Investment banking now plays a vital role in the derivatives market as well as the money market. It is one of the most essential financial practices that help upgrade the nation's economy.
However, the role of financial intermediaries is much more pivotal in the case of investment banking. They act as a catalyst between two parties in a transaction. They come with tons of benefits to a consumer regarding safety, liquidity, and economies of scale. Even though in most cases, investment bankings try to eliminate the intervention of an intermediary, it curbs much more threats than in other areas of finance.
In this article, let's learn in detail about financial intermediation, alongside its types and roles to play in the financial sector.
What is Financial Intermediation?
To put it into simple words, a financial intermediation is a catalyst that acts as a middleman between two parties in a financial transaction. Financial intermediation is commonly used by investment banks, commercial banks, and mutual funds. It is a very beneficial catalyst for an average consumer that ensures the utmost safety of the bank and its assets.
Financial intermediation often forms a safe environment for conducting financial transactions seamlessly. It is also a very flexible form of a catalyst and is not only restricted to third-party lenders and borrowers. Financial intermediation also holds the liability to adhere to the reserve bank and stock exchange guidelines.
Types of Financial Intermediation
Financial intermediation is not only limited to mutual funds and commercial banks. It is a huge spectrum and regulates various transactions inside a safe environment. Here are some examples of financial intermediation that would help you to understand its key functions in detail. They are:
- Commercial Banks: The relationship between lender and borrower is simplified.
- Stock Exchange: Shares and other stock exchanges are intermediated and centralised which further becomes easier access to both buyers and sellers.
- Pension and Mutual Funds: Future fund holders pay the current fund holders.
- Factoring Provider: In this case, the factoring clients often receive money from their providers to maintain the equilibrium of their outstanding receivables and enforce liquidity.
- Insurance: Over here, insurance companies act as an intermediary to protect their clients from various risks.
Role of Financial Intermediation in Investment Banking
Investment banking is one of the best ways to incorporate financial intermediation. They primarily create a central platform for intermediation enabling both parties for financial transactions. This is efficient from both sides.
Here are some roles that investment banks generally play when it comes to financial intermediation. They are:
Banks are primarily known to safeguard your money and also maintain a lender-borrower relationship with you from time to time. In layman's terms, banks earn money and offer their services in exchange for receiving payments via interest and other fees. Banks are also under commission for selling a financial product.
Be it an investment bank or a commercial bank, both of them generate profit primarily by granting loans or providing fruitful investments. For investment banks, profit maximisation holds paramount importance. They are only achieved through stock market products, commodities, and real estate.
In other words, financial intermediaries in a capital market are known as brokers. They help the investor to choose from a suitable stock market they would like to explore and buy their shares. For their brokerage, the investor has to pay a reasonable amount to their brokers for their service.
Sometimes these brokers or financial intermediaries focus on electronic exchanges for direct trading. The brokers primarily work for Fintech companies offering customers low-cost access to stock exchange products. These financial intermediaries finance themselves via commissions which are further received from brokering securities of electronic exchanges.
Advantages and Disadvantages of Financial Intermediaries
Financial intermediation comes with both advantages and disadvantages. However, one has to dodge the disadvantages and take 'advantage' of their merits. Let's find out what they are:
- Financial intermediaries create a central market for financial transactions.
- They help in scaling the bureaucracy appropriately and take great care in advising clients for processing transactions.
- Financial intermediaries are extremely cost-efficient and have optimal security measures to acclimate to any adversities.
- Bigger financial intermediaries can spread their risks by investing more money from their clients in various financial products.
- Financial intermediaries help in reducing client risks.
- Financial intermediaries enable clients to make special use of financial services to point out seamless solutions in no time.
- Financial intermediaries are selfish and tend to cater to their own interests.
- The fees of financial intermediaries are much higher than the actual investment. This is mainly due to the profit that the intermediary wants to cover to make a profit.
- Financial intermediaries are often misleading and might not know the proper whereabouts of the market.
The existence of financial intermediation is not a new concept but has been in existence for decades. However, with digital transformation, the use of financial intermediation is reduced from time to time.
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