Financial Intermediaries

What are financial intermediaries? Financial intermediaries are institutions that reduce the cost of moving funds between savers and borrowers. The most common financial intermediaries are banks, bond markets, and stock markets. Why do we need financial intermediaries? Well, individuals and businesses need to borrow and save at different periods of their lives. Individuals rely on borrowing to invest in things like education and housing. If your car breaks down and you don't have enough money to fix it, you can borrow money for repairs and continue living your life. And, individuals need to save for retirement when their incomes drop but their needs don't.

Businesses also rely on credit to operate and grow. Entrepreneurs with great ideas but not much money -- they can borrow money or sell a stake in their idea to get their venture off the ground. For example, Howard Schultz built Starbucks into a global brand by borrowing and raising capital through several different types of financial intermediaries. Though less common, businesses can also save money. Now, sometimes, the individual who needs to borrow knows the individual willing to lend. But financial intermediaries allow you to venture beyond just borrowing $5 from Grandma.

So we see just how common borrowing and saving through financial intermediaries is. But what happens when these institutions fail? Much like our real bridges, it's only when the metaphorical bridges of financial intermediation crumble that we recognize just how dependent we are on them. As just one example, on September 15, 2008, the world's financial system was shaken to its core when the investment bank Lehman Brothers filed for bankruptcy. The impact was great, not simply because Lehman was big, but also because it was an important financial intermediary that connected savers to borrowers. The failure of Lehman marked the beginning of a series of events that signaled America's worst economic downturn since the Great Depression. And while there are several significant angles to the Great Recession, one of them was the decreased efficacy of financial intermediation.