BCom 3rd Year Financial Intermediaries Money study material Notes 

BCom 3rd Year Financial Intermediaries Money study material Notes: working of Financial Intermediaries Role and Functions of Financial Intermediaries Underdeveloped Countries and Financial Intermediaries Kind of Financial Intermediaries Exercise Questions Long Answer Questions Short Answer Type Questions Objective Questions:

BCom 3rd Year Nature Importance Financial Money Study Material notes

FINANCIAL INTERMEDIARIES

Financial intermediaries are financial institutions. They play the role of intermediaries between the ultimate lenders and ultimate borrowers. In financial intermediaries, usually the commercial banks, co-operative credit societies, co-operative banks, Regional Rural Banks, mutual funds, savings and loan institutions, insurance companies, merchant banks, Unit Trust of India and so on are taken together. Through these financial intermediaries, flow of funds reaches from the ultimate lender to the ultimate borrowers either directly or indirectly.

Financial intermediaries are really the merchants of securities. They purchase primary securities from non-finance intermediaries through secondary securities and bear risk. These securities includes, term deposits, savings deposits, insurance policy, pension funds etc. In this way, financial intermediaries purchase primary securities sell its secondary securities. So these are called as traders of securities.

In simple words, the financial intermediaries transfer the funds from the ultimate lenders to ultimate borrower. In this way, financial intermediaries satisfy the lenders as well as borrowers. These are the important link between the ultimate borrowers and the ultimate lenders.

WORKING OF FINANCIAL INTERMEDIARIES

Financial intermediaries, both the banks and the non banking financial institutions are included. The ultimate lenders are the ultimate savers and the ultimate borrowers are the investors. So the financial intermediaries intermediate the savers and investors.

Financial intermediaries get savings by issuing secondary securities to the ultimate lenders or savers. In other words, through financial intermediaries funds are collected by selling, the demand deposit, term deposit or insurance policies and these funds are used to purchase the shares, debentures, bonds etc. issued by borrowers.

ROLE AND FUNCTIONS OF FINANCIAL INTERMEDIARIES

Following are the important role and functions of both financial and nonfinancial intermediaries :

(A) Role of Banking Financial Intermediaries

(1) Reduce Domestic Hoarding: The financial intermediaries bring the ultimate borrowers and ultimate lenders on a single stage. As a result of this. the tendency of keeping the cash in their home lessens and the cash is proner utilised.

(2) Saving Habits : The financial intermediaries provide the opportunity to common people to utilise the surplus money in profitable use. The consumers in the form of saver become depended on financial institutions for loans and mortgages. It encourages the savings and investment habit to common people.

(3) Help to Business Sector : The financial intermediaries help nonfinancial business sector by purchasing debentures, bonds, shares etc.

(4) Help to Government : Financial intermediaries help the central as well as the state government by purchasing and selling their bonds and securities.

(5) Benefit to Lenders and Financial Institutes: The financial institutes play the role of financial intermediaries when the savers deposit their money in these institutions then they earn interest as income on their deposits. Again when on the behalf of the financial institutes the ultimate borrowers get credit then they earn benefit. The difference of rate of interest of both sides is profit of the financial institutions.

(6) Spread of Risks : Financial intermediaries act as an important link between borrowers and lenders. They bear risk on their own experiences and lessen the risk of borrowers. These intermediaries invest the money in different securities which results in spread of risk instead of its centralisation. The large size of the list of investment lessens the risk through the medium of differentiation of investment.

(7) Creation of New Assets and Liabilities : All financial institutions create financial assets. The banks while purchasing the initial securities create wealth. As a result, in all aspects financial assets are created through purchasing the financial assets or real assets. The banks purchase the initial securities of various kinds. Other intermediaries create non-monetary intangible assets while depositing the money.

(8) Provide Liquidity : The financial institutions supply the funds and issue the claims on themselves. It means that these institutions always try to maintain the liquidity. Financial institutions provide liquidity by converting the assets into money without reducing the value.

(9) Helpful in Lowering Interest Rates : Financial intermediaries include and a competitive environment comes in these financial insti4tutions. As a result of such competition the rate of interest automatically fall down. Common people prefer to keep their savings in financial institutions instead of keeping cash at home. The financial institutions invest this deposited money in primary securities. It results in the increase of the rice of the securities and interest rate becomes low. As there is an opposite relationship between the price of securities and the rates of interest, so, with the increase in the value of securities the interest rate falls down. For example, if the marked price of a particular bond is 100 and the rate of interest on it is 10%, it means that there will be a certain income of 10 in a year on the investment of 100. Now if the price of bond increases from 100 to 200 even then the yearly income will be 10 only because interest will be obtained on the marked price of the bond. But due to the investment of 200 the interest rate reduces to 5%. Apart from this when people keep their money with financial institutions for safety and liquidity then demand of money reduces and rate on interest becomes low. This fact has been shown in the diagram given below.

In the above figure demand and supply of money shown on x-axis and y-axis respectively represents rate of interest. Supply of money is shown by the MS curve. Initial demand of money is MD which х intersects MS at E. So rate of interest is or. Now when demand curve of money comes on M,D, curve then MS intersects El and then rate of interest reduces from or to or,

(10) Stability in Capital Market: In the form of financial intermediaries financial institutions exchange those various assets and liabilities whose major businesses are done in capital market. The financial institutions give stability to the capital market as per certain rules and regulations. The savers get attracted on account of the stable capital market.

