2. .
Financial
intermediation is an activity of financial intermediaries. A
financial intermediary is an institution that links lenders with
borrowers, by obtaining deposits from lenders and then re-lending
them to borrowers. The role of financial intermediaries in an
economy, such as banks and building societies, is to provide means by
which funds can be transferred from surplus units in the economy to
deficit units. Surplus units are those economical agents, which have
more money, than they need for their immediate needs. Deficit units
are those, which have less money, than they need in order to fund
their current activity.
Financial
intermediaries help to reconcile different requirements of borrowers
and lenders.
They provide obvious
and convenient ways in which a lender can save money. Instead of
having to find a suitable borrower for his money, the lender can
deposit his money with a bank etc. All the lender has to do is decide
for how long he might want to lend money, and what sort of return he
requires, and choose a financial intermediary, that offers a
financial instrument of the fitting conditions.
They can package up the
amounts lent by savers and lend on to borrowers in bigger amounts.
They provide for a risk
reduction. Provided that the financial intermediary is itself
financially sound, the lender would not run any risk of losing his
investment. Bad debts would be borne by the financial intermediary in
its re-lending operations.
They provide a ready
source of funds for borrowers. Even when money is in short supply, a
borrower will usually find a financial intermediary prepared to lend
some.
Most importantly they
provide maturity transformation, i.e. they bridge up the gap between
the wish of most lenders for liquidity and the desire of most
borrowers for loan over longer periods. They do this by providing
investors with financial instruments, which are liquid enough for the
investors’ needs, and by providing funds to borrowers in a
different longer-term form.
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