bank inter mediation

8/6/2019 Bank Inter Mediation

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FINANCIAL INTERMEDIATION

In any economy, the financial sector plays a major role in the mobilization and

allocation of savings. Financial institutions, instruments and markets which constitute

the financial sector act as a conduit for the transfer of financial resources from net

savers to net borrowers.

Financial intermediation consists of channeling funds between surplusand deficit agents The process of taking in money (borrowing) so that it can be madeavailable to individuals or institutions in the form of loans or investment. the process by which the formal and informal financial sectors manageliquidity in the economy, reallocating liquid resources by mobilizingsavings from institutions and individuals and allocating it in the form of credit to institutions and individuals. Utilize of liability to finance venture in high-quality assets in thetransaction; both the investments and supporting debt are duration

matched and cash flow matched.

Having designed the instrument, the issuer should then ensure that these financialassets reach the ultimate investor in order to garner the requisite amount. When theborrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the securityshould be passed on to take place. There should be a proper channel within thefinancial system to ensure such transfer. To serve this purpose, Financialintermediaries came into existence.

Financial intermediation in the organized sector is conducted by a widerange of institutions functioning under the overall surveillance of the Reserve Bank of India. Inthe initial stages, the role of the intermediary was mostly related to ensure transferof funds from the lender to the borrower. This service was offered by banks, FIs,brokers, and dealers. However, as the financial system widened along with thedevelopments taking place in the financial markets, the scope of its operations alsowidened. Some of the important intermediaries operating ink the financial marketsinclude; investment bankers, underwriters, stock exchanges, registrars, depositories,custodians, portfolio managers, mutual funds, financial advertisers financialconsultants, primary dealers, satellite dealers, self regulatory organizations, etc.

Though the markets are different, there may be a few intermediaries offering theirservices in move than one market e.g. underwriter. However, the services offered bythem vary from one market to another.

The financial sector performs this basic economic function of intermediation

essentially through four transformation mechanisms:

1. Liability-asset transformation (i.e. accepting deposits as a liability andconverting them into assets such as loans);

2. size transformation ( i.e. providing large loans on the basis of numerous smalldeposits);


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3. maturity transformation (i.e. offering saver alternative forms of depositsaccording to their liquidity preferences while providing borrowers with loans of desired maturities); and

4. risk transformation (i.e. distributing risk through diversification whichsubstantially reduces risks for savers which would prevail while lending

directly in the absence of financial intermediation). The process of financial intermediation supports increasing capital

accumulation through the institutionalization of savings and investment and, thereby,

fosters economic growth. The gains to the real sector of the economy, therefore,

depend on how efficiently the financial sector performs this basic function of financial

intermediation.

The intermediation cost in India is still high, largely due to high operating cost.

Although overall efficiency and productivity have improved, resources are not being

utilised in the most efficient manner."


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The term financial intermediary may refer to an institution, firm or individual who performsintermediation between two or more parties in a financial context. Typically the first party is a providerof a product or service and the second party is a consumer or customer.

Financial intermediaries are banking and non-banking institutions which transfer funds from economicagents with surplus funds (surplus units) to economic agents (deficit units) that would like to utilizethose funds. FIs are basically two types: Bank Financial Intermediaries, BFIs (Central banks andCommercial banks) and Non-Bank Financial Intermediaries, NBFIs (insurance companies, mutual trustfunds, investment companies, pensions funds, discount houses and bureaux de change).

Financial intermediaries can be:

Banks; Building Societies; Credit Unions; Financial adviser or broker; Insurance Companies; Life Insurance Companies; Mutual Funds; or Pension Funds.

The borrower who borrows money from the Financial Intermediaries /Institutions pays higher

amount of interest than that received by the actual lender and the difference between the Interestpaid and Interest earned is the Financial Intermediaries/Institutions profit. Financial Intermediariesare broadly classified into two major categories:

1) Fee-based or Advisory Financial Intermediaries2) Asset Based Financial Intermediaries .

