Role and Effects of Financial Intermediaries - Essay Example

Order 142001 Topic: Role and Effects of Financial Intermediaries Introduction This paper seeks to analyse and discuss the roles of and effect of financial intermediaries. We will first start by defining what a financial intermediaries is, then we will list and explain a little bit about what are the types of financial intermediaries. Afterwards, we will analyse and discuss the role and effects of these financial intermediaries grouping them in deposit takers and non deposit takers. What are the financial intermediaries? The term financial intermediary may refer to an institution, firm or individual who performs intermediation between two or more parties in a financial context. Typically the first party is a provider of a product or service and the second party is a consumer or customer. In the U.S., a financial intermediary is typically an institution that facilitates the channelling of funds between lenders and borrowers indirectly. That is, savers (lenders) give funds to an intermediary institution (such as banks), and then that institution in turn gives those funds to spenders (borrowers). This may be in the form of loans or mortgages. Alternatively, they may lend the money directly via the financial markets. (Wikipedia, 2006) (Paraphrasing made) Riskinstitute (n.d) said, “The FSA provides that no person shall carry on, or purport to carry on, investment business in the UK unless he is authorised or exempted from authorisation (FSA, s.3). It explained that pursuant to the FSA, a person carries on investment business in the UK if he carries on investment business from a permanent place of business maintained by him in the UK or if he engages in an activity in the UK which falls within one of several categories identified in Part II of Schedule I to the FSA and are not excluded by Part III and, in respect of that activity, he is not an exempt person. It explained, “A financial intermediary is, therefore, subject to regulation in the UK where investment business is carried on from a UK base, wherever the customer is situated. A financial intermediary will also be subject to UK regulation where that financial intermediary, not operating from a UK base, nevertheless carries on business from overseas into the UK (e.g., soliciting UK customer business). Certain exceptions apply in the latter case, e.g., where the overseas person is: transacting with a UK authorised person; responding to an initiative taken by a UK investor or continuing an existing business relationship with him; or promoting his investment services in accordance with the advertising and cold-calling rules, provided that overseas person is not otherwise restricted by the provisions of the FSA.” What are the types of financial intermediaries? Financial intermediaries can be: banks; building societies; credit unions; financial adviser or broker; insurance companies; life insurance companies; mutual funds; or pension funds. Each is briefly described below: A bank is a business that provides banking services for profit. Traditional banking services include receiving deposits of money, lending money and processing transactions. Some banks (called Banks of Issue) issue banknotes as legal tender. Many banks offer ancillary financial services to make additional profit; for example: selling insurance products, investment products or stock broking. (Wikipedia, 2006) The business of banking is regulated and banks require permission to trade under different jurisdictions. Authorization to trade is normally granted by bank regulatory authorities and provide rights to conduct the most fundamental banking services such as accepting deposits and making loans (Wikipedia, 2006) (Paraphrasing made). Building Societies – Wikipedia (2006) provides, “A building society is a financial institution, owned by its members, that offers banking and other financial services, especially mortgage lending.” It also said that the term building society first arose in the 19th century, in the United Kingdom, from working mens co-operative savings groups: by pooling savings, members could buy or build their own homes. It added that in the UK today building societies actively compete with banks for most "banking services" especially mortgage lending and deposit accounts and that as of 2006 there are 61 building societies in the UK with total assets exceeding £280 billion (Wikipedia, 2006)). A credit union is another type of financial intermediary. It is a not-for-profit co-operative financial institution that is owned and controlled by its members, through the election of a volunteer Board of Directors elected from the membership itself. Only a member of a credit union may deposit money with the credit union, or borrow money from it (Wikipedia, 2006) (Paraphrasing made). Wikipedia (2006) further explained that a credit union differs from a traditional financial institution (banks, savings and loan, etc.) in that the members who have accounts in the credit union are the credit unions owners. It added that a credit union is a co-operative institution, with policies governing interest rates and other matters set to benefit the interests of the membership as a whole, hence, credit unions have historically marketed themselves as providing superior member service and being committed to helping members improve their financial health. Further it said that credit unions typically pay higher dividend (interest) rates on shares (deposits) and charge lower interest on loans than banks and that credit union revenues (from loans and investments) do, however, need to exceed operating expenses and dividends (interest paid on deposits) in order to maintain capital and solvency. One thing however is noticeable, that is, the lowered profitability of most credit unions relative to banks is indicative of credit unions focus on serving members, whereas banks must be concerned with maximizing profits in order to enhance stock performance (Wikipedia, 2006) (Paraphrasing made). Financial adviser or broker -- A financial adviser is a professional who renders consulting services to individuals and households on strategic as well as short-term financial planning, investing and budgeting. Ideally, the financial adviser helps the client maximize their net worth by proper asset allocation. Most financial advisers receive their remuneration by commission payments on the various financial products that they broker. (Wikipedia, 2006) Insurance Companies --- Wikipedia (2006) explained that insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of catastrophic financial loss. Insurance is defined as the equitable transfer of the risk of a potential loss, from one entity to another, in exchange for a premium and duty of care. Life Insurance Companies --- “Life insurance (life assurance in British English) is a type of insurance”, Wikipedia (2006) said. It added that as in all insurance, the insured transfers a risk to the insurer. The insured pays a premium and receives a policy in exchange. In this contract, the risk assumed by the