What have been the banks and other financial institutions doing in this pandemic? To answer that, first we must know about financial intermediaries.
What are financial intermediaries?
Just like intermediaries act as a go-to between various parties, financial intermediaries act as the middle man between two parties in a financial transaction.
Economy has developed from barter system to digital money system, there is great exchange of money between lenders and borrowers. So, to make the transaction free of risk and to save the time and cost, financial intermediaries play a vital role.
Just as an example if we need Rs 5000, for that there is two options: either try to find an individual who wants to lend money or approach to bank for a loan. We can see that the first option is uncertain and it will take a lot of cost and time to find the investors. However, second option is more convenient and quicker.
Financial intermediaries provide a service and they earn profits from the interest spread that exists between the interest rate offered to the borrower and the interest rate that is paid to the lender. It also helps an individual or firm to save or borrow money. There is very important role of financial intermediaries in an economy like ours. Majority of agents/brokers are in need of resources which they cannot generate on their own while some have excess of them.
Types of financial intermediaries
Broadly, financial intermediaries could be grouped into following types:
- Insurance companies
- Financial advisers
- Credit union
- Mutual funds
- Stock exchange
- Pension funds
Insurance companies are the financial institutions that provides a range of insurance policies to protect individuals and business against the risk of financial losses. It is a business that provides coverage in the form of compensation resulting from loss, damages, injuries, treatment or hardship in exchange for premium payments.
In Nepal, insurance companies are broadly classified into two types: life insurance companies such as Prime Life Insurance; and non-life insurance companies such as Shikhar Insurance.
Financial advisors are the professionals who help us to make decisions about what we should do with our money, which may include investments or other courses of action according to our situation. They use their knowledge and experience to construct personalized financial plans that helps to achieve the financial goals of a client.
Credit union is a member-owned financial cooperative, controlled by its members and operated on the principle of people helping, providing its members credit at competitive rates as well as other financial services. It differs form financial institutions because here, only those who have accounts in the credit are can be its members and owners, and they elect their Board Of Directors (BOD) in a one person one vote system.
In simpler words, credit unions are non other than banks, micro-finances and cooperatives, the financial institutions we are familiar with.
Mutual funds refer to a group of people putting their money together to buy stocks or bonds. It is a collection of stocks, bonds or others securities. The price of each mutual fund share is called net asset value.
The investment decisions in mutual funds are taken by highly-skilled team. In Nepal, subsidiary companies of banks are only allowed to issue mutual funds. E.g. Global IME Samunnat Scheme-1, NIBL Sambriddhi Fund-1, Laxmi Equity Fund etc.
Stock exchange is a marketplace where stockbrokers and traders can buy and sell securities, such as stocks, debentures and bonds. It helps in the valuation of securities based on the factors of demand and supply. It insures a ready platform for the purchase and sale of securities.
Nepal Stock Exchange (NEPSE) is the only stock exchange in Nepal and is governed by Securities Board of Nepal (SEBON).
Brokers are persons or institutions who buys and sells bonds and shares for others. They are the individual or firm that acts as an intermediary between an investor and a securities exchange. They provide that service and one who uses it has to give commissions, fees or through exchange itself.
In NEPSE, there are a total of 50 brokers facilitating buy and sell orders from the investors.
Merchant bank is a financial institution that conducts loan services, financial advices and fundraising services for large corporations and high net worth individuals. It does not provide financial services to the general public. These banks are expert in international trade, and provides same services as an investment bank but it does not provide regular banking services to the public.
In Nepal, merchant banks function as issue managers for various companies in their IPO. They also function as share registrar of companies and are responsible for depositing bonus shares and dividends on investors’ account.
E.g. Aakash Capital Limited, CBIL Capital Limited, Kathmandu Capital Market Limited etc.
Pension fund is a fund that accumulates capital to be paid out as a pension for employees when they retire at the end of their careers. It is the amount of money, separated from regular payments which is invested in order to pay whole amount when they retire.
