1. Introduction
  2. What are financial intermediaries?
  3. Examples of Financial intermediaries
  4. Why financial intermediaries = NOT bad?
  5. Mock Questions


  • Until now we saw four chapters of economic survey.
  • The fifth chapter is about financial intermediaries, so before going through the gist of chapter 5, it is essential to understand:

What are financial intermediaries?

  • On one side we’ve common men (households), these folks spend money and save money. So these are the people who have “surplus” money.
  • On the opposite side, we’ve businessmen (industries) who provide goods n services. They need money to start new business, to expand existing business, sometimes Government also needs money. So These are the people that “want” money.
  • Financial intermediaries are the middlemen between these two types of people.
  • Banks, insurance companies, pension funds, mutual funds etc. are the examples of financial intermediaries.
  • They take money from the savers (or lenders) and loan it directly or indirectly to the borrowers (Government / businessmen)
  • Borrower (Government / Businessman) pays the interest rate on this loan.
  • The intermediary (bank/insurance co./pension or mutual fund ), will get Commission
  • And the Common men will earn some profit / interest / dividend/ return on his investment.
  • Thus in financial intermediation, everyone goes home happy. (except the person who is writing this article for some stupid exam and the person who is reading his article for some stupid exam.)


  1. The institutions that channel funds from savers to users are called financial intermediaries.
  2. Institutions that channel funds between surplus and deficit agents are called financial intermediaries.
  3. Financial intermediaries serve as a middleman between saver and borrower.

Examples of Financial intermediaries

  1. Commercial banks
  2. Regional rural banks (RRB)
  3. Cooperative banks/ societies
  4. Development banks and All India finance institutions (IDBI, NABARD, SIDBI, NHB etc.)
  5. Pension/provident funds (NPS, EPFO etc.)
  6. Mutual funds (UTI and private sector mutual funds)
  7. Insurance companies (LIC, GIC etc.)
  8. Non banking financial companies (NBFC, eg. Mannapuram gold loans, Muthoot finance etc. Jab ghar mein pada hai sona to fir kaahe ko rona?)

Why financial intermediaries = NOT bad?

  • If we look at the middlemen from common man’s point of view, they’re usually considered undesirable/ bad.
  • For example real-estate agents, they take commission and hence increase the price of building or land.
  • And You’d have heard this argument hundred times : “the middlemen buy carrots from farmers for just Rs.2 rupees a kilo and charges Rs.20 per kilo to the final consumer in the city without doing any value addition. The FDI in multibrand retail will cut down these middlemen and hence reduce the prices of fruits and vegetables.”
  • So based on that logic, can we say financial intermediaries are also bad because they’re also middlemen? Answer is no. Because of following reasons:

Economies of scale

  • Financial intermediaries are big in size, spend lot of money in advertisements, have branches in many places, so for them finding prospective loan taker=very easy.
  • When loans are given, lot of paperwork, background check has to be done. Financial intermediaries have thousand of employees to do it. They buy stationary, printer inks etc. on wholesale so their operation costs are low.
  • On the other hand, if you (aam aadmi) directly try to find someone who needs loan/finance then amount of rickshaw fare for searching clients, making telephone calls, seeking help of CAs and accountants, no. of hours spent in paperwork- all that will reduce your profit margin to a very low level. So it’d be better if you let the financial intermediaries do all that work.

Your Investment is safe

  • Take an example of a mutual fund manager,
  • He’ll invest part of your money in risky securities that offer higher profit.
  • He’ll invest part of your money in Government securities, or high rated corporate bonds, where profit is less but they’re more secure.
  • In addition, He has lot of clients and many new clients keep incoming, so even if he makes losses in first place, he can make do by making profit in second place.
  • Often you hear newstories where someone committed suicide after losing money in sharemarket. But You never see a news story where a mutual fund manager committed suicide after losing money in share market.


  • Same goes for bank. You deposit your money in savings account then you’re certainly going to earn interest (profit).
  • It is bank’s headache to find a loan taker, collect EMIs and recover loans. Besides banks have to maintain CRR, SLR, – it also ensures safety of your investment.
  • Often we see in newspaper that “SBI has non-performing assets (NPAs) worth thousands of crores.” It means SBI gave loans to some people but unable to recover the money.
  • Yet you never hear a newstory where SBI branch manager told a customer ,“ sorry, you can’t take out money from your savings account or fixed deposit because we’ve unable to recover loans from third party.”
  • Why? Because SBI has lot of new incoming customers, and if it makes losses in one place, it makes profit in several other places
  • besides  SBI is doing business for years, so it has deep pockets full of cash. It can afford to bleed, it can afford to make temporary losses and yet maintain a smile on its face.
  • But If a common man directly gives loan to someone, and the loan-taker doesn’t repay on time = troublesome situation. Because then common man will have to either hire goons or goto police/court:  first solution is quick but very risky, second solution is expensive and time consuming.

Insurance / Pension funds

  • Lot of people takes insurance and pay “premium”. But not everyone dies at the same time.
  • Similarly, lot of people invest money in pension / provident funds,  but not everyone retires at the same time.
  • Hence there is lot of idle money that insurance /pension /provident company can invest in Government securities, corporate shares, bonds etc.
  • And They also take help of experts and invest some money in risky areas, some money in safe areas.

