Disintermediation

Definition

Disintermediation is a financial process in which individuals or entities withdraw funds from intermediaries such as banks or savings and loan associations and invest them directly into financial assets for higher yields. This bypasses traditional financial middlemen and can include investments in the stock market, bonds, or other instruments.

Examples

Individual Investors
- An individual withdraws their savings from a bank savings account and invests in mutual funds or stocks to achieve higher returns.
Corporations
- A corporation issues its bonds directly to investors rather than borrowing from banks, thereby avoiding intermediary fees and seeking better terms.
Real Estate Investment
- Investors might pool their resources to purchase property directly, rather than placing their money in real estate investment trusts (REITs).

Frequently Asked Questions (FAQs)

Q1: What are the risks associated with disintermediation? A1: Disintermediation can lead to higher returns, but it also entails increased risks such as market volatility, liquidity issues, and potential loss of capital.

Q2: Why do investors choose disintermediation? A2: Investors choose disintermediation to seek higher returns on their investments compared to the relatively lower yields provided by traditional financial intermediaries.

Q3: How does disintermediation affect banks and financial institutions? A3: It reduces the amount of deposits held by financial intermediaries, which can lead to reduced profitability and a smaller asset base to lend against.

Q4: What is the opposite of disintermediation? A4: The opposite is reintermediation, where financial intermediation is reintroduced, and funds flow back into traditional financial institutions.

Financial Intermediary: An institution that acts as a middleman between savers and borrowers, such as banks, credit unions, and savings and loan associations.
Yield: The income return on an investment, typically expressed as an annual percentage based on the investment’s cost or current market value.
Savings Account: A deposit account held at a financial institution that provides principal security and a modest interest rate.
Direct Investment: The act of investing directly into companies or assets without the use of financial intermediaries.

Online Resources

References

“Financial Intermediation and Markets” by Stuart I. Greenbaum, Anjan V. Thakor.
“Introduction to the Financial System” by Dennis D. Logue and James Seward.
“Investment Valuation: Tools and Techniques for Determining the Value of Any Asset” by Aswath Damodaran.

Suggested Books for Further Studies

“Principles of Corporate Finance” by Richard A. Brealey and Stewart C. Myers
“The Economics of Money, Banking, and Financial Markets” by Frederic S. Mishkin
“Investment Analysis and Portfolio Management” by Frank K. Reilly and Keith C. Brown

Real Estate Basics: Disintermediation Fundamentals Quiz

### Which term best defines the act of bypassing financial intermediaries and investing directly in financial assets? - [ ] Reintermediation - [x] Disintermediation - [ ] Intermediation - [ ] Delegation > **Explanation:** Disintermediation is the process of bypassing traditional financial intermediaries such as banks to invest directly in other financial assets. ### What generally motivates investors to engage in disintermediation? - [ ] Lower risks - [ ] Peer pressure - [x] Higher yields - [ ] Regulatory benefits > **Explanation:** Investors typically engage in disintermediation to achieve higher yields on their investments compared to the returns on traditional savings accounts or bank deposits. ### Which of the following is an example of disintermediation? - [x] Investing directly in the stock market instead of a savings account - [ ] Keeping money in a low-interest savings account - [ ] Taking a personal loan from a bank - [ ] Opening a CD account with a bank > **Explanation:** Investing directly in the stock market is an example of disintermediation as it bypasses the bank (an intermediary). ### Disintermediation can pose what type of risks compared to keeping funds in a bank? - [ ] Reduced returns - [ ] Regulatory risks - [x] Increased market volatility - [ ] Lack of liquidity > **Explanation:** Disintermediation often involves investing in higher-yield assets, which can also mean higher market volatility and risk. ### What impact does disintermediation typically have on financial institutions? - [ ] Increases their deposit base - [x] Reduces their deposit base - [ ] Stabilizes their interest rates - [ ] Encourages lower savings rates > **Explanation:** Disintermediation reduces the deposit base of financial institutions, potentially lowering their lending capacity. ### Which term describes the counter-process of funds moving back into traditional financial institutions? - [ ] Delegation - [ ] Internationalization - [ ] Depreciation - [x] Reintermediation > **Explanation:** Reintermediation is the process in which funds flow back into traditional financial intermediaries, reversing the trend of disintermediation. ### What type of institutional product might investors bypass during disintermediation seeking higher returns? - [x] Savings accounts - [ ] Real estate properties - [ ] Individual stocks - [ ] Corporate bonds > **Explanation:** Investors often bypass traditional low-yield savings accounts during disintermediation in search of higher-yield investments. ### Disintermediation is more commonly associated with which type of investment principle? - [x] Risk and return - [ ] Market saturation - [ ] Capital gains taxes - [ ] Dollar-cost averaging > **Explanation:** Disintermediation is closely linked with the risk and return principle, where investors seek higher returns and accept the associated risks. ### Which of the following is NOT typically a financial intermediary? - [ ] Investment banks - [ ] Credit unions - [ ] Savings and loan associations - [x] Public companies > **Explanation:** Public companies are not considered financial intermediaries. Intermediaries facilitate transactions between savers and borrowers. ### A corporation bypassing banks to issue bonds directly to public investors is an example of? - [ ] Financial crisis - [x] Disintermediation - [ ] Corporate malfeasance - [ ] Loan default > **Explanation:** This scenario represents disintermediation where the corporation bypasses the bank and deals directly with public investors for financing.

Disintermediation