A financial intermediary is an institution or individual that serves as a " middleman" among diverse parties in order to facilitate financial transactions. Common types include

commercial banks A commercial bank is a financial institution that accepts Deposit (finance), deposits from the public and gives loans for the purposes of consumption and investment to make a Profit (economics), profit. It can also refer to a bank or a division o ...

investment banks Investment banking is an advisory-based financial service for institutional investors, corporations, governments, and similar clients. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by und ...

stockbrokers A stockbroker is an individual or company that buys and sells stocks and other investments for a financial market participant in return for a commission, markup, or fee. In most countries they are regulated as a broker or broker-dealer and m ...

, insurance and pension funds, pooled investment funds, leasing companies, and stock exchanges. The financial intermediary thus facilitates the indirect channeling of

funds Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm us ...

between, generically, lenders and borrowers. That is, savers (lenders) give funds to an intermediary institution (such as a

bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

), and that institution gives those funds to spenders (borrowers). When the money is lent directly - via the

financial market A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial marke ...

s - eliminating the financial intermediary, this is known as financial

disintermediation Disintermediation is the removal of intermediary, intermediaries in economics from a supply chain, or "cutting out the middlemen" in connection with a transaction or a series of transactions. Instead of going through traditional distribution cha ...

Economic function

Financial intermediaries, as outlined, essentially, channel funds from those who have surplus capital (

savers Savers Value Village Inc. is a publicly held, for-profit thrift store retailer headquartered in Bellevue, Washington, United States, offering second hand merchandise, with supermajority ownership by private equity firm Ares Management. An inte ...

) to those who require liquid funds to carry out a desired activity (

investors An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of property. Types of in ...

). Financial intermediaries thus ''reallocate'' otherwise uninvested capital to productive enterprises. In doing so, they offer the benefits of maturity and

risk transformation Risk transformation is about how to mitigate risk and in parallel develop competitive advantages. The goals of risk transformation are first to combat risk and secondly to differentiate and create solutions for the benefits of Customer, clients/us ...

. In other words, through the process of financial intermediation,

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

or liabilities may be transformed into assets or liabilities with (very) different risk and payment profiles. *In the personal finance context, the instrument in question will be in the form of a

loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the deb ...

or a

mortgage A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdictions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners t ...

. *In the corporate context, the form may be take any variety of debt, equity, or hybrid stakeholding structures, extending to

private equity Private equity (PE) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...

and

venture capital Venture capital (VC) is a form of private equity financing provided by firms or funds to start-up company, startup, early-stage, and emerging companies, that have been deemed to have high growth potential or that have demonstrated high growth in ...

investments. *Even in the non-commercial context of

project finance Project finance is the long-term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of its sponsors. Usually, a project financing structure involves a number of eq ...

, climate finance and

development finance Development finance is a branch of development studies that deals with financing of economic and social development. It typically involves of both the mobilisation and dispersion of domestic and international sources of fiance. At the internationa ...

, financial intermediaries generally will be from the

private sector The private sector is the part of the economy which is owned by private groups, usually as a means of establishment for profit or non profit, rather than being owned by the government. Employment The private sector employs most of the workfo ...

.Institute for Policy Studies(2013),
Financial Intermediaries
, A Glossary of Climate Finance Terms, IPS, Washington DC The prevalence of these intermediaries, relative to disintermediated transactions, is explained in that specialist financial intermediaries ostensibly enjoy a cost advantage in offering financial services; this not only enables them to make profit, but also raises the overall efficiency of the economy. Their existence and services are then explained by the "information problems" associated with financial markets.

Functions performed by financial intermediaries

The hypothesis of financial intermediaries adopted by

mainstream economics Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a basis for discussion. Also known as orthodox economics, it can be contrasted to ...

offers the following three major functions they are meant to perform: #

Creditor A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some propert ...

s provide a line of credit to qualified clients and collect the premiums of debt instruments such as loans for financing homes, education, auto, credit cards, small businesses, and personal needs. # Risk transformation # Convenience denomination # Commercial banks may provide safe storage for both cash as well as precious metals.

Advantages and disadvantages of financial intermediaries

There are two essential advantages from using financial intermediaries: # Cost advantage over direct lending/borrowing #

Market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value.Paul Krugman and Robin Wells Krugman, Robin Wells (2006 ...

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 In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of Productivity, output produced per unit of cost (production cost). A decrease in ...

