Business columnists throw around the term “financial intermediary” often enough that you might wonder what it refers to. Financial intermediaries are a critical part of our modern economy, so it is important to understand their function.
A simple definition of “financial intermediaries” is “Institutions that provide the market function of matching borrowers and lenders or traders. [Source: Yahoo Financial Glossary. Top News Archive – Yahoo! Finance. N.p., n.d. Web. 19 Nov. 2010. ]
Take, for example, a typical commercial bank. Consumers deposit excess money in their checking accounts (and thereby, perhaps without thinking about it, become lenders); the bank then lends a portion of that money to borrowers (e.g., mortgage holders).
If it were not for financial intermediaries, most people would not be able to buy a car or a home. Without intermediaries, you personally would have to go and find someone willing to lend you the money to make your purchase. And your excess cash would likely sit idle some place, because you would not want to go the trouble of evaluating potential borrowers and making loans.
Financial intermediaries provide another important service to society, in an incidental way, by multiplying the amount of money in the economy. If you deposit $1000 in a checking account, the bank is required by law to keep a certain percentage of your money in its reserves (for this hypothetical, assume the bank must retain 10% or $100), but the rest can be loaned out. So the bank loans $900 to someone else, who deposits that $900 in another bank. Then that other bank keeps 10% of the $900 in reserves and loans out the remaining $810 to someone else, who deposits that $810 in another bank, and so forth. The money that falls into a financial intermediary’s hands is typically loaned out multiple times in this way.
So, although the primary function of financial intermediaries (i.e., matching lenders with borrowers) might seem simple, these institutions benefit society by making it amazingly easy for creditworthy individuals to borrow money and by multiplying the money available for lending.
Yahoo Financial Glossary. Top News Archive – Yahoo! Finance. N.p., n.d. Web. 19 Nov. 2010. .