Role of Financial Intermediaries.
Entities that act as a middleman between two or more individuals for any financial transaction like an investment bank or mutual funds are known as financial intermediaries. The main goal of these intermediaries is to build an efficient market and lower costs for conducting any business. However, intermediaries do not accept any deposits from the public. They provide services like leasing and factoring.
The overall stability of the economy depends on the performance of financial intermediaries and the growth of the financial services industry. They move excess funds from the parties who have excess capital to those parties who need funds. This creates an efficient market with a relatively lower cost of conducting business.
Major financial intermediaries and their Roles:
The main role of any financial intermediary is to take deposits from savers and lend them to borrowers. They also pool small savings and collectively invest those funds in assets like stocks, bonds, or any other financial assets. Further, they provide loans to small consumers and businesses. However, there any many types of intermediaries based on these roles
Insurance Companies – There are different types of insurance companies. Almost all companies work in the same way. First, they try to find customers (in large numbers) who need coverage. It can be for anything such as a car, home, or health policy. After these customers purchase this insurance policy. Then in the future, whenever customers make a claim and request the insurance company a payout, the insurance company will provide it through that pool of money.
Pension Funds – Full-time employees use their savings for their retirement by investing. The pension fund organizations work on certain factors. Such as risk, the period for which investment is made, and matching contributions. Their employer matches that contribution to a certain extent. When the employee retires, they will get all the contributions with interest.
Banks – Banks are the oldest and most trusted financial intermediaries around the world. They provide multiple services to their customers such as saving, investing, and lending with many other customized services to fit specific criteria. For example, when an individual wants to raise a mortgage, then banks may provide money from another person’s deposits into the same bank for saving. Along with small individuals, large companies also prefer banks to help find investors.
Stock exchanges – Before stock exchanges were invented, it was a very tedious process for buying any company’s stocks. But one can use stock exchanges to trade as they facilitate the entire process with transactions.
Benefits of Financial intermediaries:
1. Expertise – Financial intermediaries not only have specialist knowledge but also all resources which are needed to assess the risk. They have the financial expertise to anticipate the profitability of any proposed projects.
2. Value Transformation – Financial intermediaries can help both small and large borrowers at a time. They collect money from small investors and give them to the borrowers who need a large sum of money.
3. Transaction costs are reduced– Financial intermediaries help to reduce overall transaction cost as they provide facilities to a large number of borrowers through which overall transaction is balanced.
4. Risk Diversification – Financial intermediaries ensure that their entire risk is diversified. In case any borrowers have defaulted, it does not affect the savings of other depositors.
5. Easy borrowing – Financial intermediaries ease borrowing by giving them various facilities or options to borrowers. So the borrowers do not require to visit a bank every time.