A financial intermediary plays a crucial role by acting as the catalyst between two parties in a financial transaction, including entities such as commercial banks, investment banks, mutual funds, or pension funds. These intermediaries offer various benefits to consumers, including safety, liquidity, and the economies of scale inherent in banking and asset management. Despite advances in technology that aim to reduce the need for intermediaries in certain sectors, their role remains pivotal in areas like banking and insurance.
Key Takeaways
- Financial intermediaries serve as middlemen for financial transactions, commonly between banks or funds.
- These intermediaries help cultivate efficient markets and reduce the cost of conducting business.
- Intermediaries can offer services such as leasing or factoring but do not accept public deposits.
- Benefits of financial intermediaries include pooling risk, reducing costs, and providing economies of scale, among others.
The Mechanics of Financial Intermediaries
Non-bank financial intermediaries do not accept deposits from the general public but may offer services such as factoring, leasing, or insurance programs. These intermediaries often partake in securities exchanges and employ long-term strategies to manage and grow their funds. The activities of financial intermediaries and the growth of the financial services industry often reflect the overall economic stability of a country.
Financial intermediaries transfer funds from parties with excess capital to those needing funds. This process encourages efficient markets and reduces the costs of doing business. For instance, a financial advisor might assist clients by connecting them with insurance, stocks, bonds, real estate, and other assets.
Banks link borrowers and lenders by providing capital from various financial institutions, including the Federal Reserve. Similarly, insurance companies collect premiums for policies and provide policy benefits, while pension funds gather contributions on behalf of members and distribute payments to retirees.
Different Types of Financial Intermediaries
Mutual funds provide active management of capital pooled by shareholders. Fund managers connect with shareholders by buying stocks in companies anticipated to outperform the market. This approach provides shareholders with assets, supplies companies with capital, and ensures market liquidity.
Benefits of Financial Intermediaries
Intermediaries allow savers to pool funds, enabling larger investments that benefit the entities they invest in. Additionally, they spread risk across a diverse array of investments and loans to mitigate losses. Loans granted through these intermediaries support household and national spending beyond immediate means.
Financial intermediaries also significantly cut costs on multiple fronts. They leverage economies of scale to assess the creditworthiness of borrowers accurately and keep record-keeping costs low. They also minimize the transactional expenses individual investors would have to bear if no intermediary existed.
Example of a Financial Intermediary
In July 2016, the European Commission introduced two new financial instruments to enhance European Structural and Investment (ESI) fund investments. These instruments aimed to ease funding access for startups and urban development project promoters through loans, equity, guarantees, and other financial tools. By attracting extensive public and private funding, these tools promise continual reinvestment compared to grants.
One such instrument, a co-investment facility, aimed to fund startups to help them develop business models and attract additional financial support. Managed by one main financial intermediary, this facility was projected to attract approximately €15 million (around $17.75 million) per small and medium-sized enterprise.
Related Terms: Commercial Bank, Investment Bank, Mutual Fund, Pension Fund, Leasing, Factoring, Economies of Scale.
References
- European Commission. “Commission Launches Two New Financial Instruments to Boost Investment in Start-Ups and Sustainable Urban Development”.