(11) Benefit to the Economy: The financial institutions create environment of business in the financial market. Investment encourages on the basis of the intermediaries of financial institutions. The rate of capital formation increases rapidly due to the increase in investment. It benefits the economy.

(B) Role of Non-Bank Financial Intermediaries

Non-banking financial intermediaries include a wide variety of financial institutions which raise funds from the public directly or indirectly to lend them to ultimate lenders. The role of non-banking financial intermediaries is similar to the bank financial intermediaries. Apart from this, the following titles may be used to make the point clear :

(1) Help to Household Sector : The household sector depends on the non-bank financial intermediaries. These intermediaries invest the saying of household sector in profitable sectors. It increases the income of the household sector.

(2) Lenders and Intermediaries Both Earn : When the lenders deposit their money to non-banking financial intermediaries, then they get their income as interest. Again when these intermediaries provide loan to the ultimate borrowers then they get benefit. In other words the non-financial intermediaries earn profit from the difference of interest rates.

(3) Brokers of Loanable Funds: The non-banking financial intermediaries play the role of a broker between the ultimate saver and the ultimate investors. These investors after purchasing the initial security from the investors sell out! secondary securities to the savers. Thus, after converting the loan into credit, the non-bank intermediaries play the role of broker of loanable funds.

(4) Collecting Savings : These intermediaries provide special services with an aim to collect major portion of public savings. Easiness in liquidity together with protection to the principle amount, divisibility of funds is secondary securities etc are its special services to attract the people. The non-bank financial intermediaries also take contract from the savers so that the savers  get benefit for a long time. These Institutions include pension fund, life insurance companies, public provident fund etc.

(5) Investment of Funds : The non-bank financial intermediaries are expert of investment. They earn profit by investing the collected savings. The investment policy of different non-banks financial institutions may be different but they have the same aim.

(6) Economy : The non-bank financial intermediaries after collecting savings do have better skill in investment. So, the expenses incurred in purchasing securities and selling them is comparatively less. Decrease in cost! increases the profit. Their employees are skilled in their job. Due to this the cost of investment becomes less.

(7) Helpful in Economic Growth : These intermediaries discourage hoarding by bringing the savers and investors on a single stage. It creates a healthy financial environment in the country.

UNDERDEVELOPED COUNTRIES AND FINANCIAL INTERMEDIARIES

For an underdeveloped country the financial intermediary plays an important role. In such countries, the capital market usually appears undeveloped and unorganised. The underdeveloped economy is that economy where birth rate is comparatively higher, natural resources are not fully used the standard of living is low. In such countries the scope of investment is wide but the rate of capital formation is slow. In underdeveloped countries the quantity and tendency of saving is also minimum. In such an economic system, the industries, trade and transportation are in backward condition. In underdeveloped countries generally people invest their savings in gold, silver, real estate etc or they spend their savings in luxury items.

So, in such a situation the financial intermediaries try to give the honourable position to these countries in the economic stage of the world. Commercial banks alone are not sufficient for this. This also gives encouragement in the habit to savings.

KINDS OF FINANCIAL INTERMEDIARIES : AT A GLANCE

Looking at the following chart will make clear the financial intermediaries.

Kinds of Financial Intermediaries

Banking Financial Intermediaries                            Non-Bank Financial Intermediaries

Organized Sector                     Non-Organized Sector

Commercial Bank,                     Moneylenders

Co-operative Bank,

Regional Rural Bank

Financial Intermediaries Money study

EXERCISE QUESTIONS

Long Answer Type Questions

1 What do you mean by financial intermediaries ? Explain its role in economy.

2. What are financial intermediaries ? Explain its role in developing economy.

Short Answer Type Questions

1. What are financial intermediaries?

2. What are the working of financial intermediaries?

3. Explain the kinds of financial intermediaries.

III. Objective Type Questions

Choose the correct option

1 The financial intermediaries play the role of intermediaries ………….

(a) To Central and State Government

(b) of the Government and the banks

(c) Of the ultimate creditors and the ultimate borrower

(d) All of the above.

2. To financial intermediaries initial securities :

(a) Sell out

(b) While Purchasing

(c) Collect

(d) All of the above

3. To second securities of financial intermediaries :

(a) Sell out

(b) Purchase

(c) Collect

(d) None of the above

4. Following are the rule of financial intermediaries :

(a) To create new wealth and givers

(b) Spread of risk

(c) Provide liquidity

(d) All of the above

5. Relationship between the price of securities and the arts of interest :

(a) of the same direction

(b) Opposite

(c) No relationship

(d) Sometimes in the same direction and sometime quite opposite

6. Banking financial intermediaries do play the role of intermediaries :

(a) Commercial Banks

(b) Co-operative Banks

(c) Regional Rural Bank

(d) All of the above

7. The non-bank are the financial intermediaries in the organize area : (a) Development Bank

(b) Post office (c) Both (a) and (b)

(d) None of the above Ans. 1. (c), 2. (b), 3. (a), 4. (d), 5. (b), 6. (d), 7. (c).)

Financial Intermediaries Money study