Financial intermediaries

Quick definition

Financial intermediaries are the middlemen between parties in a transaction, such as an investment bank or a mutual fund.

Key details

• Financial intermediaries keep the financial markets ticking over by connecting individuals to each other or to the market as a whole
• The intermediaries often hold or manage money on your behalf
• Intermediaries include banks, stock exchanges, stockbrokers, and building societies

What are financial intermediaries?

Institutions which hold money balances of, or which borrow from, individuals and other institutions, in order to make loans or other investments.

The financial intermediaries commonly found in the stock market include depository institutions/investment banks, stock exchanges (clearing corporations), and stockbrokers/dealers. The intermediaries ensure that resource relocation is efficient. Specifically, they ensure that entities with surplus capital get to channel it to those who need the capital for business operations.

Stockbroker/Dealer/Brokerage firm

Usually stockbrokers act as agents of brokerage firms, but the term is also often used to refer to brokerage firms themselves. A brokerage firm, through the stockbroker, provides trading services to investors. These intermediaries obtain their authority from the license offered by a stock exchange. Investors open trading accounts with their desired stockbrokers through which they gain access to the stock market.

With a trading account, traders can buy and sell stock through intermediaries. Other roles that the stockbroker plays include facilitating transfer of funds between the trader’s bank account and the trading account, and providing market research to help traders in decision making.

Clearing corporations

These are affiliates of stock exchanges. Clearing corporations facilitate transactions within the stock market. These entities confirm, settle, and deliver transactions. As such, transactions happen promptly and efficiently. Given the bulk of transactions taking place at any given time in the stock market, these entities come in handy to ensure that transactions are smooth and that investors have confidence in the workings of the market.

Depository institutions

Depository institutions are the banks and credit unions that issue demands as well as check deposits. Traditionally, commercial banks are the major entities that offer these services. On the other hand, credit unions and savings banks issue time/savings deposits as well as loans. There are no clear-cut demarcations on what commercial banks/investment banks can offer as opposed to credit unions and savings banks.

In the stock market, there is another type of depository institution that offers sanctuary to shares. These depository institutions offer accounts where investors store their shares electronically. This “Central Depository” ensures that shares are available for exchange once a trader initiates such a transaction. The account at the depository is linked with the trader’s trading account to ensure a fast and efficient settlement of transactions.