The Major Risks of Financial Intermediaries
A financial intermediary is an establishment or an institution which
acts as a third party between investors and firms in trying to obtain
funding. A general explanation would be the instance of a saver who
has extra money and a borrower who needs this extra capital. A typical
example of a financial intermediary is a bank, but there are more such
as life insurance companies and building societies. This essay will
assess the risks which financial intermediaries face and how they
It is important to note that financial intermediaries do not use their
own money instead they use the money of its depositors. To give a
simple example of how a bank would act as a financial intermediary.
Banks receive funds for depositors and while they keep a percentage in
of this cash in reserve in case they want it back they lend a large
percentage of it out or purchase bonds.
Financial intermediaries generally provide four important services.
The first one is expert advice; they can provide the best information
for investing customer funds and alternative methods of obtaining
finance. The second service is that they provide expertise in
channelling funds; they can provide specialist advice on areas to
channel funds to yield high results. The third service is maturity
information this is where the banks who have many depositors borrow
small amounts from each one so they are able to provide long term
loans. The final area which this essay will pick up on is the risk
transformation. This service provides the know how of how to allocate
loans and money to other money at the least possible risk to the
Risk is a major factor in any financial market and in particular to
institutions which are borrowing money from there depositors or
customers. This essay will now look at the potential risks involved
through financial intermediaries.
Financial intermediaries should be concerned with risk because it can
make its capital volatile and in most cases when financial
intermediaries are faced with these types of problems the most
probable outcome is that they can go into severe financial distress or
this could lead to bankruptcy.
The risks come when the financial intermediaries do not correctly
regulate their own techniques and staff. There are many examples where
financial intermediaries such as Baring’s bank and BCCI (Bank of
Credit & Commerce International) were forced to declare bankruptcy due
the inappropriate actions as they themselves played as financial
To take Barings bank as an example a trader with the name of Nick
Leeson was able to use large cash reserves which the bank held which
belonged to the banks depositors, to implicate the bank in a serious
of rogue deals which ended up causing the bank...