Types of Financial Intermediaries

CA Manish K Dhoot (CA, B. Com, NCFM, CPCM) (5015 Points)

14 September 2010

Types of Financial Intermediaries

Money needs to be circulated for an economy to be productive. If all savings are hoarded, the surpluses of the community will not be available for investments and this in turn would lead to economic stagnation. Financial intermediaries play an important economic function by facilitating a productive use of the community's surplus money.

There are various types of financial intermediaries and their structure comprises of both organized and unorganized sectors. The dominance in terms of financial flows handled by these sectors differs from country to country.

In India, the players in the unorganized sector are:

Money lenders
Indigenous bankers
Chit funds
Nidhis or mutual benefit funds
Self Help Groups

In the current scenario, there is no estimate of the volume of business handled by the unorganized sector. While the volume of business handled in the urban sector may be small, their role in rural India is very significant.

One of the negative effects of the sway of the unorganized sector is that it reduces the efficacy of a country's monetary policy. A lot of initiatives have been undertaken over the years both by central and state governments to reduce the adverse impact. Some of these initiatives are:

All India Development Financial Institutions [DFIs]
State level Financial Corporations [SFCs]
Insurance Companies
Mutual Funds [MFs]
Non Banking Finance Corporations [NBFCs]

All India Development Financial Institutions

The following are the various institutions covered under all India DFIs:

Industrial Finance Corporation of India [IFCI]
Industrial Development Bank of India [IDBI], which merged with IDBI Bank in 2004
Industrial Credit and Investment Corporation of India [ICICI], which merged with ICICI Bank in 2002
Industrial Investment Bank of India [IIBI]. The former Industrial Reconstruction Corporation of India was converted into Industrial Reconstruction Corp of India [IRCI] and was later converted into IIBI in 1995
Small Industries Development Bank of India [SIDBI], which is a wholly owned subsidiary of IDBI curved out through an act of parliament in 1990.

State Level Financial Corporations

These are state level bodies that mainly concentrate on industrial development in a state. They are legal bodies created under the State Finance Corporations Act, 1951 and are funded through an issue of shares in which the state governments, banks, financial institutions, and private investors participate.

SFCs are also permitted to raise funds through the issue of bonds and debentures. The main focus of SFCs is financing the local industrial units, which are usually small and medium units, situated in backward regions of the state.

Insurance Companies

Insurance companies concentrate on fulfilling the insurance needs of the community, both for life and non life insurance. With the globalization of the Indian economy, a large number of private players have entered into this field, offering products that allow investors to select the kind of policies to suit their financial planning needs.

Many of these organizations are formed as subsidiaries of banks that enable the banks to cross sell insurance products to their existing customers. Banks benefit by way of fee income through referrals and enhanced relationships with insurance companies for their banking needs.

Mutual Funds

These organizations satisfy the needs of individual investors through pooling resources from a large number with similar investment goals and risk appetite. The resources collected are invested in the capital market and money market securities and the returns generated are distributed to investors.

The fund managers of MFs are specialists in the fields of investment analysis and are able to diversify and even out risks through portfolio mix. MFs offer a wide variety of schemes, such as, growth funds, income funds, balanced funds, money market funds and equity related funds designed to cater to the different needs of investors.

Non Banking Finance Corporations

NBFCs are commonly known as finance companies and are corporate bodies, which concentrate mainly on lending activities in a well defined area. The Reserve bank of India [RBI] Amendment Act, 1997 defines an NBFC as a financial institution or non banking institution, which has its principal business of receiving deposits under any scheme or arranging and lending in any manner.

There are 4 broad categories of NBFCs: