FINANCIAL INTERMEDIATION

In any economy, the financial sector plays a major role in the mobilization and allocation of savings. Financial institutions, instruments and markets which constitute the financial sector act as a conduit for the transfer of financial resources from net savers to net borrowers. Financial intermediation consists of channeling funds between surplus and deficit agents The process of taking in money (borrowing) so that it can be made available to individuals or institutions in the form of loans or investment. the process by which the formal and informal financial sectors manage liquidity in the economy, reallocating liquid resources by mobilizing savings from institutions and individuals and allocating it in the form of credit to institutions and individuals. Utilize of liability to finance venture in high-quality assets in the transaction; both the investments and supporting debt are duration matched and cash flow matched. Having designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a widerange of institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in move than one market e.g. underwriter. However, the services offered by them vary from one market to another. The financial sector performs this basic economic function of intermediation essentially through four transformation mechanisms: 1. Liability-asset transformation (i.e. accepting deposits as a liability and converting them into assets such as loans); 2. size transformation ( i.e. providing large loans on the basis of numerous small deposits);

3. maturity transformation (i.e. offering saver alternative forms of deposits according to their liquidity preferences while providing borrowers with loans of desired maturities); and 4. risk transformation (i.e. distributing risk through diversification which substantially reduces risks for savers which would prevail while lending directly in the absence of financial intermediation). The process of financial intermediation supports increasing capital accumulation through the institutionalization of savings and investment and, thereby, fosters economic growth. The gains to the real sector of the economy, therefore, depend on how efficiently the financial sector performs this basic function of financial intermediation. The intermediation cost in India is still high, largely due to high operating cost. Although overall efficiency and productivity have improved, resources are not being utilised in the most efficient manner."

The term financial intermediary may refer to an institution, firm or individual who performs intermediation between two or more parties in a financial context. Typically the first party is a provider of a product or service and the second party is a consumer or customer. Financial intermediaries are banking and non-banking institutions which transfer funds from economic agents with surplus funds (surplus units) to economic agents (deficit units) that would like to utilize those funds. FIs are basically two types: Bank Financial Intermediaries, BFIs (Central banks and Commercial banks) and Non-Bank Financial Intermediaries, NBFIs (insurance companies, mutual trust funds, investment companies, pensions funds, discount houses and bureaux de change). Financial intermediaries can be: Banks; Building Societies; Credit Unions; Financial adviser or broker; Insurance Companies; Life Insurance Companies; Mutual Funds; or Pension Funds.

The borrower who borrows money from the Financial Intermediaries/Institutions pays higher amount of interest than that received by the actual lender and the difference between the Interest paid and Interest earned is the Financial Intermediaries/Institutions profit. Financial Intermediaries are broadly classified into two major categories:

1) Fee-based or Advisory Financial Intermediaries

2) Asset Based Financial Intermediaries. Fee Based/Advisory Financial Intermediaries: These Financial Intermediaries/ Institutions offer advisory financial services and charge a fee accordingly for the services rendered. Their services include:

i.

Issue Management ii. Underwriting iii. Portfolio Management iv. Corporate Counseling v. Stock Broking vi. Syndicated Credit vii. Arranging Foreign Collaboration Services viii. Mergers and Acquisitions ix. Debentive Trusteeship x. Capital Restructuring

ASSET-BASED Financial Intermediaries: These Financial Intermediaries/Institutions finance the specific requirements of their clientele. The required infra-structure, in the form of required asset or finance is provided for rent or interest respectively. Such companies earn their incomes from the interest spread, namely the difference between interest paid and interest earned. The financial institutions may be regulated by various regulatory authorities, or may be required to disclose the qualifications of the person to potential clients. In addition, regulatory authorities may impose specific standards of conduct requirements on financial intermediaries when providing services to investors. Role of Financial Intermediaries for Poverty Reduction : Finding innovative ways to provide financial services to the poor so that they can improve their productive capacity and quality of life is the role of the financial intermediaries in the 21st century. Most of the poor live in the rural areas, and are engaged in agricultural activities or a variety of microenterprises.

Intermediary

Role Secondary Market to Stock Exchange Capital Market securities Corporate advisory services, Investment Bankers Capital Market, Credit Market Issue of securities Capital Market, MoneySubscribe to unsubscribed Underwriters Market portion of securities Issue securities to the Registrars, Depositories, investors on behalf of the Capital Market Custodians company and handle share transfer activity Primary Dealers Satellite Market making in Money Market Dealers government securities Ensure exchange ink Forex Dealers Forex Market currencies Banking sector significance in total financial sector In most emerging markets, banking sector assets comprise well over 80 per cent of total financial sector assets, whereas these figures are much lower in the developed economies. Furthermore, deposits as a share of total bank liabilities have declined since 1990 in many developed countries, while in developing countries public deposits continue to be dominant in banks. In India, the share of banking assets in total financial sector assets is around 80 per cent, as of end-March2009. There is, no doubt, merit in recognizing the importance of diversification in the institutional and instrument-specific aspects of financial intermediation in the interests of wider choice, competition and stability. However, the dominant role of banks in financial intermediation in emerging economies and particularly in India, will continue in the medium-term; and the banks will continue to be special for a long time. In this regard, it is useful to emphasize the dominance of banks in the developing countries in promoting non-bank financial intermediaries and services including in development of debt-markets. Even where role of banks is apparently diminishing in emerging markets, substantively, they continue to play a leading role in financial sector. Non-Banking Financial Institutions Non-banking Financial Institutions carry out financing activities but their resources are not directly obtained from the savers as debt. Instead, these Institutions mobilise the public savings for rendering other financial services including investment. All such Institutions are financial intermediaries and when they lend, they are known as Non-Banking Financial Intermediaries (NBFIs) or Investment Institutions. UNIT TRUST OF INDIA LIFE INSURANCE CORPORATION (LIC) GENERAL INSURANCE CORPORATION (GIC)

Market

Apart from these NBFIs, another part of Indian financial system consists of a large number of privately owned, decentralised, and relatively small-sized financial intermediaries. Most work in different, miniscule niches and make the market more broad-based and competitive. While some of them restrict themselves to fund-based business, many others provide financial services of various types. The entities of the former

type are termed as "non-bank financial companies (NBFCs)". The latter type are called "non-bank financial services companies (NBFCs)". Post 1996, Reserve Bank of India has set in place additional regulatory and supervisory measure that demand more financial discipline and transparency of decision making on the part of NBFCs. NBFCs regulations are being reviewed by the RBI from time to time keeping in view the emerging situations. Further, one can expect that some areas of co-operation between the Banks and NBFCs may emerge in the coming era of E-commerce and Internet banking.