Financial Intermediary

Definition

A financial intermediary is an entity such as a commercial bank, savings and loan association, mutual savings bank, credit union, or other institution that facilitates the flow of funds between savings surplus units (individuals and businesses that save) and savings deficit units (individuals and businesses that need credit). Financial intermediaries collect funds from savers and lend them to borrowers, helping to streamline the process of financial intermediation and improve market efficiency.

Examples

Commercial Banks

Example: JPMorgan Chase, Bank of America
Role: Accept deposits from individuals and businesses, provide loans and credit, offer investment products.

Savings and Loan Associations

Example: Washington Mutual (before its collapse in 2008)
Role: Specialize in accepting savings deposits and providing mortgage and other loans.

Mutual Savings Banks

Example: Northeast Bank (MA)
Role: Offer a range of savings products and services, focusing primarily on personal banking and real estate loans.

Credit Unions

Example: Navy Federal Credit Union, Alliant Credit Union
Role: Not-for-profit institutions that provide financial services to their members, including savings accounts, loans, and other financial products.

Frequently Asked Questions

What is the main function of a financial intermediary?

The main function of a financial intermediary is to mediate the flow of funds from savers to borrowers, helping to allocate resources efficiently in the economy.

How do financial intermediaries benefit the economy?

Financial intermediaries increase economic efficiency by reducing transaction costs, diversifying risk, and providing liquidity, thus facilitating investment and consumption.

Are financial intermediaries always banks?

No, financial intermediaries can also include non-bank entities such as insurance companies, pension funds, and investment funds that play a similar role in channeling funds.

What distinguishes a credit union from a commercial bank?

Credit unions are not-for-profit institutions owned by their members and typically offer lower fees and better interest rates, whereas commercial banks are for-profit entities and focus on maximizing shareholder value.

Can an individual act as a financial intermediary?

Generally, financial intermediation is conducted by institutions rather than individuals, due to the scale, expertise, and regulatory requirements involved in these activities.

Liquidity

Definition: The ease with which an asset can be converted into cash without affecting its market price.

Risk Diversification

Definition: The practice of spreading investments across various financial assets to reduce exposure to risk.

Transaction Costs

Definition: Expenses incurred when buying or selling goods or services, often reduced by financial intermediaries through economies of scale.

Interest Rate

Definition: The amount charged by lenders to borrowers for the use of assets, usually expressed as a percentage of the principal.

Credit

Definition: An arrangement to receive goods, cash, or services now and pay for them in the future.

Online References

Suggested Books for Further Studies

“The Economics of Money, Banking, and Financial Markets” by Frederic S. Mishkin
“Financial Institutions Management: A Risk Management Approach” by Anthony Saunders and Marcia Millon Cornett
“Money, Banking, and Financial Markets” by Stephen G. Cecchetti and Kermit L. Schoenholtz

Fundamentals of Financial Intermediary: Finance Basics Quiz

### What is the primary role of a financial intermediary? - [ ] To act as an independent financial advisor. - [x] To facilitate the flow of funds between savers and borrowers. - [ ] To regulate the stock market. - [ ] To provide tax services. > **Explanation:** The primary role of a financial intermediary is to facilitate the flow of funds between savers (surplus units) and borrowers (deficit units), ensuring efficient allocation of resources. ### Which of the following is a characteristic of a credit union? - [x] Not-for-profit organization. - [ ] Primarily regulated by the SEC. - [ ] Only offers financial services to large corporations. - [ ] Publicly traded on the stock market. > **Explanation:** Credit unions are not-for-profit organizations owned by their members, distinct from for-profit commercial banks. ### What type of financial intermediary is known for providing mortgage loans? - [ ] Credit unions - [ ] Mutual funds - [x] Savings and loan associations - [ ] Investment banks > **Explanation:** Savings and loan associations are specialized financial intermediaries primarily known for accepting deposits and providing mortgage loans. ### Which term describes the easiness of converting an asset into cash? - [x] Liquidity - [ ] Equity - [ ] Credit - [ ] Amortization > **Explanation:** Liquidity refers to how easily an asset can be converted into cash without affecting its market value. ### What is an example of a mutual savings bank? - [x] Northeast Bank - [ ] Goldman Sachs - [ ] Citigroup - [ ] American Express > **Explanation:** Northeast Bank is an example of a mutual savings bank, focusing on personal banking services and real estate loans. ### How do financial intermediaries typically reduce transaction costs? - [x] By utilizing economies of scale - [ ] By investing in high-risk assets - [ ] By decentralizing operations - [ ] By offering only short-term loans > **Explanation:** Financial intermediaries reduce transaction costs by utilizing economies of scale, which allows for spreading costs over a larger number of transactions. ### Which financial intermediary is owned by its members? - [ ] Commercial bank - [ ] Hedge fund - [ ] Mutual fund - [x] Credit union > **Explanation:** Credit unions are owned by their members who use their services, which often results in benefits such as lower fees and better rates. ### What distinguishes a mutual savings bank from a commercial bank? - [ ] A mutual savings bank cannot offer loans. - [x] A mutual savings bank is owned by its depositors. - [ ] A commercial bank can only serve corporations. - [ ] A mutual savings bank cannot accept deposits. > **Explanation:** A mutual savings bank is owned by its depositors, which distinguishes it from commercial banks that are typically shareholder-owned. ### Why is risk diversification important for financial intermediaries? - [x] To reduce exposure to any single asset or borrower. - [ ] To increase returns from high-risk investments. - [ ] To comply with international monetary policies. - [ ] To focus resources on a particular sector. > **Explanation:** Risk diversification is important as it reduces exposure to any single asset or borrower, thereby decreasing overall risk. ### What does a financial intermediary primarily provide to savings surplus units? - [ ] Employment services - [ ] Legal advice - [x] A safe place to save and invest their funds - [ ] Marketing strategies > **Explanation:** A financial intermediary primarily provides a safe and efficient means for savings surplus units to save and invest their funds.

Thank you for exploring the role of financial intermediaries and testing your knowledge with our in-depth quiz. Continue to advance your understanding of important financial concepts!