Intermediation

Intermediation refers to the activity performed by a bank, financial institution, broker or similar entity, acting as a go-between for two parties in a transaction. Intermediaries may accept some or all associated credit or commercial risks.
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What is Intermediation?

Intermediation is the process through which financial institutions, brokers, or other firms act as intermediaries between two parties in a financial transaction. These intermediaries play a critical role in facilitating transactions by managing and mitigating inherent risks while ensuring that both parties’ needs are met. The intermediary could assume part or all of the credit risk or other commercial risks associated with the transaction, offering a layer of security and efficiency.

Examples of Intermediation

  1. Bank Lending: A bank serving as an intermediary between depositors and borrowers. It collects deposits from customers and lends these funds to individuals or businesses seeking loans, bearing part or all of the credit risk.
  2. Stock Brokers: Brokers act as intermediaries in securities transactions by buying and selling stocks on behalf of clients while managing risks involved in market conditions.
  3. Insurance Companies: Insurers intermediate between policyholders and financial markets, assuming the commercial risk of coverage in exchange for premium payments.

Frequently Asked Questions (FAQs)

What Does Financial Intermediation Involve?

Financial intermediation involves collecting funds from savers or depositors and lending or investing these funds to borrowers. Intermediaries manage risks and ensure the efficient allocation of resources.

Why is Intermediation Important in Finance?

Intermediation is essential in finance as it contributes to liquidity in markets, allows for risk management, and facilitates economic growth by enabling access to funds for borrowers who need capital for investment.

How do Banks Serve as Intermediaries?

Banks collect deposits from customers (savers) and extend these funds as loans to borrowers. They assume credit risk, ensure liquidity, and perform due diligence to maintain financial stability.

Can Internet-based Financial Entities Also Act as Intermediaries?

Yes, numerous fintech companies and online lending platforms act as intermediaries, connecting borrowers and lenders through technology-driven solutions and often using algorithms to manage risk.

Is Intermediation Limited to Financial Transactions?

No, intermediation is not limited to financial transactions. It can occur in various industries, such as real estate, where brokers facilitate property transactions between buyers and sellers.

  • Disintermediation: The removal of intermediaries in a transaction. This occurs when clients bypass banks, brokers, or other financial intermediaries and deal directly to achieve costs savings or other benefits.
  • Credit Risk: The potential risk of loss due to a borrower’s inability to repay a loan or meet contractual obligations.
  • Liquidity: The ease with which an asset can be converted into cash without affecting its market price.
  • Risk Management: The identification, analysis, and mitigation of uncertainties involved in investment decisions.

Online References

Suggested Books for Further Studies

  • “Financial Intermediation in the 21st Century” by Zvi Bodie and Robert C. Merton
  • “Finance and Financial Intermediation: A Modern Treatment of Money, Credit, and Banking” by Harold Lister and Jean-Paul Laurent
  • “The Economics of Money, Banking, and Financial Markets” by Frederic S. Mishkin

Accounting Basics: “Intermediation” Fundamentals Quiz

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Intermittent Production
Intermediate Term