The Roles of Financial Intermediaries and Brokers

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1. Financial Intermediaries

Financial systems are important to an economy. Functioning well, it greases the wheel of trade, investment, and savings. Functioning poorly, it paralyses a nation and becomes the conduit of financial contagion. It does so by performing a fundamental task: channeling funds. Funds are channeled rapidly into and out of a country, responding to changes in consumer choice, by financial intermediaries (banks, investment houses, and so on) and financial markets (stock and bond markets), the two main components of the financial system.

Given the existence of surplus and deficit economic units, or a supply of and a demand for loanable funds, some financial conduit is necessary if the excess funds of surplus units are to be transferred to deficit units. The needs of these units may be reconciled either through direct financing or through financial intermediaries.

Financial intermediaries performing so-called indirect financing, assist in resolving the conflict between lenders and borrowers by creating markets in two types of financial instruments, i.e. one type for borrowers and another for lenders. They offer claims against themselves, tailored to the liquidity and maturity needs of the lenders, in turn acquiring claims on the borrowers. The former claims are usually referred to as indirect securities and the latter as primary securities.
The financial intermediaries, of course, receive a fee, represented by the difference between the cost of their indirect securities and the revenue from the primary securities held.

The functions of financial intermediaries:

A number of benefits flowing from the economic system are produced by the ability of financial intermediaries to transmute the unacceptable claims on borrowers into acceptable claims on themselves. Firstly, through aggregating small amounts of funds for on-lending in larger parcels, liquidity is created for the lender. Secondly, through investing in a diverse portfolio of primary securities a financial intermediary can achieve a more efficient diversification of risk than an individual lender. Thirdly, by providing liquidity and reducing risk, financial intermediaries are able to tap savings that would otherwise not have been available. In the fourth place, by facilitating the availability of finance these institutions ease the constraint of income on expenditure, thereby enabling the consumer to spend in anticipation of income and the entrepreneur to acquire physical capital. Finally, through their ...