Fee Based/Advisory Financial Intermediaries : These Financial Intermediaries/ Institutions offeradvisory financial services and charge a fee accordingly for the services rendered.

Their services include:

i. Issue Managementii. Underwritingiii. Portfolio Managementiv. Corporate Counselingv. Stock Brokingvi. Syndicated Creditvii. Arranging Foreign Collaboration Servicesviii. Mergers and Acquisitionsix. Debentive Trusteeshipx. Capital Restructuring

ASSET-BASED Financial Intermediaries : These Financial Intermediaries/Institutions finance thespecific requirements of their clientele. The required infra-structure, in the form of required asset orfinance is provided for rent or interest respectively. Such companies earn their incomes from theinterest spread, namely the difference between interest paid and interest earned.

The financial institutions may be regulated by various regulatory authorities, or may be required todisclose the qualifications of the person to potential clients. In addition, regulatory authorities mayimpose specific standards of conduct requirements on financial intermediaries when providing servicesto investors.

Role of Financial Intermediaries for Poverty Reduction : Finding innovative ways to providefinancial services to the poor so that they can improve their productive capacity and quality of life isthe role of the financial intermediaries in the 21 st century.

Most of the poor live in the rural areas, and are engaged in agricultural activities or a variety of micro-enterprises.


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Intermediary Market Role

Stock Exchange Capital Market Secondary Market tosecurities

Investment Bankers Capital Market, Credit Market Corporate advisory services,Issue of securities

UnderwritersCapital Market, MoneyMarket

Subscribe to unsubscribedportion of securities

Registrars, Depositories,Custodians Capital Market

Issue securities to theinvestors on behalf of thecompany and handle sharetransfer activity

Primary Dealers SatelliteDealers Money Market

Market making ingovernment securities

Forex Dealers Forex Market Ensure exchange inkcurrenciesBanking sector significance in total financial sector

In most emerging markets, banking sector assets comprise well over 80 per cent of total financial sector assets, whereas these figures are much lower in the developedeconomies. Furthermore, deposits as a share of total bank liabilities have declinedsince 1990 in many developed countries, while in developing countries publicdeposits continue to be dominant in banks. In India, the share of banking assets intotal financial sector assets is around 80 per cent, as of end-March2009. There is, nodoubt, merit in recognizing the importance of diversification in the institutional andinstrument-specific aspects of financial intermediation in the interests of widerchoice, competition and stability. However, the dominant role of banks in financialintermediation in emerging economies and particularly in India, will continue in themedium-term; and the banks will continue to be special for a long time. In thisregard, it is useful to emphasize the dominance of banks in the developing countriesin promoting non-bank financial intermediaries and services including in developmentof debt-markets. Even where role of banks is apparently diminishing in emergingmarkets, substantively, they continue to play a leading role in financial sector.

Non-Banking Financial InstitutionsNon-banking Financial Institutions carry out financing activities but theirresources are not directly obtained from the savers as debt. Instead,these Institutions mobilise the public savings for rendering otherfinancial services including investment. All such Institutions are financialintermediaries and when they lend, they are known as Non-BankingFinancial Intermediaries (NBFIs) or Investment Institutions.

UNIT TRUST OF INDIA LIFE INSURANCE CORPORATION (LIC) GENERAL INSURANCE CORPORATION (GIC)

Apart from these NBFIs, another part of Indian financial system consistsof a large number of privately owned, decentralised, and relativelysmall-sized financial intermediaries. Most work in different, minisculeniches and make the market more broad-based and competitive. Whilesome of them restrict themselves to fund-based business, many othersprovide financial services of various types. The entities of the former


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type are termed as "non-bank financial companies (NBFCs)" . Thelatter type are called "non-bank financial services companies (NBFCs)".

Post 1996, Reserve Bank of India has set in place additional regulatory andsupervisory measure that demand more financial discipline and transparency of decision making on the part of NBFCs. NBFCs regulations are being reviewed by

the RBI from time to time keeping in view the emerging situations. Further, one canexpect that some areas of co-operation between the Banks and NBFCs mayemerge in the coming era of E-commerce and Internet banking.
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