Financial intimidation can define as institutional activities that engaged in financial transactions by incurring liabilities to acquire financial assets using Accounts. Finance intermediaries are very important for business organizations as external fund source. Financial Intermediaries are Banks, Credit Units, Non-Banking Finance Companies, Stock Exchanges, Collective Investment Schemes, Mutual Fund Companies, Insurance Companies, Financial advisors or Brokers, Investment Bankers, Esc row Companies, Pension Funds and Building Societies. Financial intermediaries facilitate for financial transactions in an economy. Financial intermediation is collecting funds from savers or lenders and lending money for business organisations which are needed investments. So, Financial intermediation more important for growth of an economy for productive capital formation.
Financial development is a compulsory thing need for steady economic growth. So strong finance system needs for finance development in an economy. Strong finance system includes different financial intermediaries. Role of the finance intermediaries are very important for development of an economy. Money play neutral role in an economy. Finance system manage money supply in an economy.
Role of the finance intermediaries are very important for Capital accumulation. Collect and retain saver’s deposits, pooling money that collected from savings and invest money in different investment opportunities, such as stocks. Financial institutions support to achieve economic objectives of the country. under the financial system financial intermediaries are importantly linked to economic growth and productivity improvement of the economy. With a strong finance system government can make more efficient economic decisions.
Role of financial institutions in Intermediation process.
Financial intermediaries pooling funds of small individuals.
Financial intermediaries collecting deposits of savers and poling funds collected from deposits of small individuals. Banks and finance companies, Credit Units, Non-Banking Finance Companies, Stock Exchanges, Collective Investment Schemes, Mutual Fund Companies, Insurance Companies, Financial advisors or Brokers, Investment Bankers, Esc row Companies, Pension Funds and Building Societies collecting deposits from surplus of money from different parties. They collect deposits such as Demand deposits, Savings deposits, Fixed deposits, Time deposits and Foreign currency deposits etc. When central bank control money supply of the economy banks and other deposits holding financial intermediaries should adhere the conditions and rules of the Central bank. Central bank influence on reserves holing ability of banks as open market operations. When central bank decrease reserve holding rate, increase money lending ability of banks. Then investments increase and funds available for different business organisations. In this way central bank control money supply of the economy. Interest rate is price for investment. So, cost of finance should maintain at low for stimulate investments. Demand for loans raise when cost of finances remain at law. Then investments also increase. So, under the financial intermediation investment in Research and Development, investment in physical capital and human capital enhance economic growth. Allocating funds in these investing activities of the economy, is a role of financial intermediaries.
Financial intermediaries arrange mechanisms for resources such as safe keeping accounting and access to payment systems.
Financial intermediaries influenced by Interest rate changes. When central bank control interest rate directly effects on borrower’s ability to borrow. Because, financial intermediaries’ response on it by changing money lending. So, financial intermediaries influence on borrower’s portability, collateral funds, assets values. Further, financial intermediaries provide accounting facilities such as fixed deposits, savings accounts of business, and give access to payment systems such as online banking, bill payments. And also, financial intermediaries safe keeping abilities for resources of customers such as jewelleries, substantial documents and other materials. They provide repository services in this way. Financial intermediaries Modernising payments and settlement system for provide better service to the customers. And banks and other financial intermediaries open branches in different areas to provide banking services for customers. Under this condition create competitive environment in finance sector and promote financial innovation.
Financial intermediaries provide liquidity for business organisations.
Financial intermediaries mainly facilitate for business organisations to manage liquidity of business organisations. They decrease credit risk of business organisations by guaranteeing their income and debits. Mainly in imports and exports business transactions. And also, induce excessive credit volume and price of assets.
Central bank under the monitory policy change interest rate focusing on control loan supply. Then funds available for business organisations to maintain business cycle and It cause to maintain economic growth. Under the higher interest increase savings and it create greater efficiency of capital allocation. Under this condition Increase availability of credit for business organisations. So, central bank establishes positive interest rate on deposits and loans by eliminating interest rate and credit ceilings, stop selective credit allocation and minimizing reserve requirements. And establish true scarcity price of capital by both savers and investors. Higher positive real interest rate will increase capital accumulation and thereby increases economic growth. And business organisations can make more efficient investment decisions.
Financial intermediaries minimize risk of funds by Investing in diversified investments opportunities.
Financial intermediaries reduce risk of collected funds by managing funds. They invest funds in diversified investment sources such as government bonds and treasury bills, stock exchange, real estates, savings, foreign banks and finance companies, mutual funds. Then reduce risk of saver’s money and increase trust of individuals. In developing countries bank system consider as an important external financing source for business organizations. Central bank raises average nominal deposits rate and under this condition the demand for broad money. As a result, a flow of real credits increases, enabling firms to obtain working capital and raises the output.
Financial intermediaries are collecting and processing information, minimize asymmetric information lines of credits and reduce the cost of contracting.
Agency problems can occur as the asymmetric information between borrowers and lenders. Agency problem means conflict of interests between investors or stakeholders and business’s management. Business organizations acquire funds from internal and external fund sources. The ability of acquire external finance premium based on the quality of the borrower’s balance sheet. And it varies on interest rate level set under the monetary policy. Under the better economic conditions. As improvement of the balance sheet quality, under the better economic conditions, decrease the external finance premium. Then increases borrowing and investment, which feeds the boom. If borrower’s balances sheets are deteriorated, a crisis can be generated by a decline in asset values, leading to an increase in the external finance premium and hence to lower investment and to reduced economic activity.