insurer is the risk of death of the insured. As to how life insurance works, Wikipedia (2006) explained that life insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insureds death. In return, the policyowner (or policy payor) agrees to pay a stipulated amount called a premium at regular intervals (Wikipedia, 2006) (Paraphrasing made). Wikipedia (2006) explained that there are three parties in a life insurance transaction; the insurer, the insured, and the owner of the policy (policyholder), although the owner and the insured are often the same person. Another important person involved is the beneficiary, is the person or persons who will receive the policy proceeds upon the death of the insured and is not a party to the policy, but is designated by the owner, who may change the beneficiary unless the policy has an irrevocable beneficiary designation. Mutual fund is a collective investment scheme. Wikipedia (2006), define “A collective investment scheme is a way of investing money with other people to participate in a wider range of investments than may be feasible for an individual investor and to share the costs of doing so.” It explained that terminology varies with country but collective investment schemes are often referred to as managed funds, mutual funds or simply funds (note: mutual fund has a specific meaning in the US) and that around the world large markets have developed around collective investment and these account for a substantial portion of all trading on major stock exchanges. (Wikipedia, 2006) (Paraphrasing made). Wikipedia (2006) further said that collective investments are promoted with a wide range of investment aims either targeting specific geographic regions (e.g. Emerging Europe) or specified themes (e.g. Technology). It explained that depending on the country there is normally a bias towards the domestic market to reflect national self-interest, familiarity and the lack of currency risk and that funds are often selected on the basis of these specified investment aims, their past investment performance and other factors such as fees (Paraphrasing made). “A pension is a steady income given to a person (usually after retirement)”, accords to Wikipedia. It also said that Pensions are typically payments made in the form of a guaranteed annuity to a retired or disabled employee. Some retirement plan (or superannuation) designs accumulate a cash balance (through a variety of mechanisms) that a retiree can draw upon at retirement, rather than promising annuity payments. It added that these are often also called pensions and that in either case; a pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. It further added that labour unions, the government, or other organizations may also sponsor pension provision. (Paraphrasing made). The role and effects of the financial intermediaries and grouping whether one is deposit taker and non deposit taker. Financial intermediaries do perform intermediation. Financial intermediation is believed to improve economic efficiency in at several ways. It can facilitate transactions or portfolio creation. It can also ease household liquidity constraints and spread risks over time and can reducing the problem of asymmetric information. (Anonymous, n.d) (Paraphrasing made) Intermediaries are part of the financial institutions. Anonymous (n.d) said, “Institutions which permit indirect lending (financial intermediaries) include both deposit-takers and non-deposit-takers.” It classified financial institutions into types. It gave as example the types of financial institutions at present under the Canadian financial system into three broad categories of financial institutions and these are 1) deposit-taking institutions; 2) insurance companies and pension funds; and 3) investment dealers and investment funds. In addition, there are government financial institutions. As to deposit Deposit-Taking Institutions, Anonymous also called these depository institutions, which accept and manage deposits and make loans under two types and they are chartered banks and near banks. It explained that chartered banks are relatively large and federally regulated, while near banks are regulated by a combination of federal and provincial regulations while near banks consist of: 1) trust companies; 2) mortgage loan companies; and 3) credit unions (caisses populaires in Quebec) (Paraphrasing made) Anonymous also mentioned that in the case of Canada, some government financial institutions also accept deposits. Thus it said, “Government Financial Institutions: Deposit-taking government institutions such as Alberta savings institutions and other agencies such as the Federal Business Development Bank and the Canada Deposit Insurance Corporation (CDIC) are included in this category.” He explained that financial intermediaries are part of the financial institution under the Four Pillars in Canada. Anonymous (n.d.) explained: “The emphasis of regulating financial institutions in Canada was designed to create four pillars, each specializing in one and only one function as follows: 1) chartered banks in personal loans, commercial loans, and deposits; 2) trust companies and credit unions in fiduciary responsibilities and personal loans and deposits; 3) insurance companies in underwriting insurance contracts; and 4) investment dealers in underwriting and brokering securities. Over time, regulatory reforms deregulation in particular, and increased international competitiveness has largely eroded the separation of the four pillars.” Conclusion: Financial intermediaries perform critical functions for the economy of every nation in the world. They help in keeping the economy on the go by making funds available to those who need funds after taking from those who do not need those extra funds. Reference: Anonymous (n.d.) CHAPTER 3: The Role of Financial Intermediaries and Financial Markets {www document} URL http://www.emu.edu.tr/~ngungor/bnfn%20318/CHAPTER%2016-318.doc, Accessed November, 27, 2006. Wikipedia (2006) Banks {www document} URL; http://en.wikipedia.org/wiki/Bank, Accessed November 27, 2006. Wikipedia (2006) Building Societies, {www document} URL http://en.wikipedia.org/wiki/Building_society, Accessed November 27, 2006. Wikipedia (2006) Credit Unions, {www document} URL http://en.wikipedia.org/wiki/Credit_Union, Accessed November 27, 2006. Wikipedia (2006) Financial adviser , {www document} URL http://en.wikipedia.org/wiki/Financial_adviser, Accessed November, 27, 2006. Wikipedia (2006) Financial Intermediaries (2006), {www document} URL Wikipedia (2006) Insurance (2006) {www document} URL http://en.wikipedia.org/wiki/Insurance, Accessed November 27, 2006. Wikipedia (2006) Life Insurance (2006) , www document} URL http://en.wikipedia.org/wiki/Life_Insurance, Accessed November 27, 2006. Wikipedia (2006) Mutual Funds, {www document} URL http://en.wikipedia.org/wiki/Collective_investment_scheme, Accessed November, 27, 2006. Riskinstitute (n.d)Financial Intermdiaries Part 1 {www document} URL, http://riskinstitute.ch/137140.htm, Accessed November, 27, 2006. Read More