Intermediary

An intermediary is a person or institution that acts as a “middleman” in a financial transaction, connecting two other parties. Think of them as the matchmakers of the financial world. Instead of a small saver with €1,000 having to find a specific person who needs to borrow exactly €1,000, they can simply deposit their money in a bank. The bank then pools this deposit with others and lends it out to businesses or homebuyers. This process makes the entire financial system work more smoothly and efficiently. Intermediaries aren't just banks; they include a wide range of entities like Brokerage Firms that execute your stock trades, insurance companies that pool risk, and Mutual Funds that pool your money with other investors to buy a diverse portfolio of assets. They exist because they solve fundamental problems, such as reducing search costs, managing risk, and providing expertise that an individual might not possess.

At first glance, it might seem best to cut out the middleman to save money. So why are intermediaries so central to our economy? The simple answer is that they create value by overcoming major hurdles in the market. Without them, the financial world would be slow, inefficient, and much riskier.

Imagine you wanted to lend your savings directly to a growing local business. You would have to spend significant time and money on:

• Searching: Finding a creditworthy business that needs the exact amount of cash you have to lend.
• Due Diligence: Investigating the business's financials and prospects to see if it's a good risk.
• Legal Work: Drafting a legally sound loan agreement.
• Monitoring: Continuously checking in to make sure the business is on track to repay you.

A Commercial Bank does all of this at scale, drastically reducing the cost and effort for everyone involved. They are experts in credit analysis and have standardized processes, making the whole system more efficient.

Intermediaries help solve the problem of asymmetric information—a fancy term for when one party in a transaction knows more than the other. A business owner will always know more about their company's true health than an outside lender. An intermediary, like a bank or an Investment Bank vetting a company for an Initial Public Offering (IPO), uses its expertise to investigate and verify information, giving savers and investors the confidence to put their capital to work.

Intermediaries are financial alchemists. They take one type of asset and transform it into another that is more useful to the other party. This is often called asset transformation. For example, a bank takes in short-term, small, and low-risk deposits from savers and transforms them into long-term, large, and higher-risk loans for businesses or mortgage borrowers. This matches the different needs of both savers (who want quick access to their cash) and borrowers (who need capital for a long time).

For a value investor, an intermediary is both a necessity and a potential drain on returns. The key is to understand their function, use them wisely, and always be conscious of the costs they impose.

Every intermediary charges for their services, and these fees can significantly erode your investment gains over time. A critical part of value investing is minimizing costs.

• Brokers: The commissions you pay to buy and sell stocks directly impact your returns. Choosing a low-cost broker is a simple but powerful way to keep more of your money working for you.
• Fund Managers: Actively managed mutual funds employ managers who select stocks, and their fees are captured in the Management Expense Ratio (MER). A high MER can cripple your long-term performance. This is why many value investors, including Warren Buffett, often recommend low-cost index funds or ETFs for the average person, as they passively track the market with minimal fees.

The golden rule is to always ask what you are paying for. If an intermediary's fees are high, they must be providing exceptional value that you cannot get elsewhere. More often than not, they aren't.

When you use an intermediary, you are not just exposed to the risk of your investment (e.g., a stock going down) but also to the risk of the intermediary itself. This is known as Counterparty Risk. What if your broker goes bankrupt? What if the bank holding your cash collapses? The 2008 Global Financial Crisis was a brutal lesson in counterparty risk, with the failure of giant intermediaries like Lehman Brothers sending shockwaves through the system. While regulations and government insurance (like the FDIC in the U.S. and the Deposit Guarantee Schemes in the E.U.) protect ordinary investors to a large extent, it's still wise to use large, stable, and well-capitalized institutions. Don't be lured into using a shaky, unregulated intermediary just because it offers slightly lower fees or higher interest rates. The potential downside is rarely worth the risk.

Technology is changing the game. Disintermediation is the process of cutting out the traditional financial intermediary, thanks largely to the internet. This trend puts more power directly into the hands of investors and borrowers, often leading to lower costs and greater access. Key examples include:

• Crowdfunding Platforms: These sites allow startups and small businesses to raise capital directly from a large number of individuals, bypassing venture capitalists or banks.
• Peer-to-Peer (P2P) Lending: Online platforms match individual lenders with individual borrowers, cutting out the bank as a middleman.
• Robo-Advisors: Automated platforms that offer portfolio management services for a fraction of the cost of a human financial advisor.

While disintermediation offers exciting opportunities to reduce costs, it also shifts the burden of due diligence squarely onto your shoulders. Without a bank or established institution vetting the investment, you are responsible for assessing the risk yourself. As with all investing, the principles of value investing—thorough research, a healthy dose of skepticism, and a focus on minimizing costs—are your best guides.