take the funds of the individual or entity and work to grow investments.
Many of these investing intermediaries have investing specialists on the types of investments. It could be stocks, real estate, assets etc.
Commercial banks are the best example of a financial intermediary that provides asset storage. Cash is an asset. Gold and silver are assets too. These can all be stored by a commercial bank on behalf of the depositor.
The bank will give the depositor a deposit slip, credit card or cheques to access the funds they’ve deposited. Likewise, the bank will keep a record of the withdrawals, deposits and payments that the depositor makes on the account. The intermediary is essentially the controller of the flow of money and keeps record of all transactions.
Financial intermediaries mostly make their money from lending services. They capitalise on the interest rates of advanced short-term loans and long term loans.
Banks have many depositors with a surplus of money. They use those funds to lend money to those in cash deficit. The borrowers go to pay the money back, some goes back into the depositor accounts. The rest of the interest is profit for the intermediary. This is the core of their business.
What Are The Benefits of Financial Intermediaries?
- Range of services
The fancy term for this is economy of scope. A financial intermediary has the ability to create specialised services for all types of lenders and borrowers. They can create packages for large borrowers, like medium to large corporations. Likewise, they can offer loan products to students and small business owners that are smaller in scale.
- Economies of scale
A financial intermediary has the ability to facilitate financial transactions between multiple individuals. Operating costs are relatively low. Financial institutions are able to keep large assets liquid for borrowers. This is because of their access to many depositors.
- Diluting/spreading risk
The economies of scale and scope principles enable banks to spread the lending risk between many individuals.If your brother borrows £100 from you, you assume 100% of the risk that he won’t pay that back. If your brother borrows £100 from a bank, that risk is potential spread through millions of accounts. This dilutes the risk dramatically.
Types of Financial Intermediaries
Banks are financial intermediaries that are licensed to accept deposits from the general public. They can also provide lending products to any number of borrowers. They are highly regulated by the government. They are also a key piece of the economic stability of any country.
- Credit unions
Credit unions or building societies are similar to banks but are “member-owned”. They care more about providing services to their members than profits. Therefore you can get favourable rates from credit unions.
- Mutual funds
Mutual funds are savings pools that individual investors participate in. The fund manager will determine the most lucrative investment opportunities. They’ll then invest the money on the investors’ behalf.
Financial intermediaries make financial transactions smoother. They are a key part of the financial landscape.
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