What are financial intermediaries used for?
Financial intermediaries are intermediaries of financial services with the aim of making financial transactions safer and easier to access for clients. Here we show you which financial intermediaries there are, how they work, and what advantages and disadvantages they have.
Financial intermediaries act as an intermediary between two parties when it comes to the settlement of financial transactions or financial business in general. They offer their clients several advantages, such as security, access to and management of assets, and liquidity.
There are numerous companies or institutions that act as financial intermediaries. These include, for example:
- Banks: lending and borrowing money is simplified
- Stock exchanges: Trading in shares and other stock exchange products will be centralised and thus more easily accessible for buyers and sellers
- Pension funds: Future pensioners pay the pensions of current pensioners
- Factoring provider: Factoring clients receive money from the factoring provider for their outstanding receivables and thus liquidity
- Insurance: For money, insurance companies protect their customers against certain risks
Financial intermediaries bring two parties together through their activities: usually buyers and sellers. They create a central intermediary platform that enables both parties to conduct their financial transactions there quickly and easily. This creates efficiency and saves costs on both sides.
Depending on the industry in which financial intermediaries operate, they offer different services to their clients. While a commercial bank manages its clients' money and offers all services around financing and payment services, a private credit company only offers lending but does not manage accounts or cash.
A company that offers pension funds receives money from contributing customers, some of which is invested and used to cover costs, and some of which is paid out to current pensioners.
Like any other business, financial intermediaries need a functioning business model with which they can make profits and grow.
Banks earn money, for example, by offering their services in exchange for fees, receiving interest payments from loans, or getting a commission for selling a financial product.
A commercial bank mainly generates profit by granting loans and the associated interest payments on the part of the borrowers.
Investment banks, on the other hand, have a stronger focus on the investment business, where profit maximisation is paramount. This is achieved by investing in stock market products, real estate, commodities and other assets.
Financial intermediaries active in the capital market are, for example, brokers. They provide investors with suitable stock market products, e.g. shares of a certain company. A fee is due for this brokerage, which the investor has to pay.
In the meantime, however, there are also brokers who rely exclusively on direct trading on electronic exchanges. These brokers are in many cases fintech companies that want to offer their customers low-cost access to stock exchange products. They finance themselves through commissions they receive from the electronic exchanges for brokering securities.
The biggest advantage of financial intermediaries is that they create a central market where financial transactions can be conducted. By scaling financial intermediaries appropriately, bureaucracy is kept to a minimum and experts take care of advising clients and processing transactions. This in turn is cost-efficient for the clients.
Another advantage is that large financial intermediaries can spread their risks very widely by investing the money or premiums paid in by their clients in a variety of financial products. This also reduces the risk for the clients.
In addition, it is easier for clients to make use of special financial services, because with the financial intermediary they have a contact person who can point out solutions.
The biggest disadvantage of financial intermediaries is that they pursue their own interests. This means that they mainly recommend products that they either offer themselves or receive a commission from other providers. Clients therefore avoid a bad investment by comparing similar offers from different financial intermediaries.
Another disadvantage is that fees are charged for the services of the financial intermediary, since the latter ultimately has to cover its own costs and wants to make a profit. For this reason, some financial transactions in which buyers and sellers come into direct contact with each other are more cost-effective, e.g. direct trading on the stock exchange.