Financial Intermediary

What is a Financial Intermediary?

The process performed by banks of taking in funds from a depositor and then lending them out to borrower. The banking business thrives on the financial intermediation abilities of financial institutions that allow them to lend out money at relatively high rates of interest while receiving money on deposit at relatively low rates of interest.

For example, say you want to start a textile business and you happen to need $20,000 in startup costs. You could go around asking everyone you know to loan you the money , but there are probably few people in your life who would be willing to fork over such a sum.plus, the process of randomly looking for a loan is consuming both your time and energy.Most likely, you will go to a lender to access the funds you need to get your business going.This is why lenders exit to help connect those who have money with those who need it.

Functions of Financial Intermediaries

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 client maximize returns and reduce risks.

Example of Financial intermediaries

Several different types of financial intermediaries serve different function in the economy. These are a few of the most popular examples of financial intermediaries.

Commercial banks.
Investment banks.
Insurance companies.
Credit unions.
Financial advisors.
Pension funds.
Mutual funds.

Financial intermediaries are an important part of the economy.They are used by nearly everyone, from consumers to business to government entities.

Advantage of Financial Intermediaries

1. 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.
2. They help in saving time and cost.Since these intermediaries deal with a large number of customers, they enjoy economies of scale.
3. They accumulate and process information, thus lowering the problem of asymmetric information.

Disadvantage of Financial Intermediaries

1. Low Returns on Investment:The ultimate aim of the financial intermediaries is to earn a profit and therefore they usually provide a low rate of interest on the investment made by the depositors.
2. Opposing Goals:The goals of the investors and the financial intermediaries may not complement each other, and therefor the objective of one may not be achieved.
3. Fees and Commissions:These intermediaries impose charge, fees and commission on the financial assistance they provide to their customers.
4. High Interest on loan:These financial intermediaries charge  a high rate of interest on the loan provided to the borrowers to earn a  profit.

 More Details