When you think about investments a plethora of options baffle your mind. Bank FD, Mutual Funds, Stocks, Credit Unions and a lot more: Where to put your money? What will best suit your needs? Questions are infinite and the answer lies within Intermediaries that act as a link between you (the investor) and financial institutions for mutual benefit. But guess what? We have covered for you, all the options right here at one place.
Let’s delve deep into the world where your money works for you and not the other way round!
Financial Intermediaries: What are they? How they work?
A financial Intermediary is an Institution that acts as a middleman in financial transactions. Simply put, they help lenders meet borrowers and buyers meet sellers without either parties having to actually meet. It saves time and effort for both parties by creating an economy of scale. They can be seen as entities who accept deposits from depositors allowing them an interest on their sum.
Further, they lend the deposit to borrowers on a higher interest thus maintaining a margin. This margin is the profits they earn. Financial intermediaries have emerged as an important tool as they help channelise savings into investments.
For example: John has some excess cash in his hands. He opens a bank FD and earns a 6% Interest on it. On the other hand, Mike is seeking a loan for the down payment of his dream house. He goes to the same bank and takes up a loan on which he has to pay 8% interest. The Bank acts as an intermediary here and the difference of 2% is the profit margin it earns.
Types Of Financial Intermediaries:
The first name that comes in your mind when you hear ‘Financial Intermediary’ is banks right? They are the Classic and Conventional form of intermediaries that are an essential part of our everyday lives. Heavy Regulations are imposed on commercial banks by the Central bank, RBI and cater to the financial needs of a huge amount of public at large. Some of the services include opening up accounts, sanctioning loans, Digital banking and more.
Non Banking Financial Companies, are essentially like Banks without a Banking license and thus do not come under the usual banking regulations. The other significant difference between a Bank and NBFC is that the latter do not accept Demand Drafts. Mortgage Lenders, Money Market funds, Insurance Companies, P to P lending are all examples of NBFCs.
Think of Banks as a Club, which people become members of, that facilitate lending and borrowing services among the usurer and receiver within the Club. That is a Credit union. A credit union is defined as a Financial organisation which is owned, controlled and operated by voluntary members. It is called People helping people. Like Banks, Credit Unions also provide services like loans, saving and investment, but charge lesser than a traditional bank as they do not have to answer to a third party shareholder. They are not-for-Profit unions that enjoy the Tax-exempt status.
The intermediary that facilitates trading of securities in the Stock Market is a Stock exchange. Simply put, it is the organization where buyers and sellers come together to trade financial securities like stocks, bonds and other commodities during specific hours of a day. You might have also heard of the biggest stock exchanges of the world like New York Stock Exchanges and NASDAQ (USA).
Mutual Fund Companies
As the name suggests A mutual fund is a pool of fund created by a number of investors by putting their money in MF companies. These companies in turn invest this fund in various equity and debt securities and generate returns out of it which is distributed among the investors as Capital gain. These Funds are managed by professional Fund managers and invests money in multiple securities at one time. Depending on size of capital investments Mutual Funds are SmallCap, MidCap and LargeCap.
You must have heard of ‘LIC, Zindagi k sath bhi Zindagi k baad bhi‘ tagline. It is the Insurance company Life Insurance of India. Other prominent companies that provide insurance services include All india insurance, SBI life insurance company etc. Typically, an Insurance company drafts policies for various insurances like life,term,health,fire etc. Thousands of people make periodic payments to the company for a policy that is to pay them in case of an emergency or mishappening.
They are second level of intermediaries that help you find the right intermediary to invest in. A financial advisor creates your exclusive portfolio according to your needs and goals. The amount you invest is transferred in their AUM(Assets Under Management) and earn a commission out of it. However, now SEBI is encouraging a fee structure for the financial advisors rather than commission to protect investor rights.
An investment Bank is a financial services Company that engages in Advisory-based financial transactions on behalf of individuals who opt for it. So we can say that Financial advisors are a part of Investment banks wherein the the planning and formation of the portfolio is done by them and the background operational work of investment in securities is handled by the Investment Banker. They are also called the corporate Financial advisors.
Now that we know the types of intermediaries, Let’s look at some reasons why one would prefer using them over Direct Investments.
Advantages of Financial Intermediaries
Let’s analyse the importance and know the advantages of these intermediaries in our financial activities.
The purpose of an intermediary itself is providing convenience to the consumer. It’s the reason why you would opt for an intermediary, they make the hassle easy! They have working financial professionals so you don’t have to worry about the operations of investing and finance.
The intermediary is directly connected to you as an investor and thus can be held accountable for any errors or omissions. they are also easy to approach incase of any query or decision making.
3. Low Risk
The presence of a regulating intermediary reduces the risk of fraudulent activities and capital loss .
4. Low Cost
The operational cost of lending and borrowing, paperwork etc is reduced as Intermediaries work on an Economies of scale basis and provide Financial services to many people at large.
5. Professional Involvement
Let’s just agree that handling finances is complicated! It is largely because of the uncertain nature of the stock market and jargons related to it which a common man might not comprehend. Professional involvement assures financial specialization to help and guide you in your financial journey.
However,Everything has a flipside to it. While using Intermediaries can be effective and efficient it also comes with a set of drawbacks.
Disadvantages of Financial Intermediaries
1. Decreased Returns
Whatever capital gain your investments make, a small portion of it is taken by the intermediary as profit hence decreasing your returns on investment or ROI.
2. Fraudulent Activities
Sometimes an insurance agent or a financial advisor may make false claims ir order to trick you into more commission paying activities thus leading to Capital loss in the long run.
3. Fee and Commissions
Intermediaries are Profit making organisations working in the capital market and thus charge a Fee or Commission for their services.
Financial intermediaries are the essence of an economy which helps in smooth day-to-day transactions. In order to eliminate the disadvantages of Financial intermediaries many new forms of financial assistance are originating like Crowd Funding, P to P lending, etc. It’s up to you to decide which way you want to go after gaining knowledge of all the facts.
No matter whichever country you live, you’ll come across different type of financial intermediaries to ease out your financial expedition. And the, you must act wisely to choose the best and reliable one!
We hope this article will help you decide what’s best for your financial health. Do share your experiences with any of the above financial intermediaries.