What is a financial intermediary?
Financial intermediaries can be defined as a middleman between two different parties conducting a financial transaction. For example, Buying stock from a brokerage firm makes the brokerage firm the financial intermediary. Commercial banks, investment banks, stock exchanges, credit unions, pension funds, and mutual funds are the example of financial intermediaries.
Simply put, financial intermediaries transfer funds from individuals or corporations who have excess capital to other individuals or corporations who need cash to carry out certain economic activities.
How do financial intermediaries work?
A non-bank financial intermediary does not take deposits from the public. Instead, it offers different types of financial services such as leasing, factoring, insurance plans, or other financial products. A lot of financial intermediaries participate in securities markets and have long-term strategies for managing and growing their assets. The financial service sector’s development and the activities of financial intermediaries may indicate a country’s economic stability.
Financial intermediaries take funds from those who have excess capital to those who are in need of funds. This creates efficient markets and reduces the cost of doing business. For instance, a financial advisor helps clients buy insurance, bonds, stocks, real estate, and other assets.
Banks bridge the gap between borrowers and lenders by obtaining capital from other financial institutions and the Federal Reserve. Insurance companies accumulate premiums for policies and allot policy benefits.
Benefits of financial intermediaries
Spreading risks: Financial intermediaries spreads the risk by lending the money to various borrowers rather than lending it to only one.
Economies of scale: Financial intermediaries reduce operating costs by accepting funds from many of their customers and then lending funds to many borrowers. They save lots of money doing this practice to lower the overall operating costs than they sustain in regular business routines.
Economies of scope: Financial intermediaries offer variety of specialized financial products and services to their clients. It helps them to tailor their products according to the different needs of their clients. For instance, commercial banks lend money, and they can create loan packages that fit small to large borrowers. Generally, small and medium enterprises are the majority of borrowers. I.e., by designing packages that match their needs, banks can expand their customer base