Financial intermediaries

Financial intermediaries

? Definition

? A financial intermediary is an institution bringing together providers and users of finance, either as broker or as principal.

? A financial intermediary links lenders with borrowers, by obtaining deposits from lenders and then relending them to borrowers.

ACCA

? Examples of financial intermediaries

? Commercial banks

? Finance houses

? Mutual societies

? Institutional investors eg pension funds and investment funds

? The benefits of financial intermediation

? They provide obvious and convenient ways in which a lender can save money.

Instead of having to find a suitable borrower for their money, the lender can deposit their money with a financial intermediary. All the lender has to do is decide for how long they might want to lend the money, and what sort of return they require, and they can then choose a financial intermediary that offers a financial instrument to suit their requirements.

? Maturity transformation

A bank can make a 10-year loan (long-term) while still allowing its depositors to take money out whenever they want; They bridge the gap between the wish of most lenders for liquidity and the desire of most borrowers for loans over longer periods.

? Aggregation of funds

They can aggregate smaller savings deposited by savers and lend on to borrowers in larger amounts.

? Risk for individual lenders is reduced by pooling (risk pooling/ transforming risk)

Since financial intermediaries lend to a large number of individuals and organisations, any losses suffered through default by borrowers or capital losses are effectively pooled and borne as costs by the intermediary. Such losses are shared among lenders in general.

? Give investors access to diversified portfolio