Financial Intermediaries

The term intermediary describes an individual who serves to bring others together. In the financial world, a financial intermediary is a financial institution that borrows from savers and lends to borrowers in need of investment funds. In basic terms, a financial intermediary acts as the middleman between borrowers and savers. Though savers are likely to receive higher returns by eliminating the middleman, there are advantages to financial intermediaries. The following paper will discuss the roles and advantages of financial intermediaries in the financial system as well the links between financial intermediaries and the Federal Reserve. Additionally, this paper will discuss how intermediary institutions and the Federal Reserve are interlinked with the flow of capital.

The primary types of financial intermediaries include commercial banks, thrift institutions, investment companies, pension funds, insurance companies and finance companies. Basically, individuals deposit money into bank accounts, pay insurance premiums, or invest in stocks or bonds and these funds are used to make loans to other consumers and businesses or are invested in securities. Financial intermediaries gain income based on the interest rate, or the difference between interest rates paid to savers and interest rates charged to borrowers. The financial intermediary bears all risk on money loaned. Financial intermediaries protect savers assets while providing funds to borrowers. These intermediaries help to maintain a constant flow of money in the economy. Without financial intermediaries, movement of capital would be hindered and commercial growth would undergo a lack of funds. Additionally, it is imperative that one understands the impact of monetary policy, both domestic and global, and the affect it has on an organization's cost of capital.

The Federal Reserve System, or the Fed, is the United States central banking system and serves to manage the United States money supply. The Fed consists of two committees that report to the Board of Governors- the Federal Advisory Council and the Federal Open Market Committee (FOMC). According to the Board of Governors of the Federal Reserve System (n.d.), "the Federal Reserve controls the three tools of monetary policy--open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations" (Federal Open Market Committee, para. 2). The Fed sets the rate charged to member banks for borrowing money- this is called the discount rate. The discount rate is used by lenders when calculating the prime rate. Therefore, when discount rates fluctuate, a firms cost of capital also fluctuates.

Financial intermediaries collect and exchange funds. This allows borrowers to avoid dealing with individual investors and helps