Financial Intermediary

What is a Financial Intermediary?

A financial intermediary is an institution that facilitates the channeling of funds between savers and borrowers. They usually operate by collecting deposits from individuals and businesses, which they then allocate into different investment vehicles such as loans and various securities. Common examples of financial intermediaries include banks, savings and loan associations, credit unions, and mutual savings banks.

Examples of Financial Intermediaries

Banks: A commercial or retail bank collects savings from customers and then provides various forms of loans such as mortgages or business loans.
Credit Unions: These are member-owned financial cooperatives that provide traditional banking services to their members.
Savings and Loan Associations: These focus primarily on accepting savings deposits and making mortgage loans.
Investment Banks: These specialize in large and complex financial transactions such as underwriting, facilitating mergers and acquisitions, and corporate restructuring.
Mutual Funds: These are investment vehicles that pool funds from multiple investors to invest in a diversified portfolio of securities.

Frequently Asked Questions (FAQs)

Q1: Why are financial intermediaries important?

A1: Financial intermediaries are crucial for the efficient functioning of the economy as they facilitate the flow of funds from savers to borrowers. They provide liquidity, risk management through diversification, and access to capital.

Q2: How do financial intermediaries make a profit?

A2: Financial intermediaries make a profit by charging higher interest rates on loans than they pay on deposits, earning fees for services, and investing in interest-bearing securities.

Q3: What is disintermediation?

A3: Disintermediation occurs when borrowers bypass financial intermediaries, seeking direct financing options such as issuing bonds or equity directly to investors, commonly facilitated by advancements in technology.

Disintermediation: The reduction or elimination of financial intermediaries in transactions between buyers and sellers.
Liquidity: The ease with which an asset can be converted into cash without affecting its market price.
Interest Rate Spread: The difference between the interest rate that banks charge borrowers and the rate they pay depositors.
Risk Management: The process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions.
Diversification: The practice of spreading investments across various financial instruments, industries, and other categories to reduce exposure to risk.

Online Resources

Investopedia: Financial Intermediary
Federal Reserve’s Website: Understanding Financial Intermediaries
Khan Academy: Financial Intermediation

References

Mishkin, Frederic S., and Stanley Eakins. “Financial Markets and Institutions.” Prentice Hall, 2018.
Fabozzi, Frank J., and Franco Modigliani. “Foundations of Financial Markets and Institutions.” Pearson, 2010.
Barth, James R., Gerard Caprio Jr., and Ross Levine. “Rethinking Bank Regulation: Till Angels Govern.” Cambridge University Press, 2006.

Suggested Books for Further Studies

“Financial Markets and Institutions” by Frederic S. Mishkin and Stanley Eakins.
“Foundations of Financial Markets and Institutions” by Frank J. Fabozzi and Franco Modigliani.
“Bank Management & Financial Services” by Peter S. Rose and Sylvia C. Hudgins.

Real Estate Basics: Financial Intermediary Fundamentals Quiz

### What is a financial intermediary? - [x] An institution that facilitates the channeling of funds between savers and borrowers. - [ ] A direct transaction between savers and borrowers that bypasses any middleman. - [ ] A type of insurance policy meant to manage financial risks. - [ ] A form of government regulation on financial markets. > **Explanation:** A financial intermediary is a middleman institution that collects deposits from savers and then allocates these funds into loans and securities for borrowers. ### Which of the following is NOT typically considered a financial intermediary? - [ ] Bank - [ ] Credit Union - [ ] Mutual Fund - [x] Real Estate Broker > **Explanation:** A real estate broker facilitates property transactions, not financial intermediation between savers and borrowers. ### What primary function do financial intermediaries serve? - [ ] Printing money - [x] Facilitating the flow of funds between savers and borrowers - [ ] Creating new stock markets - [ ] Insuring against investment losses > **Explanation:** The primary function of financial intermediaries is to facilitate the flow of funds from savers to borrowers, ensuring liquidity and capital availability in the economy. ### What is disintermediation? - [x] Borrowers bypassing financial intermediaries - [ ] The creation of new financial institutions - [ ] Government banks taking over private banks - [ ] Merging two financial institutions > **Explanation:** Disintermediation involves borrowers directly accessing financing without using financial intermediaries like banks. ### How do financial intermediaries typically make a profit? - [ ] By charging high fees for access - [ ] By using government grants - [x] By earning an interest rate spread and fees for services - [ ] By trading real estate properties > **Explanation:** Financial intermediaries earn profits by charging higher interest rates on loans than they pay on deposits and through various service fees. ### Which of the following is a function of a financial intermediary? - [ ] Lending money to government - [x] Providing loans and investing in securities on behalf of depositors - [ ] Direct property management - [ ] Manufacturing financial instruments > **Explanation:** A major function of financial intermediaries includes providing loans and making investments with the funds collected from depositors. ### Who are the primary users of financial intermediary services? - [ ] Only large corporate clients - [ ] Only individual investors - [x] Both individual and corporate clients - [ ] Only government entities > **Explanation:** Both individual and corporate clients frequently use the services of financial intermediaries for various banking and investing needs. ### What is one of the risks mitigated by financial intermediaries through diversification? - [ ] Political risk - [ ] Regulatory risk - [x] Investment risk - [ ] Competition risk > **Explanation:** By diversifying investments across various asset classes, financial intermediaries help to mitigate investment risks. ### A financial intermediary provides liquidity. What does this mean? - [x] They make it easier to convert assets into cash - [ ] They insure deposits against loss - [ ] They stabilize the currency market - [ ] They eliminate financial risks > **Explanation:** Providing liquidity means making it easier for assets, like bank deposits, to be converted into cash quickly without significant loss in value. ### Which institution typically focuses on accepting savings deposits and making mortgage loans? - [x] Savings and Loan Associations - [ ] Hedge Funds - [ ] Brokerage Firms - [ ] Stock Exchanges > **Explanation:** Savings and Loan Associations primarily focus on accepting savings deposits from individuals and making mortgage loans.