What do you understand by the terms ‘financial intermediation’ and ‘financial dis-intermediation’? Explain in detail
Financial intermediation refers to the process of channeling funds from savers to borrowers through various financial institutions or intermediaries. These intermediaries act as a bridge between those who have surplus funds (savers) and those who need funds (borrowers). They help facilitate efficient allocation of capital and mitigate risk.
When savers have excess funds, they deposit them in financial institutions like banks. These banks subsequently lend out these funds to borrowers such as individuals, businesses, or governments. By acting as intermediaries, financial institutions pool funds from various savers to provide loans or make investments. They also provide other financial services like insurance, brokerage, and asset management.
Financial intermediation offers several advantages. First, it helps match the supply and demand for funds, ensuring that funds are available for productive investments. Second, it allows savers to earn interest on their funds, providing an incentive for saving. Third, it provides borrowers with the necessary capital to invest in projects, stimulating economic growth. Finally, financial intermediaries conduct credit assessments and manage risks, reducing information asymmetry between savers and borrowers.
On the other hand, financial disintermediation is the process of bypassing traditional financial intermediaries and directly accessing the financial markets. Disintermediation occurs when savers and borrowers interact directly, usually through the use of financial instruments like bonds, stocks, or other securities.
Disintermediation gained prominence with the development of capital markets, online financial platforms, and new financial technologies. Savers can now invest directly in the financial markets, bypassing traditional savings accounts or loans provided by banks. Likewise, borrowers can obtain funding directly from investors through bond issuances or equity offerings, without relying solely on bank loans.
Advantages of financial disintermediation include lower transaction costs, increased transparency, and potential for higher returns. By eliminating the intermediaries, individuals and businesses have more control over their investments and can access a wider range of financial products. However, direct market participation is typically riskier, as it requires greater knowledge and expertise in managing investments.
In summary, financial intermediation involves the flow of funds from savers to borrowers through intermediaries like banks, while financial disintermediation involves bypassing these intermediaries and directly accessing financial markets. Both approaches have their advantages and potential risks, and the choice between them depends on individual circumstances and preferences.