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Where does your business go when it needs some dough? One option is to speak to a financial intermediary. These people match parties who need money with financial resources. An example of this is a lender offering you a loan for your mortgage, a process known as intermediation.
TL;DR (Too Long; Didn't Read)
Financial intermediaries match parties who need money with the financial backing they need. There are several types, with the most well-known being commercial banks, credit unions and financial advisors.
Financial Intermediary Definition
Simply put, a financial intermediary is an entity that helps connect people and institutions that need money with those that have money. A few financial intermediaries examples are commercial banks, insurance companies, pension funds, financial advisors, credit unions and mutual funds. These entities help people and institutions access money.
For example, say you want to start a textile business and you happen to need $20,000 in startup costs. You could go around asking everyone you know to loan you the money, but there are probably few people in your life who would be willing to fork over such a sum. Plus, the process of randomly looking for a loan is consuming both your time and energy. Most likely, you will go to a lender to access the funds you need to get your business going. This is why lenders exist: to help connect those who have money with those who need it.
Functions of Financial Intermediaries
There are numerous functions of financial intermediaries, depending on the type of institution. The most important is that financial intermediaries transfer funds from one party to another. This results in making the cost of business cheaper, because business owners can quickly and easily access the resources they need.
Other important functions of financial intermediaries is that they provide safety in accessing money and spread the risk. For example, think about your health insurance policy. You pay a premium each month, and if you happen to need expensive surgery, the insurance company gives you access to the money you need to pay for that surgery. Because so many people are in the health insurance pool and paying premiums, the risk is spread. Most policyholders will not need an expensive surgery in a given year, so the money is spread out and able to go to those who need it.
Another example of this is a car loan. Lenders spread their money across thousands of buyers, so if a few people don’t pay off their loans and default, it doesn't throw off the entire group. Of course, financial intermediaries must lend responsibly in order to properly spread risk.
Examples of Financial Intermediaries
Several different types of financial intermediaries serve different functions in the economy. These are a few of the most popular examples of financial intermediaries:
- Commercial banks.
- Investment banks.
- Insurance companies.
- Credit unions.
- Financial advisors.
- Pension funds.
- Mutual funds.
- Investment trusts.
Financial intermediaries are an important part of the economy. They are used by nearly everyone, from consumers to businesses to government entities.
Chelsea Levinson earned her B.S. in Business from Fordham University and her J.D. from Cardozo. She is a small business owner who has created content for Bank of America, H&R Block, CNBC, AOL and many more.