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Financial Intermediaries Essay

1534 words - 6 pages

Financial intermediaries are common across the entire financial world. A financial intermediary is an institution that borrows money from people who have saved and in turn makes loans to others, acting as a middleman between investors and firms raising money. Common institutions that conduct the intermediary actions are commercial banks, credit unions, insurance companies, mutual funds, and finance companies. These institutions are an integral part to the overall health and functionality of the world financial market.
Functions performed by financial intermediaries can be categorized into three functions; (1) maturity transformation, (2) risk transformation, and (3) convenience denomination. With maturity transformations, intermediaries convert short-term liabilities to long term assets. This conversion is common with banks and other institutions that provide liquidity for entrepreneurs, giving a short term debt a match with a long term loan. Rather than constantly evaluating short term loan options and rolling over the debt balance, a longer term commitment is able to be made that locks in a lower rate to benefit all parties. Additionally, intermediaries can provide risk transformation, which offer the ability to convert risky investments into relatively risk-free by lending to multiple borrowers to spread the risk. By pooling the funds of multiple investors, the intermediary – such as a mutual fund – inherently provides diversification and tolerance against a single investment producing undesirable results. Finally, convenience denomination is provided by an intermediary. With a large quantity of deposits being held at a financial intermediary, they are able to match small deposits with large loans, and larger deposits with small loans. Being able to match these amounts without any restrictions (i.e. minimum deposits, etc) provides a great convenience for the investor.
Numerous advantages are also present within financial intermediaries. Two essential advantages are cost advantages and market failure protection. Cost advantages arise with direct lending/borrowing due to several reasons from risk aversion as intermediaries help spread out and decrease the risks, also reconciling conflicting preferences between lenders and borrowers. Both economies and scale and scope come into play when using financial intermediaries. By reducing the cost of lending and borrowing, along with concentrating demands of lenders and borrowers the enhancement of their product becomes inevitable.
Many institutions act as financial intermediaries within the financial world, but none embody the idea better than Warren Buffett’s Berkshire Hathaway. Buffett began in the investing world at a young age; his business savvy was shown at age six when he would purchase 6-packs of Coca-Cola from a grocery store and resell them individually for a profit. (Kennon, 2010). After his graduate studies at Columbia, Buffett began working at his father’s brokerage...

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