A financial intermediary is a financial institution that connects surplus and deficit agents.
The classic example of a financial intermediary is a bank that consolidates deposits and uses
the funds to transform them into loans.
Through the process of financial intermediation, certain assets or liabilities are transformed
into different assets or liabilities.
As such, financial intermediaries channel funds from people who have extra money or
surplus savings to those who do not have enough money to carry out a desired activity.
A financial intermediary is typically an institution that facilitates the channeling of funds between
lenders and borrowers indirectly.s.
That is, savers give funds to an intermediary institution, and that institution gives those
funds to spenders.
This may be in the form of loans or mortgages.
Alternatively, they may lend the money directly via the financial markets, which is known
as financial disintermediation.
In the context of climate finance and development, financial intermediaries generally refer to
private sector intermediaries, such as banks, private equity, venture capital funds, leasing
companies, insurance and pension funds, and micro-credit providers.
Increasingly, international financial institutions provide funding via companies in the financial
sector, rather than directly financing projects.
Functions performed by financial intermediaries Financial intermediaries provide three major
functions: Maturity transformationConverting short-term
liabilities to long term assets
Risk transformationConverting risky investments into relatively risk-free ones.
Convenience denomination Matching small deposits with large loans and
large deposits with small loans
Advantages and disadvantages of financial intermediaries
There are two essential advantages from using financial intermediaries:
Cost advantage over direct lending/borrowing Market failure protection the conflicting
needs of lenders and borrowers are reconciled, preventing market failure
The cost advantages of using financial intermediaries include:
Reconciling conflicting preferences of lenders and borrowers
Risk aversion intermediaries help spread out and decrease the risks
Economies of scale using financial intermediaries reduces the costs of lending and borrowing
Economies of scope intermediaries concentrate on the demands of the lenders and borrowers
and are able to enhance their products and services
Various disadvantages have also been noted in the context of climate finance and development
finance institutions.
These include a lack of transparency, inadequate attention to social and environmental concerns,
and a failure to link directly to proven developmental impacts.
Types of financial intermediaries Financial intermediaries include:
Banks Building societies
Credit unions Financial advisers or brokers
Insurance companies Collective investment schemes
Pension funds Summary and conclusion
Financial institutions perform the vital role of bringing together those economic agents
with surplus funds who want to lend, with those with a shortage of funds who want to
borrow.
In doing this they offer the major benefits of maturity and risk transformation.
It is possible for this to be done by direct contact between the ultimate borrowers, but
there are major cost disadvantages of direct finance.
Indeed, one explanation of the existence of specialist financial intermediaries is that
they have a related advantage in offering financial services, which not only enables
them to make profit, but also raises the overall efficiency of the economy.
The other main explanation draws on the analysis of information problems associated with financial
markets.
See also Debt
Financial economics Investment
Saving Financial market efficiency
References
Bibliography Pilbeam, Keith.
Finance and Financial Markets.
New York: PALGRAVE MACMILLAN, 2005.
Valdez, Steven.
An Introduction To Global Financial Markets.
Macmillan Press, 2007.