What are the major risks that financial intermediaries face and how do they manage them?

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What are the major risks that financial intermediaries face and how do they manage them?

A financial intermediary is an establishment or an institution which acts as a third party between investors and firms in trying to obtain funding. A general explanation would be the instance of a saver who has extra money and a borrower who needs this extra capital. A typical example of a financial intermediary is a bank, but there are more such as life insurance companies and building societies. This essay will assess the risks which financial intermediaries face and how they manage them.

It is important to note that financial intermediaries do not use their own money instead they use the money of its depositors. To give a simple example of how a bank would act as a financial intermediary. Banks receive funds for depositors and while they keep a percentage in of this cash in reserve in case they want it back they lend a large percentage of it out or purchase bonds.

Financial intermediaries generally provide four important services. The first one is expert advice; they can provide the best information for investing customer funds and alternative methods of obtaining finance. The second service is that they provide expertise in channelling funds; they can provide specialist advice on areas to channel funds to yield high results. The third service is maturity information this is where the banks who have many depositors borrow small amounts from each one so they are able to provide long term loans. The final area which this essay will pick up on is the risk transformation. This service provides the know how of how to allocate loans and money to other money at the least possible risk to the institution.

Risk is a major factor in any financial market and in particular to institutions which are borrowing money from there depositors or customers. This essay will now look at the potential risks involved through financial intermediaries.

Financial intermediaries should be concerned with risk because it can make its capital volatile and in most cases when financial intermediaries are faced with these types of problems the most probable outcome is that they can go into severe financial distress or this could lead to bankruptcy.

The risks come when the financial intermediaries do not correctly regulate their own techniques and staff. There are many examples where financial intermediaries such as Baring’s bank and BCCI (Bank of Credit & Commerce International) were forced to declare bankruptcy due the inappropriate actions as they themselves played as financial intermediaries.

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To take Barings bank as an example a trader with the name of Nick Leeson was able to use large cash reserves which the bank held which belonged to the banks depositors, to implicate the bank in a serious of rogue deals which ended up causing the bank to file bankruptcy. The management of Barings broke a cardinal rule of any trading operation - they effectively let Leeson settle his own trades by putting him in charge of both the dealing desk and the back office. This is tantamount to allowing the person who works a cash-till to bank ...

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