The Concept of Financial Intermediation

I. Introduction

Financial intermediation is usually understood as a process of connecting lenders and borrowers, performed by banks and other intermediaries . It is a main basis of all financial systems, which are extremely important for capitalist economies. It allows banks to make profits and is one of the sources of economies’ well-being.

Why is financial intermediation so important? Because it brings together economic agents with surplus who want to lend money and those with insufficient funds who need to borrow. Also, financial intermediaries are companies, whose goal is to make profits and they do so by fulfilling the proverb of the banking world “Lend high and borrow low”.

First of all, the vast percentage of external money comes from banks. As seen in the table below, in the USA alone, about 25% of the companies’ assets comes from bank loans. They are the main source of external funding in all countries.

As the primary source of outside funding, banks take on important functions in corporate administration, particularly during periods of firm distress and failure. They are their “guardian angels” and loans are sources of information if the bank should intervene or not. Moreover, many bankers are on the boards of directors.

Individual customers use financial intermediation in everyday life: when they want to invest in checking or savings account, when they take loan for a new house or car, etc.

II. Functions of financial intermediation

1. Maturity transformation

The first function of financial intermediation is maturity transformation. It’s converting short-term liabilities into long-term assets. It simply means that banks borrow money for shorter periods than they lend it.

Every day, customers lend money to the banks ...

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...ities, because of the highly predictable inflow of cash.

4. Mutual funds

Mutual funds sell equity shares to investors and use them to purchase stocks and bonds. The advantage of a mutual fund is that it allows small investors to invest less risky because of diversification, economies of scale and professional financial managers.

Works Cited

Kidwell, D. S., Blackwell, D. W., Whidbee, D. A., & Peterson, R. L. (2008). Financial Institutions, Markets, and Money. Jefferson City: John Wiley & Sons Inc.

Mayer, C. (1990). Financial Systems, Corporate Finance, and Economic Development. In R. G. Hubbard, Asymmetric Information, Corporate Finance, and Investment. Chicago: University of Chicago Press.

Pilbeam, K. (2005). Finance and Financial Markets. New York: PALGRAVE MACMILLAN.

Valdez, S. (2003). An Introduction To Global Financial Markets. New York: Palgrave Macmillan.