Role of Financial Intermediaries in Economic Development

What is the Role of Financial Intermediaries in Economic Development?

You can take a financial intermediary as a mediator who connects both parties whenever a financial transaction takes place. A commercial bank can be a true example of a financial intermediary.

Every country must have an effective financial system that assists people in getting an ROI (Return on Investment). And financial intermediaries use this investment capital to grow or lend the capital to other organisations to grow. That is how economic growth and household wealth increase over time. Financial intermediaries play a critical role in every financial system.

Imagine how retirement savings would be affected by the financial industry's high volatility, where you may wake up one morning and discover that all of your savings have been gone. That is why financial intermediaries are important.

Types of Financial Intermediaries

Financial intermediary services are offered by a variety of organisations, ranging from those that don't accept deposits like NBFCs to banking institutions taking deposits like commercial banks, savings banks, and Federal Reserve Banks. It is divided into bank and nonbank intermediates. Additionally, they could be public or private organisations.

Other insurance categories include property insurance firms, private life insurance organisations, and government insurance. Further instances of the variability in kinds include stock exchanges, brokerage firms, brokers, dealers, and clearinghouses.

It can also be classified as primary or secondary financial intermediaries based on the source of their funding. The main intermediate organisations get their money from people's homes, businesses, or governments and lend money to those same organisations. Secondary intermediaries, on the other hand, work with the principal intermediate entities. Factoring businesses are one type of secondary intermediary.

Depending on the nation, the definition of an intermediate may alter over time. Additionally, the legal system and financial traditions of the nation in power have an impact. The development of decentralised finance (DeFi) has also made it possible to remove intermediaries from financial transactions.

Examples of Financial Intermediaries

There are many organisations or businesses that serve as financial intermediates. These, for instance, include –

• Insurance Companies

Insurance providers offer a range of coverage options, including liability, house, and life insurance, all of which are intended to protect consumers' finances. To complete the transactions, they work with other entities, including brokers and agents. It combines policyholder fees and puts them in a variety of investment vehicles, such as bonds and other securities in the money market. Furthermore, even if the payouts are substantial, they can make a large profit and settle claims and other responsibilities without incurring massive losses. The insurance business is protected against this by the profits from their investments.

• Mutual Fund Companies

In general, fund directors in mutual fund businesses invest money gathered from consumers in various financial assets and divide the return to retail investors according to their investment. Investment fund managers choose suitable securities and put them together to construct the portfolio based on the client's preferences and their focus on increasing investors' wealth. Companies that handle investments for clients include mutual fund companies.

• Banks

Deposits made by customers are generally used by banks to assist other qualifying customers who are in need. The banks receive their money from the interest on the loans they make. Along with these services, banks also provide credit cards, deposit insurance, and FX services.

The Role of Financial Intermediaries in the Economy

Here are the advantages and the role of financial intermediaries. Let’s have a look –

• Self-Employment Program

Increased employment is an indication of developing economies. Financial intermediaries increase production and revenue in the nation by financing the launch of self-employment schemes. Following the nationalisation of commercial banks in India, banks have started a number of programmes for self-employment plans.

• Housing Finance

Financial intermediaries offer housing loans as part of enhancing habitation. They also offer refinancing services to organisations like HUDCO (Housing and Urban Development Corporation). Due to this, a lot of people in the fixed income bracket are now able to apply for a mortgage. A bank will typically lend a borrower using this facility a maximum of three years' worth of aggregate net income, or the value of the home, whichever is less.

• Backward Area Development

To avoid geographical inequities, financial intermediaries have advanced loans to start-up industries in underserved areas. The government has made a few concessions in the manner of tax breaks for these companies, and banks have been offering rates on credit so that underdeveloped regions can draw in more businesses.

• Comprehensive Rural Development Programme

In accordance with this plan, financial intermediaries gave loans to individuals who were socially and economically marginalised so they may engage in a variety of economic activities. One-third of the borrowing will be subsidised, with the remaining two-thirds carrying lower rates of interest under the RBI's interest subsidy scheme. This led to the implementation of numerous economic initiatives targeted at enhancing rural economic conditions.

• Priority Industry

According to RBI standards, financial institutions must devote a set percentage of their loans to the priority sector, which includes agriculture and its linked sectors such as meat products, dairy, and so on, as well as privately owned micro and small industry and businesses.

• EDP

A number of banks have established successful EDPs. Banks initially created employment possibilities at the regional level through the Lead Bank Scheme. Later, the Service Area Strategy was set up in 1978, whereby certain specified areas were assigned to the organisations for the introduction of various economic activities for the growth of such areas.

• The Development of an Electronic System

Financial intermediaries today conduct the majority of their business using computers, and they can connect their branches via a network. Customers were able to quickly cash their checks as a result of the quicker money transfers across facilities.

Wrapping Up,

As we've seen, today's economy can't exist without financial intermediaries

. They serve as the "lubricants" necessary to run the whole economy smoothly.

The word "intermediary" suggests that these organisations are crucial to the operation of the economy. And with the help of the monetary authorities, they must make certain that money reaches the underprivileged without compromising the interests of investors!