That’s the second advantage of financial intermediaries: they ensure safety of your investment. To put this in refined words: “financial intermediaries invest in diversified portfolios and hence suffer less risk compared to an individual investor.”

  • Besides, financial intermediaries are supervised by regulators (RBI, SEBI, IRDA etc.) so they can’t fleece small investor and run away.
  • And financial intermediaries offer you a reasonable return on investment, their profit margin is also reasonable. It is not like they give your 2% return on your investment and loan it to businessman for 48%.

Body of Experts and asymmetry of information

  • Again the example of Mutual funds. A mutual fund manager is an expert in financial matters, he has lot of experience on share market fluctuations, how individual companies are performing, which companies’ shares are likely to go up in near future etc.etc.etc.
  • So he can make better investment decision compared to a new player in the sharemarket.
  • Similarly bank has battery of full time officers for processing loans application and recovering the loans. They look at the credit history / record of a Borrower before granting loans.
  • Insurance company also has experts to look into fraudulent insurance claims, and make prudent investment decisions.
  • Thus, there exists an asymmetry of information. (Those intermediaries have experts so they can make better decisions compared to an individual investor).

Large Pool of money

  • For the moment let’s assume you love challenges and despite all the odds presented to you so far, you still decide to play this game on your own.
  • But at most you’ll have a few lakh rupees to invest but on the other side there is a big businessmen who needs loan worth cores of rupees for a long term project (e.g. 25 years).
  • You may not have the time / mood to wait for 25 years to recover your entire investment. (even if he took partial loan from you).
  • But on the other hand a financial intermediary receives lot of money (e.g. SBI has lakhs of savings accounts and fixed deposits ), so they can offer large amount of loans and wait for years to recover the entire investment.
  • And if you had saved money in SBI, you would still be earning regular interest and can take out your money any time you want.

^These are the advantages from investor / lender’s side. Now let’s look at the advantages from borrower’s side.

From Borrower’s side

If you’re a businessman, how does a financial intermediary help you?

  1. Easy availability: because you can easily find their office, take the application form.
  2. Reasonable cost of borrowing:
    1. Debt: if you borrow from a money lender, he’ll charge very high interest rate, compared to a bank.
    2. Equity:  if mutual fund has invested in your shares, all you have to do is pay reasonable amount of dividend on the shares (if your company makes profit).
  3. You Can take long term loans worth crores of rupees.

So far we know how financial intermediaries help the lenders/investors/households/Aam-Aadmi and the borrowers/loan-takers/businessmen. Now let’s see how financial intermediaries help the entire economy of a country.

+ve impact on the Whole economy

  1. Financial intermediaries help circulating money in the system. If money is staying idle (e.g. under your bed pillow or as gold in your locker) then it is not good for the economy. Money must keep changing hands. If you look at this from a different angle: if nobody buys skin whitening creams then who will feed the families of those chemists who work there And the businessman who supplies raw material to that factory?
  2. They promote the habit of savings.
    1. Individual can use that saved money in bad times / emergency and earn profit in between.
    2. A needy businessman will easily get loans.
  3. When businessmen can get loans easily at a reasonable cost, they’ll start new business, expand existing business, hire more employees, increase production of goods / services = India’s GDP increases, IIP increases. When people are making more money, they spend more money. A family goes to restaurant, poor waiter makes money. Family hires maid, gardener, driver. Family buys new car, mobile or bike- it breaks down, the repairman makes money. That’s how money trickles down from rich people to poor people.

Big picture is: if India wants a better GDP growth rate then

  1. Financial intermediaries should be able to do their business easily. e.g. banks should have better facilities to recover bad loans….there comes SARFAESI Act amendment.
  2. Regulators (RBI, SEBI) should have more powers to supervise the Financial intermediaries….there comes the amendments in their respective acts/ rules.
  3. Businessman should be able to raise money not from Indian financial intermediaries but also from abroad, wherever they can get finance at a cheaper rate….there comes ADR, GDR.
  4. People (particularly in rural areas) should be made aware of the benefits of these financial intermediaries….there comes the topic of financial literacy.
  5. People should be able to get help from financial intermediaries easily….There comes the topics of financial inclusion, banking correspondence agents, ultra small branches, New pension schemes etc.

^These are some of the topics discussed in fifth chapter of Economic survey. (we’ll see them in a separate article later.)

Mock Questions

Q1. What do you understand by the term financial intermediaries?

  1. Arbitrators who settle commercial disputes outside court.
  2. Persons who take finacial decisions for a firm using the power of attorney.
  3. Software / accountings firm hired by a bank to do back office functions.
  4. Institutions that act as middleman between those who want to lend and those who want to borrow.


  1. only ii and iii
  2. only I and iv
  3. only I, iii and iv
  4. only iv

Q2. Which of the following is an example of financial intermediary?

  1. Competition Commission of India
  2. CAG
  3. Banking ombudsman
  4. LIC


  1. Only I and iii
  2. Only ii
  3. Only iii and iv
  4. Only iv

Q3. Financial intermediaries are

  1. Non-essential for a country.
  2. Essential for a country.
  3. Essential for a communist country but non-essential for a capitalist country.
  4. None of above.

Q4. A financial intermediary is in a stronger position than an individual investor due to

  1. economies of scale
  2. asymmetry of information
  3. investments in diversified portfolios
  4. All of above.