Financial intermediation is the process where financial intermediaries accept funds from savers and lend those funds to borrowers. This allows for maturity and liquidity transformation between net savers and net borrowers. Financial intermediaries are important as they are major providers of funds to borrowers compared to financial markets. Regulations aim to address moral hazard and curb excessive risk taking by intermediaries given the risks involved in financial services.

1. FINANCIAL
INTERMEDIATION
Financial intermediation is the process of accepting funds
from one entity and lending these funds to another entity.
Financial intermediaries intermediate between the net
savers and net borrowers of funds in an economy.
Geetha Iyer

2. The Process of Financial
Intermediation
NET NET BORROWER
SAVER
SECONDARY MONEY
SECURITIES SE
MO PR CU
NE IM RIT
Y
AR I E
Y S
FINANCIAL
INTERMEDIARY
Geetha Iyer

3. Financial Institutions
 RATIONALE FOR FINANCIAL
INTERMEDIATION
 Reduction in Transaction Costs
 Diversification benefits
 Maturity and Liquidity Transformation
Geetha Iyer

4. Financial Institutions
 IMPORTANCE OF FINANCIAL
INTERMEDIATION
 Financial intermediaries are very important
compared to financial markets as providers of funds
to the net borrowers
Geetha Iyer

5. Financial Institutions
Select external sources of funds to industry
(in Rs. Crores) 2005-06 2006-07
Flow from Banks to Corporates
Bank Credit to Industry 127, 192 74, 981
Flow from Non-banks to Corporates
Capital issues 13, 781 23, 349
ADR/GDR Issues 7, 263 8, 019
External Commercial Borrowing (ECBs) 45, 078 48, 328
Issue of CPs -1, 517 10, 818
Source: RBI Bulletin, May 2007
Geetha Iyer

6. Financial Institutions
Percentage shares of instruments in annual savings of households
100%
Shares & debent-
90% ures
80% Claims on Govern-
ment
70% Provident and
60% pension fund
50%
Non- banking Life insurance fund
40% deposits
30%
Bank deposits
20%
10%
0%
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06
Geetha Iyer

7. Financial Institutions
 CATEGORIES OF
FINANCIAL
INSTITUTIONS
 Depository institutions
 Finance Companies
 Contractual institutions
 Mutual funds
Geetha Iyer

8. Financial Institutions
 REGULATION OF FINANCIAL INTERMEDIARIES
 The central argument in favor of regulation of financial
services is that financial products and services are different
from other services .
 Regulations can be designed to deal with moral hazard and
curb excessive risk taking by financial intermediaries.
Geetha Iyer