Financial Intermediaries Paper - FIN 324

Essay by kymberly76University, Master'sA+, April 2004

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In its broadest sense, the term "intermediary" includes any person who serves to bring other persons together. In the world of corporate finance, a financial intermediary is an institution that acts as a middleman between savers and borrowers. Specifically, these institutions accumulate money from investors and lend it to borrowers. A person with extra money could seek out borrowers alone and bypass intermediaries altogether (Schenk). By removing the middleman, the saver would most likely receive a higher return. So why then, do so many savers and borrowers use intermediaries? This paper will discuss the roles of financial intermediaries, as well as the two most important advantages of these institutions. A discussion of the importance of the most common financial intermediaries will also be included.

Financial intermediaries provide two important advantages to depositors. The first advantage is that lending through an intermediary is usually less risky than lending directly. The intermediary has the ability to diversify.

Financial intermediaries make a considerable number of loans, and while a percentage of them will be unsound, the losses are largely balanced by the profitable loans. Consequently, the average depositor could only directly make a handful of loans and any unsound loans would significantly affect his personal wealth. Intermediaries have the ability to put their "eggs" in many "baskets," thus ensuring minimal risk to its depositors (Schenk).

The second important advantage financial intermediaries' offer is liquidity. Liquidity is the ability to quickly turn an asset into cash. Real estate property is considered an illiquid asset; selling a home can take a great deal of time. For example, if an individual loans money to another person, this loan can also be considered an illiquid asset. If the lender needs cash, collecting quickly on the loan may be very difficult. Even though an intermediary may...