What Is a Financial Intermediary?
Let me explain to you what a financial intermediary is—it's an entity that acts as the middleman between two parties in a financial transaction, like a commercial bank, investment bank, mutual fund, or pension fund.
As someone looking into finance, you should know that financial intermediaries offer several benefits to the average consumer, including safety, liquidity, and economies of scale in banking and asset management.
While advances in technology might threaten to eliminate the financial intermediary in areas like investing—something called disintermediation—it's much less of a threat in other areas such as banking and insurance.
Key Takeaways
- Financial intermediaries serve as middlemen for financial transactions, generally between banks or funds.
- These intermediaries help create efficient markets and lower the cost of doing business.
- Intermediaries can provide leasing or factoring services, but do not accept deposits from the public.
- Financial intermediaries offer the benefit of pooling risk, reducing cost, and providing economies of scale, among others.
How a Financial Intermediary Works
You need to understand that a non-bank financial intermediary does not accept deposits from the general public; instead, it may provide factoring, leasing, insurance plans, or other financial services.
Many of these intermediaries participate in securities exchanges and use long-term plans for managing and growing their funds.
The overall economic stability of a country can be gauged through the activities of financial intermediaries and the growth of the financial services industry.
Financial intermediaries move funds from parties with excess capital to those needing funds, which creates efficient markets and lowers the cost of conducting business.
For instance, a financial advisor connects with clients by purchasing insurance, stocks, bonds, real estate, and other assets.
Banks connect borrowers and lenders by providing capital from other financial institutions and from the Federal Reserve.
Insurance companies collect premiums for policies and provide policy benefits, while a pension fund collects funds on behalf of members and distributes payments to pensioners.
Types of Financial Intermediaries
Consider mutual funds as one type—they provide active management of capital pooled by shareholders.
The fund manager connects with shareholders by purchasing stock in companies he anticipates may outperform the market.
By doing this, the manager provides shareholders with assets, companies with capital, and the market with liquidity.
Benefits of Financial Intermediaries
Through a financial intermediary, you as a saver can pool your funds with others, enabling large investments that benefit the entity you're investing in.
At the same time, financial intermediaries pool risk by spreading funds across a diverse range of investments and loans.
Loans through these intermediaries benefit households and countries by allowing them to spend more money than they currently have.
Financial intermediaries also reduce costs on several fronts; for example, they access economies of scale to evaluate the credit profile of potential borrowers expertly and keep records cost-effectively.
Finally, they reduce the costs of the many financial transactions you as an individual investor would otherwise have to make without them.
Example of a Financial Intermediary
Take the case from July 2016, when the European Commission introduced two new financial instruments for European Structural and Investment (ESI) fund investments.
The goal was to create easier access to funding for startups and urban development project promoters.
Loans, equity, guarantees, and other financial instruments attract greater public and private funding sources that can be reinvested over many cycles compared to receiving grants.
One instrument, a co-investment facility, was designed to provide funding for startups to develop their business models and attract additional financial support through a collective investment plan managed by one main financial intermediary.
The European Commission projected the total public and private resource investment at approximately €15 million (about $17.75 million) per small- and medium-sized enterprise.
