Financial markets ‘transfer’ funds from surplus to deficit units in a way desirable to both the participants and profitable to financial institutions.
This is mainly due to the fact that the financial institutions take advantage of scale economies that have succeeded by transferring funds from agents with a surplus of funds to those who are short of funds.
Finally, the financial intermediaries ask for a higher rate of return on their primary security[1] portfolios than the lending rate they must pay on their own secondary securities[2]. In this respect, we can argue the following factors as the main determinants of the financial intermediaries’ characteristics. That also represent the major differences between the institutions in question and the individual householders.
Market imperfection
Undoubtedly, the financial intermediaries due to their larger volume of transaction, are able to reduce their average fixed cost and consequently to lessen the exchange cost per unit.
Diversification
Indisputably, we can state that the larger the volume of financial portfolio the greater the diversification[3] that can be achieved, which in turn results in the reduction of risk.
For example, one can put assets in different categories: bonds, stocks, precious metals, and real estate.
Certainly, such a diversification can be much easily achieved from financial intermediaries than from individual householders.
Specialisation
The operation of the financial intermediaries is entrusted to professional staff with expertise in portfolio management, asset selection, negotiation, and general financial services. On the contrary, it is not anticipated from individuals to have a similar expertise.
Certainty
Due to their volume of transactions, the financial institutions of financial markets, as earlier stated, reduce the risk through the diversification and at the same time because of a better scheduling of inflows-outflows, reduce the uncertainty to the individuals.
Miscellaneous services
In addition to their main role in financial intermediation, the financial institutions can offer non-income services tailor made to the specific needs of the ultimate wealth-owners. For example, the financial markets can offer different types of mutual funds oriented to specific group needs, i.e. age, income, time frame, and tolerance to risk.
Manolis Anastopoulos, Economist, Financial Analysis, University of Leicester
[1] Primary securities are issued by a firm to raise new capital and are exchanged via an underwriter in the primary market.
[2] Secondary securities are claims against financial intermediaries who are holders of financial assets and are exchanged in the secondary market.
[3] A well-worn adage, states “do not put all your eggs in one basket”
