Financial Intermediaries

Financial Intermediaries Meaning

Financial Intermediaries are institutions or entities that bridge the gap between two parties involved in a transaction, the service provider, and the consumer. Acting as the link between two parties, financial intermediaries facilitate negotiations by providing assurance and liquidity.

Typically, in the world of finance, of the two parties involved, one is a borrower and the other one is a lender. Financial intermediaries broker an agreement between the borrower and the lender, thereby creating efficient markets and lowering the overall cost of finance.

Financial intermediaries in stock market

For example, a stock exchange, as a financial intermediary, acts as the strongest link between a retail investor and a company raising finance from the public.

Financial Intermediaries examples

Financial intermediaries examples include bank, brokers, stock market, insurance companies, depository participants, and clearing houses

Financial Intermediaries Role and Characteristics

  • The major role played by financial intermediaries is that of converting and channelizing savings into investments
  • Provide a source of finance for corporations, institutions, and individuals
  • Wealth creation by providing the parties with a platform to grow their investments and providing prudent investment advice
  • Provide liquidity by enabling quick conversion of assets or securities into cash
  • Offer storage of assets

Benefits of Financial Intermediaries

  • By catering to a large client base, financial intermediaries work on the law of large numbers and spread the risk across their clients’ base. This lowers the systemic risk in an economy by keeping the default risk under check.
  • Financial intermediaries, while offering their services on a widespread basis, offer economies of scale which convert into cost reduction for all the parties involved. The operational costs serviced per client is reduced.
  • Some financial services have developed a one-stop-shop for their clients. For example, an insurance plan provider will advertise plans for all age groups, spanning across numerous products.
  • Financial intermediaries lead to efficient markets by facilitating a smooth flow of information and increasing formalization.

Financial Intermediaries Types

Intermediary Description Parties involved Method of Generating Profit
Banks Institutions that accept deposits from the public, and lend toward loans Depositors and Borrowers Net interest income
Investment Banks Cater to large corporations with complex corporate transactions and deals, such as M&A; raise capital for such corporations Large businesses and Investors Investment banking fee arrangements
Credit Unions Co-operative banks which only lend to their members at a competitive rate Credit union members No profit motive
Pension Funds Pooled investment funds which look after the retirement needs of the employees Employees are the beneficiaries Fund management fees
Insurance Companies Risk reduction for the mass public; law of large numbers invoked where the risk of a claim is spread over the number of people Insurance companies provide claims in return for premiums from the insured Premium minus claims
Mutual Funds Pooled investment funds which provide capital appreciation and income generation for their unitholders Unitholders of the fund Fund management expenses (Expense Ratio)
Stock Exchanges Facilitate listing of shares of large corporations; shares can be bought or sold on the stock exchange; bonds and other assets are also traded on the exchange Buyers and sellers on the stock exchange Transaction fees and interest rates
Clearing Houses Handle the final settlement of a trade and impose margin requirements Buyers and sellers trading in future markets  
Financial Advisors Professionals that carry out financial planning and make investments on behalf of the client Clients and markets Investment management fees
Dealers Maintains inventory to provide liquidity and brokers agreement Buyers and sellers in the market Agency fees and commission

Financial Intermediaries in capital markets

Financial Intermediaries in the capital markets are highly regulated to ensure that the interests of the investors are protected. In the Indian capital markets, financial intermediaries include brokers, depository participants, banks, and clearing houses, and they are regulated by SEBI and the RBI.

Source: Tavaga Research

Financial intermediaries face the risk of disintermediation with technology evolving at such a rapid rate. For example, intermediaries in the arena of investments are facing the risk of developing artificial intelligence. However, banks and insurance companies are presently not threatened by redundancy.