Question

Describe the role of financial intermediaries.

Answer 1

Financial intermediaries are those entities that connect people and institutions who need money with those that have money. Examples of Financial intermediaries are commercial banks,non-banking financial institutions, insurance companies, pension funds,mutual funds etc. These entities help needy people and institutions to mobilize and to access money for their utilization.

The role of Financial intermediaries are-

1)By connecting the ultimate lenders (or savers) and ultimate borrowers together,they reduce the blockage of unnecessary idle cash in economy and helps to channelize those cash for better utilization.

2)FIs also help the non-financial business sector by financing it through loan’s, mortgages, purchase of bonds, shares, etc. Thus they facilitate investment in plant, equipment and inventories.

3)FIs buy and sell central government securities and state govt. bonds and thus they help the central government,state government and local bodies financially.

4)FIs assembles greater resources than individuals to bear and spread risks among different borrowers because of their large size and diversification of their portfolios. savers of funds with FIs i.e the lenders earn interest as well as when FIs lend to ultimate borrowers, they earn profits. Profit of the FIs arises from the difference between the rate of return provided by the FI to the lenders and the rate of interest charged by FI from the borrowers.

5)Competition among FIs leads to the lowering of interest rates. FIs prefer to keep their savings with FIs rather than in cash. The FIs, in turn, invest them in primary securities. Consequently interest rates fall and prices of the securities are maintained.

6)FIs deal in a variety of assets and liabilities which are mostly traded in the capital market.As FIs function within a legal framework and set rules, they provide stability to the capital market and reduced the threat of stock scam.

7)By transferring funds from surplus to deficit units, FIs help the economy in executing monetary and credit policies of the central bank and hence in promoting the growth of an economy.

8)FIs provide liquidity when they convert an asset into cash easily and quickly without loss of value in terms of money and thereby helps maintain their liquidity in economy.

9)Since they offer a large number of services, it helps them to provide customize services for their client. For instance, banks can customize the loans for small and long term borrowers or as per their specific needs.

10)They are also providing refinancing facility to agencies such as HUDCO (Housing and Urban Development Corporation). Thus they are helping the economy by helping the housing sector and In order to prevent regional disparities, financial intermediaries have been advancing loans to industries which are started in backward areas. Government has given certain concessions in the form of tax benefits to such industries and banks provide cheap loans so that the backward areas could attract more industries.Thus FI s are helping in the development of economy.