Financial Intermediaries are one of the most crucial components of the Indian financial sector. Financial Intermediaries fill the gap between lenders and borrowers and make the financial services industry smoother. Knowingly or unknowingly, you and millions of other people benefit from a financial intermediary, but very few of them know about it.
What is a Financial Intermediary?
A financial intermediary is an institution or a body that collects savings from people who have surplus units, converts them into investments, and lends that money to borrowers.
The financial intermediary between lender and borrower is like a link or a middleman who governs the financial transactions and assures secure and safer investments.
Generally, a financial intermediary helps people very efficiently, and for that, they take a tiny commission from their financial transaction. Financial intermediaries channel funds (surplus funds) into deficit units, and like all the other middlemen, they take a small commission from that financial transaction.
There are many of these in the Indian capital market, but we can commonly categorize them into two parts: banking intermediaries and non-banking intermediaries.
How does a Financial Intermediary work?
While we have given you an overview of how they work, let’s take a practical example to understand the concept deeply.
Investors are investing their savings or surplus units to banks at 7%, and investment banks are shaping that amount and lending it to people as Home Loans, Car Loans, Personal Loans, etc., at more than 7% (Suppose 8%).
Now, investors are getting 7% interest on that capital, but banks are taking 8% interest from the borrower, where banking intermediaries make money. So banks charge that extra 1% (8%-7%) as their commission, and that’s how banking intermediaries work.
Now, let’s take another example in the form of the Indian capital markets. Think about how we buy stocks from the stock exchange. Right from depositing money to getting the stock in our DEMAT account, the process goes through various entities, and all of those entities are known as financial intermediaries.
Such financial intermediation is governed by the Securities and Exchanges Board of India (SEBI). SEBI has created multiple checkpoints for a smooth and secure stock transaction, and for this service, SEBI charges a small commission on the turnover.
Importance of Intermediaries in Financial Services
What are the advantages of financial intermediaries?
How do financial intermediaries help us?
Do we even need these intermediaries?
These are the questions related to financial intermediaries that come to peoples’ minds. When we talk about the importance or advantages of financial intermediaries, there are many.
Let us first unlock some benefits of financial intermediaries through some quick bullet-points, and then we’ll elaborate on those points.
Also read about: Types of Indian stock market participants
Advantages of Financial Intermediaries:
- A large community of people with surplus capital and deficit units
- Provides a platform to people who want to invest or borrow capital
- Low commission rate
- Advance and efficient system
- The low-risk platform for both investor and borrower
- Secure with various checkpoints
- Transparent costs
Suppose we don’t have any bank in the world, but you have money, and you want to invest that money. Now, would you go door to door to ask people if they want you to invest or not? Obviously no! So, let’s say you’ve found someone, to whom you can lend your money, but what if he runs away with your money? What next?
Now, let’s take another situation where you wish to start your business and want capital. Where would you go to borrow money? Who’ll trust you? That’s where financial intermediaries provide a risk-averting cushion, especially for small businesses.
Not only do they give you a platform to invest or borrow money, but they provide you security as well. They work as a link between the surplus unit and deficit unit. They use new-age technology and efficient system, and that’s why the fear of getting scammed comes down to almost 0.
All the intermediaries provide you with a smooth and secure transaction experience, and as service charges, they take a small amount as commission, which is worth it.
Let’s understand the advantages from the financial market’s perspective. Suppose SEBI doesn’t exist, you’ve invested your life savings in TATA stocks, and after two days, you’re hearing that it wasn’t TATA, it was a scam, so what then? Your life savings are gone.
To prevent these scams, we need governing bodies, financial regulatory institutions, and other intermediaries. A financial intermediary can help stop scams while keeping your transactions accurate and secure. We are confident about our money, just because of financial intermediaries.
Types of Financial Intermediaries
In 1992, to govern the Indian stock market, SEBI (Securities and exchanges Board of India) was created. SEBI controls the whole market, and it performs under the finance ministry of India. SEBI has made various checkpoints through intermediaries to provide investors with accuracy, smooth investing experience, and security. We have four leading intermediaries:
- Stock Broker
- Depository and Depository Participant
- Clearing Corporation
But there is a difference between financial intermediaries and regulators. Read our blog on Financial market regulators
Let’s get into the details of these intermediaries:
The primary intermediary is a Stock Broker. Stock Brokers provide people with the platform to trade stocks. Although not everyone can execute trades as per SEBI’s guidelines, only registered and verified stockbrokers could execute trades in any exchange.
SEBI provides every stockbroker with a stockbroking license, and without a license, it’s impossible to execute any trade. You have to open a trading account from any stockbrokers to trade in stocks.
Nowadays, you can open a trading account online, and if you want, you can also go to broker’s brunch for account opening. The broker will ask you for some identity and financial details to open a trading account. Here are some services that Stock Brokers provide:
- Give you access to the stock exchanges
- Allow you to trade in stocks
- Provide you stock updates
- Calculate and reshape your portfolio
- Note the details of your transactions
- It helps you to transfer funds from a bank to the trading account
- Calculate your margin and present it to you
- Give you total support related to trading
For all these technical and communicational support, stockbrokers levy ‘Brokerage Charge.’
Here are some Indian stock exchanges:
Depository and Depository Participant
Nowadays, when you buy a stock, you get an e-certification on your account, but earlier, it used to be physical papers. To store the e-certifications, you need a special electronic place, and that’s where we get DEMAT accounts and the concept of the depository.
The depository is the place that records securities but in electronic form. As per SEBI guidelines, every company has to be a depository member to maintain records. We have two types of Depositories in India, and those are:
Banks fall under the category of a financial institution that’s one of the most essential intermediaries. For example, if you want to buy a stock, you have to transfer money to your broker, where banks play a significant role. Similarly, when you sell stocks, you’re going to withdraw the amount through your bank account.
Also, even insurance companies are considered to be one of the many types of financial intermediaries. Just like other financial institutions, insurance companies too
Clearing Corporation matches the price of a buyer and seller and makes the deal happen. If you want to buy a TATA stock for RS.500, there must be a seller of TATA who’s selling the stock at RS.500. Clearing Corporation ensures accuracy and no defaults. We have three Clearing corporations in India, and those are:
- A financial Intermediary is very interconnected with the Indian Capital Market.
- A financial Intermediary works like a link between investors and borrowers
- We have four significant mediators in the Indian capital markets
- SEBI is the governing force of these markets
- A financial Intermediary charges commission for its services.
- You need to have a DEMAT account for trading stocks.