What is a Financial Intermediary?

A financial intermediary refers to a company or an individual who links two other parties involved in a financial transaction. For example, a Bank, a mutual fund, or another entity could be involved, with one side serving as the lender and the other as the borrower.

How do Financial Intermediaries Work?

Banks, insurance firms, credit unions, stock exchanges, mutual fund companies, and building societies are all examples of financial intermediaries. Banks offer well-known financial services such as Investing and borrowing money.

Depositors invest money at a lower interest rate than borrowers. The difference between these rates is how the bank makes money. Non-banking financing companies (NBFCs) provide loans as well, but at a considerably higher rate than banks.

Mutual fund providers pool numerous funds and offer investors investment options based on their budget and risk tolerance. Shares, Bonds, and other investment alternatives are available through these funds. Stock exchanges make stock trading and other trade operations easier. Each transaction made through mutual fund firms and stock exchanges is subject to a commission or Brokerage Fee.

Credit unions and building societies, for example, were established to provide financial assistance to their members. Individuals and businesses can purchase insurance from Insurance companies to protect themselves from risk and uncertainty, such as fire, death, illness, and business loss. Investment banks help with mergers and acquisitions, initial public offerings, and other services.

Financial Intermediaries' Functions

The following are some of the responsibilities of a financial intermediary:

1. Storage of Assets

Commercial banks store currency (notes and coins) and various precious metals like gold, silver, etc., in a secure environment. Depositors are given deposit cards, cheques, deposit slips, and credit cards with which they can access their money. The bank also keeps track of the deposits, withdrawals, and direct payments that depositors have authorized.

2. Providing Loans

The fundamental business of financial intermediaries is advancing short- and long-term loans. They transfer funds from depositors with excess cash to others who need to borrow money. Borrowers generally use loans to buy Capital-intensive items like commercial properties, automobiles, and equipment related to factories. The loans are advanced with interest, which is paid to the depositors whose funds were utilized. The remainder of the interest is kept as profit. Borrowers are subjected to a credit check to verify their creditworthiness and ability to pay back the loan.

3. Investments

Some financial intermediaries, like, Mutual Funds or investment banks, have In-House investment specialists that assist clients in growing their portfolios. The firms use their extensive Industry knowledge and numerous investment portfolios to identify the best investments for maximizing profits while minimizing risk. Stocks, Treasury notes, Real Estate, and financial derivatives are all examples of investments. Intermediaries sometimes invest their clients' money and pay them interest annually for a set time. They manage client assets and offer investment and financial advice to assist them in making the best investment decisions.

Financial Intermediaries' Advantages

Here are some advantages of a financial intermediary:

1. Spreading Risk

They provide a platform for people with extra Income to diversify their risk by lending to multiple people rather than just one. Lending to a single person entails a greater level of risk. Institutions can lend to a variety of vetted borrowers by depositing surplus funds with a financial intermediary. As a result, the risk of loss due to Default is reduced. The same model for risk reduction is followed by insurance companies. Client premiums are collected, and policy benefits are provided if clients are affected by unforeseeable events such as death, accidents, or disease.

2. Economies of Sale

Financial intermediaries benefit from Economies of Scale because they can accept deposits from a significant number of consumers and lend money to many borrowers. The approach aids in lowering their overall operating costs in their typical business operations. Unlike individuals with Insufficient Funds to loan the required amount, financial institutions have access to significant sums of liquid cash that they can lend to people with Good Credit.

3. Economies of Scale

Intermediaries frequently provide clients with a variety of specialized services. This allows them to improve their products to meet the needs of all types of customers. For example, when commercial banks lend money, they can tailor loan packages to suit small and large clients. This is because small and medium-sized businesses make up the majority of borrowers. As a result, banks can expand their customer base by preparing packages that meet their needs. Insurance businesses, too, benefit from economies of scale when it comes to Offering insurance packages. It enables them to improve their products and services to meet the demands of a specific consumer group, such as those with chronic illnesses or senior citizens.