Table of Contents

Financial Intermediaries – Meaning, Role, and Its Importance

Introduction

A financial intermediary is a company or organization that works as a middleman between a service provider and a customer. In a financial context, it is the entity or someone that stands between two or more parties. A financial intermediary, in theory, converts savings into investments. Financial intermediaries exist to make money in the financial system, and their actions must occasionally be regulated. Furthermore, recent trends imply that financial intermediaries’ engagement in savings and investment activities may either be beneficial to an efficient market economy or, as the subprime mortgage crisis has shown, can be harmful.

Financial Intermediaries - Meaning, Role and Its Importance

Financial Intermediation

Financial intermediaries play a role in an economy’s savings/investment cycle by acting as conduits for financing between borrowers and lenders. Intermediaries such as banks and insurance firms play a critical part in the financial system, as banks are projected to account for a large share of all externally funded dollars. Financial intermediaries are a vital source of outside capital for businesses. Unlike the capital markets, where investors directly contract with corporations to create marketable securities, financial intermediaries borrow from lenders or consumers and lend to businesses in need of funds.

Role of the Financial Intermediaries

The distinctiveness of financial intermediaries such as banks and insurance firms is the cause for their all-pervasive character. As previously stated, banks frequently act as “intermediaries” between individuals who have resources and those who want them. Financial intermediaries, such as banks, are asset-based or fee-based, depending on the type of service they provide and the type of customer they serve. Institutions such as banks and insurance firms are asset-based financial intermediaries, whereas fee-based financial intermediaries provide portfolio management and syndication services.

Need for regulation

The complexity of the financial system that we have at this moment makes regulation all the more vital and urgent. Any financial institution cannot be forced to hold the financial system hostage to its dubious business practices, as the subprime mortgage crisis demonstrated. As the effects of the crisis become more evident, and it becomes clear that asset-backed derivatives and other “exotic” products are worth trillions of dollars, the central bank’s or monetary authorities’ involvement in reigning in rogue financial institutions is essential to avoid systemic collapse.

As capital becomes more mobile and unrestricted, monetary authorities must intervene to guarantee that sufficient checks and balances are in place in the system to protect investors and the economy as a whole.

Recent trends

Recent trends in the growth of financial intermediaries, particularly in the developing world, have demonstrated that these institutions may play a critical role in poverty reduction and other debt reduction initiatives. Some measures, such as reaching out to the people with microcredit, have improved the economic well-being of formerly marginalized groups of the population.

Furthermore, financial intermediaries such as banks are maturing into “financial hyper marts,” or umbrella organizations that cater to the entire demands of both investors and borrowers.

Conclusion

As we have seen, financial intermediaries have a key role to play in the world economy today. They are the “lubricants” that keep the economy going. Due to the increased complexity of financial transactions, it becomes imperative for the financial intermediaries to keep re-inventing themselves and cater to the diverse portfolios and needs of the investors. The financial intermediaries have a significant responsibility towards the borrowers as well as the lenders. The very term intermediary would suggest that these institutions are pivotal to the working of the economy and they along with the monetary authorities have to ensure that credit reaches the needy without jeopardizing the interests of the investors. This is one of the main challenges before them.

In a market economy, where the effective allocation of resources is the duty of the market mechanism, financial intermediaries play a critical role. Banks and other financial intermediaries must come up with new and creative goods and services to meet the different demands of borrowers and lenders in today’s increasingly complicated financial system. The efficacy of a financial intermediary is determined by the correct mix of financial products combined with the requirement to reduce systemic risk.

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