What is financial disintermediation? Its effects on the financial system?

What is Financial Disintermediation?

Financial disintermediation refers to the process in the financial system where funds are redirected from traditional financial intermediaries, such as banks, to direct financing channels like the securities market. It signifies a shift where capital flows are not solely dependent on traditional financial intermediaries but are instead satisfied through direct transactions in the capital markets.

Why Does Financial Disintermediation Occur?

The growth of financial disintermediation can be driven by the following factors:

1. Advantages of Direct Financing: For borrowers, accessing direct financing channels allows them to interact directly with investors, gaining access to a wider source of funds. This could provide them with more financing opportunities and more competitive interest rates.
2. Investor Demand: Some investors seek more investment options and higher returns and may turn to direct investment markets to access a broader range of investment opportunities.
3. Technological Advancements: The development of digital technologies and the internet has made the dissemination of information and transactions more convenient and efficient, fostering the growth of direct financing. For instance, online financial platforms and crowdfunding platforms offer channels for direct financing.

What Impact Does Financial Disintermediation Have on the Financial System?

1. Financial Stability: Financial disintermediation could weaken the position of traditional financial institutions, increasing the complexity and fragility of the financial system. The absence of intermediary institutions' regulation and risk management might heighten financial market instability.
2. Interest Rates and Financing Costs: Financial disintermediation could alter the supply and demand for funds, impacting interest rates and financing costs. Direct financing post-disintermediation might render financing costs more market-driven and competitive.
3. Financial Innovation and Market Development: Financial disintermediation drives financial innovation, facilitating the growth and activity of the securities market and the capital market. It provides businesses with more financing channels and investment options.

It is important to note that financial disintermediation does not imply a complete replacement of traditional financial intermediaries but rather indicates a shift in capital flows from traditional intermediaries to direct financing channels. Traditional financial intermediaries still play a significant role in the economy.

What Are Some Examples of Financial Disintermediation?

Specific examples of financial disintermediation include:

1. Securities Market: Companies can obtain funds directly from investors by issuing bonds or stocks, bypassing bank loans. This direct financing method circumvents traditional bank intermediaries and provides more financing channels.
2. Internet Financial Platforms: Through online financial platforms, individuals and businesses can directly match with investors for loans or financing support. This form of direct financing eliminates the intermediary role of traditional financial institutions, offering more choices to borrowers and investors.
3. Crowdfunding: Through crowdfunding platforms, individuals or businesses can directly raise funds from the general public to support entrepreneurial projects, artistic endeavors, charitable causes, etc. This method bypasses traditional financial institutions, enabling more people to participate in funding provision and project support.