Financial intermediation is the crucial process in any of free capitalist markets or economies because it allows for capital-raising activities and helps to promote economic growth. This is achieved through a dual savings – investment process.
Financial intermediation accomplishes three general objectives which are: convert a short-term liability into a long-term asset (banks do this by reconciling different maturities), a way to mitigate market risks (such as by lending to several borrowers instead of just one) and to re-denominate fund amounts (like bundling several small investors together and lend their monies to one big borrower; conversely, one big deposit can be lent out to many borrowers). When financial regulation is performed by the concerned government authorities/agency in a prudential manner, it will safeguard the economy from excessive risks and abuses.
The primary beneficiaries of financial intermediation are the borrowers who will be able to keep their borrowing costs down as opposed to borrowing directly on the markets and other primary beneficiaries are the lenders who will be insulated from any of probable market failures if done properly, as stated earlier, in a prudent way. The entire nation will benefit if it is well-managed, in the sense that intermediation increases financial efficiency.
Using Financial Intermediation to Trade Risks – a good example to trade risks is the insurance industry. What insurance firms do is spread the risks by issuing several life policies, for example, because not all people die at the same time. In other words, only a few people do die in a certain year based on statistics (or probabilities) and so the insurance people can make money based on these probabilities. For example, they issue a thousand life insurance policies and accept premium payments on these policies; however, maybe only 10 people die within a single year and so they are able to earn profits because their payout is