Corporate Finance & Accounting

financial intermediary

What is a financial intermediary?

A financial intermediary is an entity that acts as an intermediary between two parties in a financial transaction, such as a commercial bank, investment bank, mutual fund or pension fund. Financial intermediaries offer the average consumer many benefits, including the security, liquidity, and economies of scale involved in banking and asset management. While technological advances have the potential to eliminate financial intermediation in some areas, such as investing, in other areas of finance, including banking and insurance, the threat of disintermediation is much smaller.

key takeaways

  • Financial intermediaries act as middlemen in financial transactions, usually between banks or funds.
  • These intermediaries help create efficient markets and reduce the cost of doing business.
  • Intermediaries can provide leasing or factoring services, but do not accept deposits from the public.
  • Financial intermediaries provide benefits such as sharing risks, reducing costs and providing economies of scale.

How Financial Intermediation Works

Non-bank financial intermediaries do not accept deposits from the public. Intermediaries can provide factoring, leasing, insurance plans or other financial services. Many intermediaries participate in stock exchanges and utilize long-term plans to manage and develop their funds. The overall economic stability of a country can be reflected through the activities of financial intermediaries and the development of the financial services industry.

Financial intermediaries move funds from those with excess capital to those in need. This process creates efficient markets and reduces the cost of doing business. For example, financial advisors connect with clients by purchasing insurance, stocks, bonds, real estate, and other assets.

Banks connect borrowers and lenders by providing funds from other financial institutions and the Federal Reserve. Insurance companies collect premiums for policies and provide policy benefits. Pension funds collect funds on behalf of members and distribute payments to pensioners.

Types of Financial Intermediaries

Mutual funds actively manage the capital pooled by shareholders. A fund manager connects with shareholders by buying shares in companies he expects to outperform the market. By doing so, managers provide assets to shareholders, capital to companies, and liquidity to markets.

The benefits of financial intermediation

Through financial intermediaries, depositors can pool their funds, enabling them to make substantial investments, which in turn benefit the entities in which they invest. At the same time, financial intermediaries share risk by spreading funds across various investments and loans. Loans benefit households and countries by enabling them to spend more money than they currently do.

Financial intermediation also offers the benefit of reducing costs in several ways. For example, they can leverage economies of scale to professionally assess the credit profile of potential borrowers and maintain records and profiles in a cost-effective manner. Finally, if financial intermediaries do not exist, they reduce the cost of many financial transactions that individual investors must conduct.

example of financial intermediary

In July 2016, the European Commission adopted two new financial instruments for European Structural and Investment (ESI) fund investments. The goal is to create easier access to funding for start-ups and promoters of urban development projects. Loans, equity, guarantees, and other financial instruments attract more public and private funding sources that can be reinvested over multiple cycles than grants.

One such vehicle is the Co-Investment Vehicle, which aims to finance start-ups through a collective investment scheme managed by a major financial intermediary to develop their business models and attract additional financial support. The European Commission estimates a total investment of around 15 million euros (approximately US$17.75 million) from public and private resources per SME.

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