- using financial intermediaries reduces the costs of lending and borrowing #

Economies of scope Economies of scope are "efficiencies formed by variety, not volume" (the latter concept is "economies of scale"). In the field of economics, "economies" is synonymous with cost savings and "scope" is synonymous with broadening production/service ...

- intermediaries concentrate on the demands of the lenders and borrowers and are able to enhance their products and services (use same inputs to produce different outputs) Various disadvantages have also been noted in the context of climate finance and

development finance institution Development finance institution (DFI), also known as a Development bank, is a financial institution that provides risk capital for economic development projects on a non-commercial basis. DFIs are often established and owned by governments or ...

s. These include a lack of transparency, inadequate attention to social and environmental concerns, and a failure to link directly to proven developmental impacts.Bretton Woods Project (2010
Out of sight, out of mind? IFC investment through banks, private equity firms and other financial intermediaries
, Bretton Woods Project, London

Types of financial intermediaries

According to the dominant economic view of monetary operations,"The currently dominant intermediation of

loanable funds In economics, the loanable funds doctrine is a theory of the market interest rate. According to this approach, the interest rate is determined by the demand for and supply of loanable funds. The term ''loanable funds'' includes all forms of credit, ...

(ILF) model views banks as

barter In trade, barter (derived from ''bareter'') is a system of exchange (economics), exchange in which participants in a financial transaction, transaction directly exchange good (economics), goods or service (economics), services for other goods ...

institutions that intermediate deposits of pre-existing, real,

between depositors and borrowers. The problem with this view is that, in the real world, there are no pre-existing loanable funds; and ILF-type institutions do not exist. Instead, banks create new funds in the act of lending, through matching loan and deposit entries, both in the name of the same customer, on their

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

s. The financing-through-money-creation (FMC) model reflects this, and therefore views banks as fundamentally monetary institutions. The FMC model also recognises that, in the real world, there is no deposit multiplier mechanism." Fro
"Banks are not intermediaries of loanable funds — and why this matters"
b

and

Michael Kumhof Michael Kumhof (born 15 October 1962) is a German researcher and economist. He is the senior research advisor in the Bank of England's research hub. He is most known for his research into the financial system, income inequalities and the oil supp ...

Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the Kingdom of England, English Government's banker and debt manager, and still one ...

Working Paper No 529, May 2015 the following institutions are or can act as financial intermediaries: *

Bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

s *

Mutual savings bank A mutual savings bank is a financial institution chartered by a central or regional government, without capital stock, owned by its members who subscribe to a common fund. From this fund, claims, loans, etc., are paid. Profits after deductions ...

s *

Savings bank A savings bank is a financial institution that is not run on a profit-maximizing basis, and whose original or primary purpose is collecting deposits on savings accounts that are invested on a low-risk basis and receive interest. Savings banks ha ...

s *

Building societies A building society is a financial institution owned by its members as a mutual organization, which offers banking institution, banking and related financial services, especially savings and mortgage loan, mortgage lending. They exist in the Unit ...

Credit union A credit union is a member-owned nonprofit organization, nonprofit cooperative financial institution. They may offer financial services equivalent to those of commercial banks, such as share accounts (savings accounts), share draft accounts (che ...

s *

Financial adviser A financial adviser or financial advisor is a professional who provides financial services to clients based on their financial situation. In many countries, financial advisors must complete specific training and be registered with a regulatory ...

s or

broker A broker is a person or entity that arranges transactions between a buyer and a seller. This may be done for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither ...

s *

Insurance Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect ...

companies *

Collective investment scheme An investment fund is a way of investment, investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the risks of the investment by a significant percentage. These ad ...

s *

Pension fund A pension fund, also known as a superannuation fund in some countries, is any program, fund, or scheme which provides pension, retirement income. The U.S. Government's Social Security Trust Fund, which oversees $2.57 trillion in assets, is the ...

s * Cooperative societies * Stock exchanges According to the alternative view of monetary and banking operations, banks are not intermediaries but "fundamentally

money creation Money creation, or money issuance, is the process by which the money supply of a country, or an economic or monetary region,Such as the Eurozone or ECCAS is increased. In most modern economies, money is created by both central banks and comm ...

" institutions, while the other institutions in the category of supposed "intermediaries" are simply

investment fund An investment fund is a way of investment, investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the risks of the investment by a significant percentage. These ad ...

References

Bibliography

*Pilbeam, Keith. Finance and Financial Markets. New York: PALGRAVE MACMILLAN, 2005. *Valdez, Steven. An Introduction To Global Financial Markets. Macmillan Press, 2007. {{Authority control Financial services organizations