Roles of Financial Intermediaries
Financial intermediaries are any institutions that move money between savers and borrowers
- Pooling of resources
Financial intermediaries pool resources of small savers and lend them out when necessary. In transaction one, U. S. banks loan money to foreigners. Without this service, an individual for example, would need to go to 200 people each lending him $1000 so as to get 200,000 dollar loan which is highly inefficient. But instead the large sum of money needed is readily available in banks. Foreigners who borrow from the U. S. have offshore accounts based here. A good example of pooled resources is insurance companies, who accumulate and invest a few small premiums and pay out a few large premiums.
- Provide Liquidity
Liquidity refers to how economically and easily an asset can be converted to a means of payment. Financial intermediaries act to give liquidity to contributors of their investments thereby reducing the challenges faced in transforming various assets into a means of payment through ATMs, debit cards, checking accounts etc. Intermediaries incur minimum cost since they enjoy the benefits of economies of scale. Money to pay out international debts is readily available to the U. S. government which allows for efficiency in servicing financial obligations. This allows for good business relations with foreign countries since payments made are timely.
- Diversifying risk
Financial intermediaries help organizations and individuals to spread the risk over a wide range of monetary investments. This is referred to as diversification. Banks spread deposited funds over a variety of loans, thus if any of the loans is not services it doesn’t affect the deposited funds in any way. An example is transaction 1, where the U. S. banks give loans to foreigners. This is one of the ways in which the financial institutions spread their risk as opposed to investing all their money in the country and hence minimizing the risk of suffering tremendous loss.
- Collection and processing of information.
Financial intermediaries provide information and guidance to investors. They possess expertise in the collection and processing information so as to accurately assess risk of various investments and price them accordingly. This information is provided inform of a prospectus which is a document that contains comprehensive information about potential risks investments and returns. The need to acquire this data results from a basic asymmetric information problem adopted from financial markets.
Without financial intermediaries, corporate fund users would be forced to directly approach household savers of funds so as to quench their borrowing needs for example, in order to get $ 1000000, loan one would have to go to 1000 individuals and ask for a $1000 from each. The information acquired would be extremely expensive due to the initial cost of information met by potential lenders. Discovery of potential borrowers would lead to cost inefficiencies; finance for corporate activities would be acquired by pooling of little savings into substantial size, and the evaluation of risk and investment opportunities. This would also make lenders to keep tabs on the activities of their borrowers during the loan repayment period. The net result would be poorly calculated allocation of resources in an economy.
Financial intermediaries serve a critical role of consolidating economic agents that possess surplus funds to lend and those experiencing shortage to borrow. By doing this, they present huge benefits of maturity and risk transformation.
References
Baldwin, F. (2006). Exposure of financial institutions to criminal liability. Journal of Financial Crime, 13(4), 387 – 407.
Gökhan, S. and Ismail, S. (2006). Fragilitiy in Banking Sector and Public’s Role. Social Responsibility Journal, 2(3/4), 335 – 343.
Olatunde, J., Solabomi, O. and Eddy O. (2012). The role of financial intermediaries in elite money laundering practices: Evidence from Nigeria. Journal of Money Laundering Control, 15(1), 58 – 84.
