Financial intermediaries are the entities that act as a middleman between the two parties in a financial transaction such as commercial banks, investment banks, etc. Financial intermediaries facilitate the function of matching users and providers of capital and structuring products/services. Different types of financial intermediaries are:
1.1. Brokers, Exchanges, and Alternative Trading Systems (ATS)
1.1.1. Brokers
a. A broker is an individual or a firm that fulfills the order to buy or sell financial instruments for the traders/clients.
b. The presence and the functions of a broker are usually more critical for the large block traders.
1.1.2. Exchanges
a. An exchange acts as a marketplace where financial instruments such as securities, commodities, derivatives, etc. are traded.
b. They provide an auction platform for such financial instruments.
c. An exchange, in order to function effectively, must print the best bid and ask rate.
1.1.3. Alternative Trading System (ATS)
a. ATS is a nonregulated exchange system that facilitates matching buy and sell orders for its subscribers, typically the institutional investors and large block traders.
b. In an ATS, there is no regulatory authority over the members.
c. These are also sometimes called dark pools, and also do not display orders sent to them.
1.2. Dealers
a. Dealers are the persons who undertake the transactions on the behalf of the traders.
b. Dealers have functions similar to the brokers, but they have more responsibilities than a broker. They are the ones who hold the inventories, become the contract counterparties, and also create liquidity.
c. The dealers can also act as the broker.
d. The primary dealers can also buy and sell with the central bank.
1.3. Securitizers
Securitizers are individuals, banks, and business entities that originate or initiates asset-backed securities. They are basically involved in buying assets, placing them in a pool, and selling securities against them.
1.4. Depository Institutions and Other Financial Corporations
These are the institutions that take deposits, pay interest and lend to borrowers, and charge interest on the lent amount. These usually include banks, savings and loan providers, credit unions, etc.
1.5. Insurance Companies
a. Insurance companies are the companies that provide insurance services to their customers. They create and sell contracts that protect the buyers from different kinds of risk such as auto, fire, theft, life, etc.
b. The insurance companies act as an entity that connects the buyers of the insurance services with the investors, creditors, and reinsurers.
1.6. Arbitrageurs
An arbitrageur is an investor who tries to make a profit from the price inefficiencies in the market. They make a profit by making simultaneous trades in two markets showing differences in the price, till the time the prices in the two markets converge.
1.7. Settlement and Custodial Services
Custodial services involve holding the securities on the behalf of clients. The settlement and custodial services are provided by the clearinghouses, which arrange for the final settlement and act as a counterparty for the futures contract.