Financial markets: structure and role in the financial system

1.3. Financial intermediaries and their functions
Financial intermediary is a special financial entity, which performs the role of efficient allocation of funds, when there are conditions that make it difficult for lenders or investors of funds to deal directly with borrowers of funds in financial markets. Financial intermediaries include depository institutions, insurance companies, regulated investment companies, investment banks, pension funds. The role of financial intermediaries is to create more favourable transaction terms than could be realized by lenders/investors and borrowers dealing directly with each other in the financial market. The financial intermediaries are engaged in:
· obtaining funds from lenders or investors and
· lending or investing the funds that they borrow to those who need funds. The funds that a financial intermediary acquires become, depending on the financial claim, either the liability of the financial intermediary or equity participants of the financial intermediary. The funds that a financial intermediary lends or invests become the asset of the financial intermediary.Financial intermediaries are engaged in transformation of financial assets, which are less desirable for a large part of the investing public into other financial assets—their own liabilities—which are more widely preferred by the public. Asset transformation provides at least one of three economic functions:
· Maturity intermediation.
· Risk reduction via diversification.
· Cost reduction for contracting and information processing.
Source: Madura J. (2008). Financial Institutions and Markets, Eight Edition
These economic functions are performed by financial market participants while providing the special financial services (e.g. the first and second functions can be performed by brokers, dealers and market makers. The third function is related to the service of underwriting of securities).Other services that can be provided by financial intermediaries include:
· Facilitating the trading of financial assets for the financial intermediary’s customers through brokering arrangements.
· Facilitating the trading of financial assets by using its own capital to take a position in a financial asset the financial intermediary’s customer want to transact in.
· Assisting in the creation of financial assets for its customers and then either distributing those financial assets to other market participants.
· Providing investment advice to customers.
· Manage the financial assets of customers.
· Providing a payment mechanism.