Benefits of financial intermediaries
Financial intermediaries help the people and economy in various ways. Some of the benefits of financial intermediaries are:
- Arrangement of resources
In case borrowers may require large sum of money, for that, financial intermediaries collect a large sum of money from different depositors and lend a required money to the borrowers.
2. Cost reduction
Financial intermediaries help to reduce cost in many ways. For e.g. if we take loan directly with the depositor then we have to bear the cost of arrangements, transportation and contracts but it is simple in case of financial intermediaries.
3. Providing safekeeping, accounting and payments mechanisms
We know bank is one of the great examples for the safekeeping of money in accounts. This process is less risky and easier in comparison to other. There will be less chances of frauds and spam through this process.
4. Maturity transformation
There might be a case that depositor wanted to deposit money for short term but borrowers want to take money for long term. In this case financial intermediaries deals with many customers over a long period of time and provide the required amount of money to the borrower for required time.
Financial intermediaries are experts and specialist knowledge and resources to assess the risk. They are experts at collecting and processing information in order to accurately gauge the risk of various investments and to price them accordingly.
Disadvantages of Financial Intermediaries
Although there are many benefits of financial intermediaries, there are several potential disadvantages of it while connecting borrowers and lenders. Some of them are:
- Low return on Investment
Financial intermediaries work to make profit, so using this service might result in lower return on investment than the actual. For e.g. when we save money at a bank, bank pays us interest on the money and then lends those funds to other consumers or companies at a higher interest rate to make a profit. In this case, bank acts as an intermediate between us and the borrower. While we receive interest on our saving from bank, we could potentially make more money if we lent directly to a borrower rather than channeling money to then through bank.
It is important to consider the cost of fees, commissions, interest rates and potential alternatives before making any sort of financial transaction. There may be chances of spam and frauds if we trust blindly to the brokers.
3. Lack of co-ordination among financial institutions
There is lack of co-ordination among financial institutions so if the business where we invest money is down then the money is lost. We cannot get our money or stock back from another institution. Thus, this is also one of the drawbacks of financial intermediaries.
4. High rate of interest
There is a chance of charging high interest rate by financial institutions. So, to prevent that first we must have knowledge of current interest rate in the market.
5. Lacks of skilled manpower
Lack of skilled manpower is also one of the drawbacks of financial intermediaries. In rural areas digital platform has just been established. Due to lack of skilled and technical manpower, there is chances of wrong outcomes of the transactions which will affect both borrowers and lenders.
Role of financial intermediaries in our country?
In context of Nepal, Nepalese authorities have made important progress in strengthening the financial stability framework. This framework consists of provisions for liquidity supports to financial institutions. It has played a great role in balancing the economic situation by adopting the environment situation.
Financial intermediaries have been helping the people by providing loans at a very less interest. Their e-banking service facilitates transaction through any internet-connected device, eliminating the need to go to bank.
In addition, they have been working in the saving and investment cycle of an economy by serving as conduits to finance between the borrowers and lenders. They ensure that there are no trust issues between the borrowers and lenders. They also ensure that the relevant parties in the economic circuit are able to deal with the aspect of maturity transformation.
Strategies used by financial intermediaries of Nepal in this Pandemic
In this pandemic situation, financial intermediaries have been helping the people and government by providing funding and through the corporate social responsibility. Government of Nepal has also helped by providing financial support to set up the digital platforms for financial transactions.
Likewise, people are able to connect IPS (Initial Public Service) between financial sectors which has made easier for payment of taxes and other expenditure to the people.
Financial institutions have reduced the transfer charge from one bank to another which resulted in doing more digital banking by the people. People needn’t go to the same place for transaction in this pandemic.
In a nutshell, we can say that, in this pandemic situation also financial intermediaries are doing their best to provide their services and to make the economy stable in our country.
Yunil Ghimire is a second‐semester student of BBA at Mahendra Multiple Campus, Dharan.