Financial Intermediaries: Why They're Important

Financial institutions are an integral part in developing the economic growth of a country. Financial systems enhance economies and allow firms to develop by channeling funds when needed to exploit profitable opportunities (Tumpel-Gugerell, 2003). Financial institutions like banks play an important role by providing liquidity through the redistribution of funds, in handling payment systems, implementing monetary policy, and provide approved channels for national and international financial flows. Banks are important financial intermediaries because a proportionally large amount of each dollar financed for firms externally comes from banks. As lending institutions, banks are a main source for funding in all countries. Because banks are a predominant source of funding, they play an important role in corporate governance, and act as monitors to the firms they lend to. "Basically, financial intermediation is the root institution in the savings-investment process" (Gorton & Winton, 2002).

When privately held companies go public, they become responsible to the investors and shareholders for its actions. Shareholders invest in a company expecting that company to "play by the rules" by complying with the transparency requirements of Sarbanes-Oxley and by disclosing any necessary information without performing any unethical changes in financial statements.When a company goes public, it is the intermediaries that examine the functioning of that company to ensure compliance to the rules and regulations required of a public company. Banks often perform this function to guarantee that the actions of the company in its operations and in its financial reporting comply with transparency requirements as well as fair and ethical practices. A public company is under obligation to its shareholders and to the public to function in an open and ethical manner.

References:
Gorton, G. & Winton, A. (2002). Financial Intermediation. The Wharton School, University of Pennsylvania. Retrieved September 1, 2008 from http://fic.wharton.upenn.edu/fic/papers/02/0228.pdf.

Tumpel-Gugerell. G. (2003). The role of institutions in the financial system. European Central Bank. Retrieved September 1, 2008, from http://www.ecb.int/press/key/date/2003/html/sp031111.en.html.