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Financial Intermediaries Paper Fin 324

840 words - 3 pages

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 make illiquid loans, its size allows it to make cash available to individual savers. Only when a large number of depositors want to withdraw money at the same time, is an intermediary unable to provide liquidity to its investors (Schenk). Thankfully, this is a rare occurrence by today's industry standards.Commercial banks are the largest and probably the most important financial institutions in the United States and in most other countries as well. In the U.S., the approximately 8,300 commercial banks have total assets that exceed $6 trillion. Commercial banks also offer the most services of any financial institution. These services include a wide range of checking and savings accounts, consumer loans, credit cards, home mortgage loans, business loans, and trust services (Boone, 692). Commercial banks raise funds by offering a diverse variety of checking and...

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