Checklist Description
This checklist describes the role of financial intermediaries and how they function within the financial markets.
Definition
Generally, when a company wants to enter a financial market, it uses the services of a financial intermediary rather than entering directly. In many transactions the intermediary will be the company’s commercial bank, which will broker financial deals such as loans. For more complex or specialist deals a company is likely to turn to an intermediary that specializes in transactions for financial products such as mutual funds, pension funds, bonds and shares, and insurance. In such cases, the intermediary may be a fund or insurer itself.
A financial intermediary typically facilitates the channeling of funds between lenders and borrowers indirectly, in the form of a loan or a mortgage. Sometimes the intermediary may lend money directly via the financial markets. This is known as financial disintermediation.
The intermediary’s role is to seek the best possible investment opportunities on behalf of its clients. The intermediary will often have contacts within its areas of expertise that would not be accessible to private individuals using a retail bank, for example. This enables the intermediary to broker the most appropriate deals for its client, which is spared the trouble of having to seek these out itself. The intermediary charges a fee to the client for its services.
Advantages
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Lending is often less risky through an intermediary, who can, for example, diversify lending, providing the company with a variety of different loan plans. If some loans then prove themselves to be unviable, they are offset by those that are sound. Experience is an important element of this. By making many and diverse loans, financial intermediaries gain experience in identifying clients who will be able to repay their loans, as well as those who will not. This reduces risk and minimizes the number of unviable loans for the client, who is spared the burden of making expensive mistakes.
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Financial intermediaries have liquidity, which means they are in a position to convert assets to money quickly. This has obvious advantages in terms of obtaining cash when it is needed. For a company this can be of crucial importance if it experiences difficulties such as temporary cash flow problems.
Disadvantages
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The main disadvantage is that, on top of their fee, financial intermediaries often take a percentage of profits as part of any transaction they broker. Direct loaning can significantly increase the potential income of such a loan for the intermediary. However, the advantages outlined above significantly mitigate any such disadvantages. That is why many companies use intermediaries rather than entering the market directly.
Action Checklist
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Ask around for recommendations. Your bank should have knowledge of specialist intermediaries who can cater for your needs, for example. Your accountant or lawyer may also have useful contacts.
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Investigate a financial intermediary thoroughly before entering into a relationship. Check that they have any necessary certification or license.
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You should be confident that your intermediary is a responsible and experienced broker and/or lender.
Dos and Don’ts
Do
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Approach your decision by comparing and contrasting several choices of intermediary.
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Research your options carefully to ensure that potential intermediaries are both experienced and economically sound.
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Have interview meetings with intermediaries you are considering to ensure that you will be able to work with each other before you enter into any financial relationship.
Don’t
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Don’t rush hastily into a relationship with an intermediary.
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Don’t use an intermediary who cannot produce evidence of the right certification or license to practice.
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