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Financial intermediaries are entities that function as the line of communication between investors and firms that are seeking investors. Functioning as a middleman, an intermediary seeks to match investors who have specific financial goals with investment opportunities that can aid in the achievement of those goals. In most cases, the financial intermediary is a financial institution, such as a bank or an insurance company. Financial intermediaries also come in the form of mutual funds, pension plans, and broker-dealers.
There are several advantages associated with the use of financial intermediaries. One has to do with minimizing the degree of risk associated with the investment process. This is due to the fact that intermediaries often diversify the types of investments they undertake. This creates a situation where there is less risk for the individual investor, since the intermediary is able to offset losses with greater ease than a lone investor could manage. For example, the single investor could only underwrite a limited number of loans, and would be affected substantially by the failure of one of those loans. By contrast, a bank can underwrite many more loans, and can offset losses from a defaulted loan with greater ease.
Another benefit to financial intermediaries is that much of the research needed to assess an investment opportunity has already been done. This saves the investor time and money, while also reducing the potential for making a bad investment. Since intermediaries tend to be proficient in such investment options as lending or purchasing shares of stocks, the chances that the investor will lose money on the transaction are lower, while the opportunity for returns is higher. As a bonus, intermediaries can also function as central counter-party clearing houses, creating and managing the investment transactions for all parties concerned.
Financial intermediaries also have the ability to maintain a high degree of liquidity. This is important for investors, as it means the intermediary can convert assets to cash without delay. For example, an individual with a savings account at a local bank wishes to withdraw funds from that account, there is usually no delay, even if the withdrawal is substantial. The only situation in which financial intermediaries may be unable to quickly supply the cash is when a huge number of depositors or investors wish to withdraw their assets at one time. Even then, many national banking systems can intervene and prevent the need for suspending payments to depositors.
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