The Role That Financial Intermediaries Play - Essay Example

The Role That Financial Intermediaries Play In The Domestic Financial System College 144792 "The term financial intermediary may refer to an institution, firm or individual who performs intermediation between two or more parties in a financial context.[4] "Financial intermediaries may include banks, broker-dealers, investment advisers and financial planners"[3]. In the U.S., a financial intermediary is typically an institution that facilitates the channeling of funds between lenders and borrowers indirectly.

"The financial system plays a key role in the smooth and efficient functioning of the economy. The most fundamental contribution that any financial system makes is to channel resources from individuals and companies with surplus resources to those with resource deficits. In doing so, the financial system not only satisfies savings needs of the economy but also facilitates the accumulation of investment capital that is critical to growth and development." (J. Carmichael & M. Pomerleano, 2002).

[5] The financial intermediaries are important in regulating and distributing the financial resources in the economy. The intermediaries in general and the banks in particular, help the Federal Reserve and the State Banks of economy to regulate and manage the financial transactions and controls in the economy. In any economy, growth is directly affected by the accumulation of input factors of production and the technical knowledge that is used to convert inputs to outputs. In the input factors, financial and capital resources are of major importance.

These financial and capital factors are directly related to the financial growth of industries and the economy. Financial sector and banks are major facilitators of economic growth. For economies to prosper and reach to their potential, they should have good financial intermediation systems in place. "More specifically, financial development can affect growth through three main channels: (i) it can raise the proportion of savings channeled to investment, thereby reducing the costs of financial intermediation; (ii) it may improve the allocation of resources across investment projects, thus increasing the social marginal productivity of capital; and (iii) it can influence the savings rates of households, for example, if it induces a higher degree of risk sharing and specialization, which as a result stimulates higher growth.

"[1] The major advantage of the presence of financial intermediaries is that they act as collectors of financial resources from the suppliers and deliver them to the customers. The incentive in the form of their commission is earned in return for their intermediation services and at times providing support and help to both the parties. "Financial intermediaries therefore serve as the "go between" between lenders and borrowers. They take funds from those with surplus and give to those in deficit.

They pay the "lender" for the use of these funds and earn a return from borrowers. The difference between what they earn and pay is their reward for intermediation (spread, intermediation margin)."[2] A complex financial system comprises both financial markets and financial intermediaries. We distinguish financial intermediaries according to whether they issue complete contingent contracts or incomplete contracts. Intermediaries such as banks that issue incomplete contracts, e.g., demand deposits, are subject to runs, but this does not imply a market failure.

[6] With regard to the Central Bank, the central bank can easily regulate and delegate its duties to these financial intermediaries who are directly in touch with the final users of finances as well as the providers and suppliers of funds in the economy. For example, if the circulation of currency notes is considered, these intermediaries can act as consolidators of old notes and disburse the new notes to their customers and depositors. In this way, the central bank can do away with its duty to circulate them itself.

Similarly, various policies and controls can be designed by the central banks which are to be put in practice by these intermediaries. To summarize, the financial intermediaries play a vital role in regulating and managing financial resources of a financial system. With the presence of these financial intermediaries, the central banks and the reserve bank can put their policies in practice in a more efficient way. References 1. European Central Bank, Directorate Communications. The role of institutions in the financial system.

Retrieved December 14, 2006 from http://www.ecb.int/press/key/date/2003/html/sp031111.en.html 2. Kargbo, Osman. (December 03, 2005). The Role of Financial Intermediaries in the Economy. Retrieved December 14, 2006 from http://www.thepoint.gm/Economic%20Watch10.htm 3. Risk Institute. The role of financial intermediaries. Retrieved December 14, 2006 from http://riskinstitute.ch/135660.htm 4. Wikipedia. Financial Intermediaries. Retrieved December 14, 2006 from http://en.wikipedia.org/wiki/Financial_intermediary 5.

Financial Dictionary. Financial Intermediaries. Retrieved December 14, 2006 from http://financial-dictionary.thefreedictionary.com/Financial+intermediaries 6. Allen, Franklin., & Gale, Douglas. (January 2003). Financial Intermediaries and Markets. Retrieved December 14, 2006 from http://fic.wharton.upenn.edu/fic/papers/00/p0044.html