A financial intermediary is an organization

Last Updated: 10 Aug 2020
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A financial intermediary is an organization that raises money from investors and provides financing for individuals, companies and other organizations. A financial intermediary is typically an institution that facilitates the channeling of funds between lenders and borrowers indirectly. That is, savers (lenders) give funds to an intermediary institution (such as banks), and then that institution in turn gives those funds to spenders (borrowers). This may be in the form of loans or mortgages. For corporations, intermediaries are important sources of financing.

Intermediaries are a stop on the road between savings and real investments. The financial intermediaries in turn raise funds, often in small amounts, from individual households. Two important classes of financial intermediaries include mutual funds and pension funds along with Credit unions and Brokerage houses. Financial institutions such as banks and insurance companies are not only financial intermediaries but they also provide other financial services such as loaning out money to individuals and businesses. (Kavels and Arshadi, 1997)

The basic function of financial intermediaries is to provide financial assistance to organizations and individuals. So, financial intermediaries help pool resources from households mostly, and then use these resources issuing them as loans to organizations or invest it in equities. They also contribute in many other ways to our individual well-being and the smooth functioning of the economy. Thus, another important function that emanates from the basic function of issuing cash to businesses is the efficient utilization of one's savings.

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This helps increase the overall economic stability and improves the overall efficiency of the economy. Another important function provided by financial intermediaries is the absorption of risk. These intermediaries issue loans and invest money at their own risk, and are legally liable to pay them back to the initial investors incase of loss. Similarly, incase of mutual funds, risk is reduced by efficient and professional portfolio management which results in a high degree of diversification. Read also how financial intermediaries engage in maturity transformation

The portfolio type varies with respect to how risk-averse or contrary the investor may be. Financial Intermediaries also act as a market for Firm's Assets. Financial intermediaries appear to have a key role in the restructuring and liquidation of firms in distress. In particular, there is rich evidence that financial intermediaries play an active role in the reallocation of displaced capital, meant both as the piece-meal reallocation of assets (such as the redeployment of individual plants) and, more broadly, as the sale of entire bankrupt corporations to healthy ones.

A key part of reorganization under main bank supervision or management is the implementation of a plan of asset sales with proceeds typically used to recover bank loans. (Kavels and Arshadi, 1997) In Germany a function of banks during reorganizations is to "use bank contacts to facilitate a merger with another firm as a means of resolving the crisis". Knowing possible synergies among firms, banks can suggest solutions for the efficient reallocation of assets and of corporate control and that in several countries there is widespread anecdotal evidence, though not quantitative one, on this role of banks.

Healthy firms search around for the displaced capital of bankrupt firms but matching is imperfect and firms can end up with machines unsuitable for them. Financial intermediaries arise as internal, centralized markets where information on machines and buyers is readily available, allowing displaced capital to migrate towards its most productive uses. Financial intermediaries can perform this role by aggregating the information on firms collected in the credit market. The function of intermediaries as matchmakers between savers and firms in the credit market can support their function as internal markets for assets.

Intuitively, by increasing the number of highly productive matches in the credit market, intermediaries increase the share of highly productive second hand users in the decentralized resale market. This improvement in the quality of the decentralized secondary market reduces the incentive of firms to address financial intermediaries for their ability as re-deployers. However, by increasing the number of highly productive matches in the credit market, intermediaries create also wealthy buyers without assets and contribute to decrease the thickness of the decentralized resale market.

This makes the decentralized market less appealing and increases the incentive of firms to use intermediaries as resale markets. (Kavels and Arshadi, 1997) Pension funds may be defined as forms of institutional investor, which collect pool and invest funds contributed by sponsors and beneficiaries to provide for the future pension entitlements of beneficiaries. They thus provide means for individuals to accumulate saving over their working life so as to finance their consumption needs in retirement.

Pension funds have had an important indirect role in boosting the efficiency of the financial systems, by influencing the structure of securities markets. By demanding liquidity, pension funds help to generate it, firstly by their own activity in arbitrage, trading and diversification, secondly via the fact that liquidity is a form of increasing return to scale, as larger markets in which pension funds are active attract more trading, reducing costs and improving liquidity further.

A third effect arises from funds' countervailing power as they press for improvements in market structure and regulation. The major advantage with Pension funds as compared to other funds is that Pension funds are only taxed once when they are redeemed. Another important function of financial intermediaries is to provide investors or potential investors information on the prospects and the performance of different companies.

All in all, financial intermediaries play a very important role in optimizing the performance of firms in the corporate sector and to help individuals and households to manage their savings better and to ensure them minimum and least amount of risk in doing so. BIBLIOGRAPHY 1. Kavels, Gordon V. ; Arshadi, Nasser. (1997). Modern Financial Intermediaries and Markets 1st edition (pp. 31-38). Prentice Hall College Division. (Kavels and

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