Generally, financial intermediaries are engaged in bringing together the ultimate borrowers and ultimate lenders of finance. They allocate the funds of companies that have a surplus of capital and lend them to production companies.
In this way, their objective is to convert savings into investments. The financial intermediaries charge a fee for their service and this fee is called intermediation cost.
There are many characteristics of financial intermediaries depending on their type. Financial intermediaries work in the investment cycle of an economy by serving the borrowers and lenders.
The characteristics of financial intermediaries are described below:
1) Risk Reduction
Financial intermediaries have greater resources than other individuals to bear and spread the risk among different individuals.
Because they have expertise in managing diversified portfolios and employ other financial experts.
As they manage the portfolio’s large sizes, it helps reduce risk through diversification.
Financial intermediaries carefully select and examine the borrowers and reduce the risk of default. They provide safety in accessing money and spread the risk by lending to several people.
For example, insurance companies collect premiums from their customers and provide benefits of the policy if any customer is affected by unpredictable accidents.
2) Scale Economies
Financial intermediaries are commercial banks, mutual funds, credit unions, stock exchanges, insurance companies, and other financial institutions that help the economy’s growth process.
Financial intermediaries take deposits from a large number of clients and lend money to multiple borrowers. In this way, they maintain economies of scale.
They intermediate between ultimate lenders and borrowers and discourage stockpiles by people. If financial intermediaries don’t exist many operational costs may incur by investors.
Financial intermediaries help invest, provide investment advice to their clients, and help save their clients’ costs.
They promote economic growth by encouraging savings and investments.
Regulation is necessary for financial intermediaries because of the complexities of the financial system. Due to weak regulation financial crises may happen and may put the economy at risk.
The monetary authorities should control dishonest financial intermediaries and ensure there is enough balance in the system to avoid a loss to the economy.
4) Provide Loans
Financial intermediaries play an important role in bringing together those investors who have surplus cash wishing to lend them and those companies who wish to obtain loan facilities.
They provide liquidity to the market by providing shares to shareholders and capital to companies. One of the core businesses of financial intermediaries is providing short-term and long-term loans.
They accumulate the deposited funds and assist the entities who are looking for funds to borrow.
Financial intermediaries grant loans to borrowers at interest. A part of that interest is given to the depositor whose surplus cash has been used and the remaining balance of the interest is retained as the intermediary’s profit.
Before lending intermediaries also evaluate the ability and creditworthiness of the borrowers to ensure whether the borrowers will be able to pay off the loan or not.
5) Asset Storage:
Financial intermediaries provide their clients with safe storage for both cash and precious metals such as gold and silver.
Clients who make deposits receive proof of deposit and all records of withdrawals. Depositors can use deposit cards and checks to access their funds.
6) Investment Advice:
Many financial intermediaries help their clients in increasing their investments. They assist their clients in growing money by making investments.
Companies find it difficult to choose the right industry to make investments and maximize returns.
Financial intermediaries invest their clients’ funds and pay them an agreed interest rate. Besides managing the funds of their clients, they also provide investment advice to their clients.
7) Provide Liquidity
Financial intermediaries provide liquidity by converting an asset into cash very easily. They always try their best to maintain their liquidity.
They make short-term loans and finance them for longer periods and diversify loans among different types of borrowers. Basically, with their diversified operation, they maintain liquidity.
8) Bring Stability to the Capital Market
Financial intermediaries deal with a lot of assets and liabilities which are traded in the capital market.
By following rules and regulations, financial intermediaries bring stability to the capital market and help industries through diversified financial services.
If there were no financial intermediaries, unexpected changes in the demand and supply of financial assets would bring instability to the capital market.
In advanced countries with extensive regulations under which financial intermediaries operate, there is less risk of stock scams.