Question

Why are banks called "financial intermediaries"?

Short answer

Banks are called "financial intermediaries" because they serve as a middleman between savers who deposit their money and borrowers who take out loans. They help in the efficient allocation of funds between these two parties and perform crucial functions in the economy, such as mobilizing savings, allocating credit, managing risk, facilitating payment systems, and offering financial services. By efficiently channeling funds, banks contribute to the overall stability and growth of an economy.

Step-by-step solution

Definition of a Financial Intermediary

A financial intermediary is an institution or individual that serves as a middleman between two or more parties, most commonly in the process of financial transactions. In simpler terms, financial intermediaries help in the efficient allocation of funds between savers and borrowers. Some common examples of financial intermediaries include banks, credit unions, insurance companies, and investment firms.

Role of Banks as Financial Intermediaries

Banks are called financial intermediaries because they act as an intermediary between two important parties - savers who deposit their money in the bank and borrowers who take out loans from the bank. In doing so, they perform crucial functions in the economy like: 1. Mobilizing Savings: Banks attract deposits from individuals and businesses, consolidating these funds into larger pools to be made available for lending and investment. 2. Allocating Credit: Banks decide when and how to lend money to borrowers, playing a significant role in determining investment patterns and economic growth. 3. Risk Management: Banks manage various risks associated with lending, such as Interest rate risk, credit risk, and liquidity risk. 4. Payment System: Banks facilitate transactions by enabling the efficient transfer of funds between parties through various payment methods like cheques, wire transfers, and electronic funds transfers. 5. Financial Services: In addition to lending, banks also offer a wide range of financial services like investment management, insurance, and advisory services.

Importance of Banks as Financial Intermediaries

Banks, as financial intermediaries, contribute to the overall stability and growth of an economy. They efficiently channel funds between savers and borrowers, enabling investments in various sectors and promoting economic development. Moreover, banks help to maintain financial stability by managing different types of risks associated with financial transactions. Thus, their role as financial intermediaries is crucial to the functioning and health of the financial system.