Financial Intermediaries
Financial intermediaries assist in the economy by facilitating the flow of funds
between savers and borrowers. These institutions help allocate resources efficiently,
reduce transaction costs, and manage risks. Understanding their functions and types is
necessary for making informed financial decisions.
Functions of Financial Intermediaries
1. Mobilization of Savings
Collects funds from individuals and institutions who have surplus money.
Encourages savings by providing secure and convenient options like bank
deposits.
2. Credit Allocation
Channels funds to individuals, businesses, and governments in need of capital.
Facilitates economic growth by ensuring efficient use of financial resources.
3. Risk Diversification
Spreads risks across multiple investors and borrowers, reducing the impact of
defaults.
Investment firms pool funds to invest in diversified portfolios, minimizing potential
losses.
4. Liquidity Provision
Provides easy access to funds through savings accounts, checking accounts,
and money market instruments.
Helps businesses and individuals manage short-term financial needs.
5. Payment and Settlement System
Facilitates transactions through checks, wire transfers, credit cards, and online
payments.
Ensures the smooth processing of domestic and international transactions.
6. Information Asymmetry Reduction
Conducts due diligence on borrowers and investment opportunities to assess
creditworthiness.
Reduces uncertainty and increases confidence in financial transactions.
Types of Financial Intermediaries
Financial intermediaries can be categorized based on their roles in the financial
system:
1. Depository Institutions
These institutions accept deposits from individuals and businesses and provide loans.
Commercial Banks – Offer savings and checking accounts, loans, credit cards,
and investment services.
Savings and Loan Associations – Specialize in mortgage lending.
Credit Unions – Member-owned cooperatives offering loans and savings
accounts with lower fees.
2. Non-Depository Institutions
These institutions do not accept traditional deposits but provide financial services.
Investment Banks – Help companies raise capital through underwriting
securities, mergers, and acquisitions.
Mutual Funds – Pool money from multiple investors to invest in stocks, bonds,
or other assets.
Hedge Funds – Invest in high-risk, high-return opportunities, often using
leverage and derivatives.
Pension Funds – Manage retirement savings and provide future payouts to
retirees.
Insurance Companies – Offer protection against financial risks such as health
issues, accidents, and property damage.
3. Specialized Financial Institutions
These organizations cater to specific financial needs.
Microfinance Institutions – Provide small loans to low-income individuals or
small businesses.
Finance Companies – Offer consumer and business loans without taking
deposits.
Development Banks – Fund infrastructure and industrial projects to support
economic development.
Discussion Questions
1. Why are financial intermediaries important to the economy?
2. How do banks differ from investment firms in their roles as financial
intermediaries?
3. What risks do financial intermediaries face, and how do they manage them?
