Financial Intermediary can be defined as an organization that acts as a bridge between the investor and the borrower. The main underlying premise behind financial intermediary is the fact that it stands to ensure that the financial objectives are duly met for both organizations.
Therefore, they mainly act as a middle man between the investor and the borrower, where they obtain funds from the lender at lower interest rates, and then subsequently lend it out to the investor at higher rates.
In this regard, this is considered as their profit margin, in terms of the spread between the offering interest rate to the borrower, and the interest rate that they pay to their lenders.
The Need for a Financial Intermediary
The underlying need for a financial intermediary arises in the case where there is a need to develop a trust between both the parties, the borrower, and the lender. When a financial transaction is taking place, the lender wants to ensure that his money is invested in a secure place, and he would be paid back the amount that he has lent.
Additionally, the lender needs to find the respective buyer for the amount. In this case, financial intermediaries are established in order to establish the link between the buyer and seller.
Types of Financial Intermediaries
There are different types of financial intermediaries in place that serve different purposes. The underlying reason for different types of financial intermediaries is that they cater to the different needs of the consumers.
- Banks: The central and commercial banks are created constitute to be the most widely known used financial intermediaries. The main purpose of banks to offer their services as financial intermediaries vests on the grounds of creating a reliably, and simplified process for their customers.
- Credit Unions: Credit Unions can be regarded as cooperative financial units, which are meant to create financial lending and borrowing of funds in order to provide financial assistance to their members.
- Non-Banking Finance Companies: Non-Banking Financial Companies are mainly engaged with activities that offer relatively specialized services like advancing loans to their clients.
- Stock Exchanges: The stock exchanges are established to ensure that companies are able to raise capital from the general public, in exchange for ownership in the company. Therefore, it is a place where public limited companies are able to sell their stocks and securities, in exchange for money. The profit in this case is mainly generated from the spread obtained between the trading of these shares.
- Mutual Fund Companies: Mutual Fund Companies are formed with the premise to amalgamate the amount that is collected from various investors. In this regard, it can be seen that different investors have different pools within which they can be seen to have similar investment objectives as well as risk profile. In this regard, it can be seen that funds are then subsequently collected and then invested in bonds, marketable securities, and other options that can be utilized to get a capital gain in the longer run.
- Insurance Companies: Insurance Companies provide insurance policies to individuals that can ensure that individuals and companies are procured against unprecedented events. In this regard, they mainly rely on deposits that are in the form of premium, subsequently pooled to gain profitable returns for the company.
- Escrow Opinion: Escrow companies are companies that act as the third party which acts as an intermediary because they are responsible to get all the conditions fulfilled at the time of the loan transaction that takes place between both, the investor as well as the borrower. This mostly takes place in situations that involve a real estate mortgage. This financial intermediary is created to establish a bridge between the transaction taking place so that the deal is secured.
Therefore, it can be seen that financial intermediaries are mainly formed in order to act as a link between two parties conducting a financial transaction. The main purpose is to provide security to the borrower, as well as the lender. Furthermore, financial intermediaries provide a proper structure to carry forward a financial transaction in a proper manner.
The role of financial intermediaries in creating and establishing a good resonance in the financial system is quite important to facilitating transactions between the buyer and seller.
The trust deficit that would otherwise exist in the case where financial intermediaries do not exist, would deter any borrower from obtaining funds from any lender, and similarly, the lender would not have any security before lending money, because of the credibility under question.