Financial intermediaries mobilize wholesale finance and lines of credit
Commercial banks allocate funds to public sector as a leading financial intermediary in Sri Lanka. Public sector credits are the large component of assets in a commercial bank assets structure. Under a matured financial system and stable economic environment reduce uncertainty of business environment and increase investor’s confidence. Financial intermediaries enable benefits of existing profit opportunities for investors. If an economy has weak link between financial intermediation and economic growth, that reflect inefficiencies in the credit allocation mechanism, probably requiring the strengthening of financial sector legislation and banking system supervision to enhance efficiency of finance sector.
Finance disintermediation means remove the middlemen or intermediaries within financial transactions. Financial intermediaries reduce their lending operations in this condition, because of savers withdraw deposits and unable to attract new depositors for generate funds. Savers withdraw their deposits from financial institutions such as banks, life insurance companies, finance companies and thrifts for the purpose of investing in stock or other investment plans. They directly connect with ultimate users of funds. Advancement of the internet and improvement of electronic exchanges are facilitating for effective and efficient platform for buying and selling finance instruments. And also contributes to less prominent roles for financial institutions in an economy. Mainly financial technology become as a reason for financial disintermediation. A matured finance system is critical thing in achieving economic development in any country. Financial institutions become a key pillar in promoting economic growth through allocating funds required for development, providing a mechanism for facilitating payments and practicing monetary regulation.
Financial technology disintermediates flow of funds such as banking services and other financial transactions between investor and investee lender and borrower directly connect with each other and carry out their transactions using internet and online banking. Therefore, they can do their transactions using fast and flexible technology with forward strategies.
Capital markets are a funding sources for business firms. As the development of capital markets in the world business organisations can acquire more investments. So, firms have diversified forms of debt capital. So, they have ability to face shocks affecting from bank lending channel.
In these phenomena banks should generate assets. therefore, banks allocate credits for small and medium size business organisations and business organisations that do not have access to capital markets. Then they significantly increase their deposits in banks. This reallocation of credit was very beneficial for businesses which have not access to capital markets since it contributed to a significant increase in their investments. Therefore, growth of the capital markets is posing challenges for finance institutions. Financial intermediaries will need to adopt to these changes.
With the advancement of capital market, expanding investment fund sector and financial crisis is striking. Investment funds facing investors run risk and bank system is facing classic run risk. So, quality of both contingency planning and liquidity risk management are very important for stability of investment fund sector and finance sector. Investors are purchasing stocks in primary and secondary market and cost of financing of business firms decreeing because of direct transactions between investee and investor. So, this increase willingness to issue bonds, stocks and to a bond-loan substitution strategy by business organisations to financial markets.
Worldwide financial institutions face the impact of technological development in finance. So, more competition has emerged in financial services due to new competitors such as new FinTech companies. All these variations may have impact on financial institutions and economy. Because of the new technologies investors no longer need to call connect with brokers before placing trades. They only need log into a secure web portal and make traces quickly, seamlessly and anonymously.
As the technological improvement in financial sector it courses to growth in income investments and consumption and development of an economy. The development of these things also has an impact on financial institutions.
New financial technologies reduce the barriers to entering traditional banking activities; create the possibility for new competitors to finance institutions, such as the FinTech companies. Further new technologies also offer opportunities for financial institutions in terms of potential efficiency gains.
Income inequality implicate with finance structure. Because capital markets, banks and other financial institutions tend to reduce inequity of income distribution. But the size of bank credit and market capitalization over GDP leads to higher inequality. In a financial system facing disintermediation, business organisations acquire capital from the market will normally float into the market securities and products that savers can invest in. The investors will end up holding this security directly. The risk in such a transaction is then borne by the investors. Only very wealthy households purchase securities directly. In most instances, savers will invest in such products though pension funds, mutual funds and investment trusts. Only large investors can afford to make the purchases directly. This in turn allows such trusts and a mutual fund to pool together small amounts from individual customers and invest in large scale. These things can cause to inequalities in income.
Within the development of new technologies Bank oriented systems are less vulnerability of investments funds raised because investors can deceive to frauds and scams. But bank systems are less vulnerable to “normal” downturns. a financial crisis can impair the shock absorbing capacity of relationship banks given that when they are under strain, they are less able to help their clients through difficult times. In fact, this situation could lead to zombie lending since banks may opt to postpone loss recognition. On the contrary, this mechanism is not in place for capital market investors. In a financial crisis, more market-oriented systems may speed up the necessary deleveraging, thereby fostering a sustainable recovery.
cyclical and structural forces contribute to reduce the importance of financial institutions in financial intermediation. This trend has many positive things since a more diversified financial system, in which financial institutions play a limited role, could favour the efficiency and the risk sharing. As examples limited lending capacity of banks, monetary policy implications facilitating for bond issue, development of capital markets, increasing ageing population, raise in income levels. These types of cyclical forces increase new kind of financial intermediation.