There are evidences that “financial intermediaries play a key role in improving the performance of the economy”. (Morawski 4) Not to mention that they “could even act as a good predictor of long run rates of economic growth, capital accumulation and productivity improvement” (King and Levine cited in Chakraborty 1). However, what –exactly- is the principle role of financial intermediaries? This is what this essay tries to answer.
This essay aims at discussing the principle role of financial intermediaries (banks, investment companies, financial advisors or brokers, credit unions, mutual funds, and insurance companies). The best approach to achieve this goal is to search the literature to study what is written concerning financial intermediaries’ different roles and assess these roles to come up with the principle role of these institutions.
However, first of all, it was necessary to study different definitions for financial intermediaries in case these definitions could give an idea about the principle role of them. For example, -according to Claus et al. – financial intermediaries “‘channel funds’ from those who have savings to those who have more ‘productive’ uses for them” (2). Also, Jalan defined financial intermediaries as “institutions which ‘transfer funds’ from economic agent with surplus funds (surplus units) to economic agents (deficit units) that would like to utilize those funds.
Then, Morawski provided a better definition to ‘Financial intermediaries’ term as institutions which provide “‘channeling’ or efficiently ‘transfer funds’ between lenders (surplus units) and (deficit units) borrowers that are brought together in order to achieve higher production and efficiency for the economy as a whole. ” or in another word, as she mentioned institutions which “pool ‘resources’ from various small investors so that they can be able to later lend those ‘funds’” (2, 3)
Then, it was clear that these definitions actually give the financial intermediaries’ principle role. However, to be sure that the principle role is what mentioned in definitions of the term, it was logical to move to other research findings that discussed basic or vital roles of financial intermediaries. Corrigan mentioned that the vital and indispensible role of financial intermediaries is in “helping societies ‘economies’ achieve a broad range of public policy goals, including, but not limited to- ‘mobilizing’ and ‘allocating savings’ in an effective and efficient manner” (10)
According to Chakraborty, financial intermediaries “perform the roles of (a) resource mobilization and allocation, (b) risk diversification and (c) liquidity management to foster development of the real sector” (1) and that’s exactly what Morawski assure “The low transaction costs allow those institutions to offer liquidity services as it is simpler to sell financial instruments to raise cash and in the same time reduce the exposure to potential risks by sharing risks among various investors” (3)
Diamond and Dybvig summarized these roles when they showed that financial intermediaries “can enhance risk sharing, which can be a precondition of liquidity, and can thus improve welfare” (cited in Claus et al. 2). And through these two financial services –provision of liquidity and risk sharing- they “reduce the costs of ‘moving funds’ and help in overcoming information asymmetry between borrowers and lenders, leading to more ‘efficient allocation of resources’ and faster economic growth” (Claus et al. , 2) Claus et al. mentioned two channels through which financial intermediaries “can have an effect on economic growth, capital accumulation and technological innovation”. (7-8) While “this ‘supply of funds’ provided by financial intermediaries –according to Goldsmith- through loans or through the purchase of securities is an essential if not the primary economic function of financial intermediaries” (180)
Finally, based on these definitions and research findings, the principle role of financial intermediaries is in achieving the efficiency and effectiveness in supplying funds to the market by mobilizing and allocating resources or funds -with (a) low transactions costs and (b) overcoming information asymmetry- between borrowers (surplus units) and lenders (deficit units) -through two main services, the (1) provision of liquidity and (2) risk sharing-; and as a result to this better utilization of these funds (more investments and higher production- leads to economic growth or welfare (through (1) capital accumulation, (2) improved or enhanced productivity, and (3) technological innovation).