Question

Describe how financial intermediation and financial innovation affect banking.

Answer 1

Financial intermediation is the process by which institutions connect lenders to borrowers or transfer funds from those who have excess funds to those who are in need of funds. This results in better availability of money to businesses and better returns to people. As a result, it also results in enhanced growth of the country because the factors affecting GDP like private investment, etc increase.

In the recent past, various kinds of financial intermediaries and financial innovation have taken place. If we compare the financial industry now to what it was before, we will observe that earlier larger portions of financial activities were taken up by depository institutions and thrifts, etc. People depended majorly on such institutions to invest their savings and hence the returns they could expect was also limited. With the advent of new kinds of financial institutions like hedge funds, non-banking financial companies (NBFCs), etc that is hardly the case now. People have access to various sources to invest and gain returns according to their risk profiles. Not only in terms of business models, but technology has also taken a big role in reshaping the financial services industry. Earlier, a person trading in the markets had to call up his/her broker to get the prices and execute decisions on his/her behalf. With rapid changes in technology, people have more freedom now to take better decisions and in a faster way. Hence, the overall effect of financial intermediation and financial innovation has expanded the market for financial services. People have more trust now than before and with the up and coming technologies like Blockchain, this is only going to improve the situation to a more advanced state.