A financial intermediary refers to an entity that operates as a middleman between two parties in a financial transaction, such as an investment bank, commercial bank, pension or mutual fund. Financial intermediation benefits businesses and consumers alike by offering services on a larger economy of scale than would otherwise be possible. In the world of finance, intermediaries play a crucial role in areas like banking and insurance.
Let us take a closer look at the role financial intermediaries in India and their considerable impact across the financial landscape.
Also read: Liquidity asset
Key players in the Indian financial intermediation system
- Banks: The most prominent financial intermediaries, banks mobilize deposits from individuals and businesses, offering interest in return. These funds are then loaned out to borrowers for various purposes like housing, education, or business expansion. Banks play a critical role in economic growth by facilitating credit creation.
- Non-Banking Financial Companies (NBFCs): NBFCs offer a wide range of financial services similar to banks, including loans, investments, and money transfers. However, unlike banks, they cannot accept demand deposits from the public. NBFCs cater to a diverse clientele, especially those who might not qualify for traditional bank loans.
Bajaj Finance, a reputable NBFC in India, is a prime example of how NBFCs contribute to the financial landscape. They offer Fixed Deposit (FD) different tenure option catering to different investment horizons and financial goals. - Mutual funds: Mutual funds pool savings from multiple investors and invest them in a diversified portfolio of stocks, bonds, and other assets. This allows even small investors to participate in the capital market and gain exposure to a variety of investment options with professional management.
Advantages of financial intermediaries
Finance intermediation offers numerous advantages to all parties involved. By leveraging a financial intermediary, investors can make greater investments by pooling their capital together. At the same time, businesses can get access to a bigger pool of investors.
Here are some benefits provided by financial intermediation:
- Spreading out risk
Financial intermediaries offer a platform where lenders with surplus money can spread their risk by lending it to several people as opposed to just one individual. As such, the funds are spread out across a diverse range of investments, which in turn spreads out the risk of capital loss. - Economies of scale
Financial intermediaries involve economies of scale as they collect deposits from a larger customer base and lend money to multiple borrowers. This practice helps them decrease the overall operating costs that they typically incur in their usual business practices. Unlike borrowing from people with insufficient funds to loan the requested amount, financial institutions can access large amounts of liquid cash that they can loan to people with a strong credit rating. - Economies of scope
Intermediaries provide a range of specialised services to clients. This allows them to enhance their products to cater to the requirements of different types of clients. For instance, when commercial banks lend money, they can customise the loan packages to suit the requirements of small and large borrowers. Small and medium enterprises essentially make up the majority of borrowers. Offering packages that suit their needs can help banks expand their customer base. - Reduce the risk of fraud
Intermediaries also helps reduce the risk of fraudulent behaviour as they have strict security measures in place.
Also read: Fixed deposit can help you earn higher returns
Conclusion
A financial intermediary provides a middle ground between two parties in any financial transaction. There are various types of financial intermediaries, such as banks, insurance companies, credit unions, mutual fund companies, and building societies. Understanding financial intermediaries is crucial for making informed financial decisions in India. By knowing the different players in the market and the services they offer, individuals and businesses can leverage the financial system effectively to achieve their financial goals.
