The significant role of financial intermediaries Essay

The significant role of financial intermediaries - Essay Example In the process of redistributing savings into productive uses, financial intermediaries combine small savings into substantial pools of capital which are re-lent to a wide number and variety of borrowers, or invested in various forms of securities, thus providing risk diversification and liquidity. Intermediation is defined as the placement of money with a financial intermediary which invests in bonds, stocks, mortgages, loans, money market securities and government obligations to achieve targeted returns. Essential to understanding the intermediation market is the existence of a direct credit market where borrowers or investors meet and transact financial business directly with the providers of funds. An example is a cash-rich business which purchases a commercial paper directly from a finance company. Another would be a household that buys a new share of stock of an industrial company from a stockbroker which underwrote the issue. No financial intermediary was involved here because it was not necessary. A financial intermediary plays a significant role only when hindrances or inefficiencies can occur, such as when the denomination, maturity, and other security characteristics do not match exactly the desires and requirements of the SSU. When a household has available funds of only â‚ ¤500, it would not be able to participate in buying a bond issue denominated at â‚ ¤5000 each. Financial intermediaries come into the picture when it buys direct claims from the DSUs with specific security characteristics (maturity, denomination, and liquidity) and sells indirect claims to SSUs packaged to conform to the specific requirements of the market.