Question

Answer the question below Please in 150 - 200 words atleast

1. Explain the benefits of intermediation and the role of banks?

Answer 1

A financial intermediary is an entity that facilitates a financial transaction between two parties. Such an intermediary or a middleman could be a firm or an institution. Some examples of financial intermediaries are banks, insurance companies, pension funds, investment banks and more.

THE ROLE OF BANKS/FUNCTIONS OF FINANCIAL INTERMEDIARIES

A financial intermediary performs the following functions:

As said before, the biggest function of these intermediaries is to convert savings into investments.

Intermediaries like commercial banks provide storage facilities for cash and other liquid assets, like precious metals.

Giving short and long term loans is a primary function of the financial intermediaries. These intermediaries accept deposits from the entities with surplus cash and then loan them to entities in need of funds. Intermediaries give the loan at interest, part of which is given to the depositors, while the balance is retained as profits.

Another major function of these intermediaries is to assist clients to grow their money via investment. Intermediaries like mutual funds and investment banks use their experience to offer investment products to help their clients maximize returns and reduce risks.

ADVANTAGES OF FINANCIAL INTERMEDIARIES

They help in lowering the risk of an individual with surplus cash by spreading the risk via lending to several people. Also, they thoroughly screen the borrower, thus, lowering the default risk.

They help in saving time and cost. Since these intermediaries deal with a large number of customers, they enjoy economies of scale.

Since they offer a large number of services, it helps them customize services for their client. For instance, banks can customize the loans for small and long term borrowers or as per their specific needs. Similarly, insurance companies customize plans for all age groups.

They accumulate and process information, thus lowering the problem of asymmetric information.

Let us consider a simple example that will help us understand these advantages better. Suppose you need some loan, but you don’t know who has enough money to give you. So, you contact a middleman, who in turn is in contact with those with surplus money.

Reading the above points, it is clear that financial intermediaries play a very important role in the economic development of the country. They play even bigger role in the developing countries, including helping the government to eliminate poverty and implement other social programs.