Financial intermediary

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A financial intermediary is a financial institution that connects surplus and deficit agents. The classic example of a financial intermediary is a bank that consolidates deposits and uses the funds to transform them into loans.[1]

Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities.[1] As such, financial intermediaries channel funds from people who have extra money or surplus savings (savers) to those who do not have enough money to carry out a desired activity (borrowers).[2]

A financial intermediary is typically an institution that facilitates the channeling of funds between lenders and borrowers indirectly.s.[3] That is, savers (lenders) give funds to an intermediary institution (such as a bank), and that institution gives those funds to spenders (borrowers). This may be in the form of loans or mortgages.[4] Alternatively, they may lend the money directly via the financial markets, which is known as financial disintermediation.

In the context of climate finance and development, financial intermediaries generally refer to private sector intermediaries, such as banks, private equity, venture capital funds, leasing companies, insurance and pension funds, and micro-credit providers.[5] Increasingly, international financial institutions provide funding via companies in the financial sector, rather than directly financing projects.[6]

Functions performed by financial intermediaries[edit]

Financial intermediaries provide three major functions:

  1. Creditors (finance) provide a line of credit to qualified clients and collect the premiums of debt instruments such as loans for financing homes, education, auto, credit cards, small businesses, and personal needs.
    Converting short-term liabilities to long term assets (banks deal with large number of lenders and borrowers, and reconcile their conflicting needs)
  2. Risk transformation[citation needed]
    Converting risky investments into relatively risk-free ones. (lending to multiple borrowers to spread the risk)
  3. Convenience denomination
    Matching small deposits with large loans and large deposits with small loans

Advantages and disadvantages of financial intermediaries[edit]

There are two essential advantages from using financial intermediaries:

  1. Cost advantage over direct lending/borrowing[citation needed]
  2. Market failure protection the conflicting needs of lenders and borrowers are reconciled, preventing[citation needed] market failure

The cost advantages of using financial intermediaries include:

  1. Reconciling conflicting preferences of lenders and borrowers
  2. Risk aversion intermediaries help spread out and decrease the risks
  3. Economies of scale using financial intermediaries reduces the costs of lending and borrowing
  4. Economies of scope intermediaries concentrate on the demands of the lenders and borrowers and are able to enhance their products and services (use same inputs to produce different outputs)

Various disadvantages have also been noted in the context of climate finance and development finance institutions.[7] These include a lack of transparency, inadequate attention to social and environmental concerns, and a failure to link directly to proven developmental impacts.[8]

Types of financial intermediaries[edit]

Financial intermediaries include:[citation needed]

Summary and conclusion[edit]

Financial institutions (intermediaries) perform the vital role of bringing together those economic agents with surplus funds who want to lend to those with a shortage of funds who want to borrow.[9]

In doing this they offer the major benefits of maturity and risk transformation. It is possible for this to be done by direct contact between the ultimate borrowers, but there are major cost disadvantages of direct finance.[citation needed]

Indeed, one explanation of the existence of specialist financial intermediaries is that they have a related (cost) advantage in offering financial services, which not only enables them to make profit, but also raises the overall efficiency of the economy. The other main explanation draws on the analysis of information problems associated with financial markets.[10]

See also[edit]


  1. ^ a b Siklos, Pierre (2001). Money, Banking, and Financial Institutions: Canada in the Global Environment. Toronto: McGraw-Hill Ryerson. p. 35. ISBN 0-07-087158-2. 
  2. ^ Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 272. ISBN 0-13-063085-3. 
  3. ^ Global Shadow Banking Monitoring Report 2013 (PDF). Global: FSB. 2003. p. 12. ISBN 0-07-087158-2.  |first1= missing |last1= in Authors list (help)
  4. ^ Robert E. Wright and Vincenzo Quadrini. Money and Banking: Chapter 2 Section 5: Financial Intermediaries.[1] Accessed June 28, 2012
  5. ^ Institute for Policy Studies(2013), "Financial Intermediaries", A Glossary of Climate Finance Terms, IPS, Washington DC
  6. ^ Eurodad (2012), "Investing in financial intermediaries: a way to fill the gaps in public climate finance?", Eurodad, Brussels
  7. ^ Institute for Policy Studies(2013), "Financial Intermediaries", A Glossary of Climate Finance Terms, IPS, Washington DC
  8. ^ Bretton Woods Project (2010)"Out of sight, out of mind? IFC investment through banks, private equity firms and other financial intermediaries", Bretton Woods Project, London
  9. ^ The Role Of Financial Intermediaries, retrieved 16 April 2015 
  10. ^ Gahir, Bruce (2009). "Financial Intermediation". Prague, Czech Republic. 


  • Pilbeam, Keith. Finance and Financial Markets. New York: PALGRAVE MACMILLAN, 2005.
  • Valdez, Steven. An Introduction To Global Financial Markets. Macmillan Press, 2007.