Disintermediation

Disintermediation is the removal of intermediaries from a transaction or a supply chain, so that parties deal with each other directly. In finance, the term refers to the withdrawal of funds from banks and other intermediaries and their direct placement in securities or other assets.

Forms

Disintermediation can take several forms. In finance, it refers to the shift from intermediated credit, in which banks collect deposits and make loans, to direct finance, in which savers lend to borrowers through securities markets. It can also refer to the withdrawal of deposits from banks in favour of money market instruments.

In commerce, disintermediation refers to the removal of wholesalers, distributors, or agents from a supply chain, so that producers sell directly to consumers. This is associated with the growth of electronic commerce and with the restructuring of distribution.

In intermediation, the term also describes the emergence of new intermediaries that displace existing ones, a process sometimes called reintermediation.

Causes

The causes of disintermediation include changes in technology, in regulation, and in the preferences of savers and borrowers. Improvements in information technology reduce the cost of matching savers and borrowers directly. Deregulation can remove barriers to direct finance and increase competition among intermediaries.

Changes in the relative cost of intermediated and direct finance also drive disintermediation. When the spread between deposit rates and lending rates is wide, savers have an incentive to seek higher returns elsewhere, and borrowers have an incentive to seek cheaper funding directly.

Consequences

Disintermediation has consequences for the financial system and for the economy. For banks, it reduces the deposit base and the lending capacity, and it changes the composition of their funding. It can reduce their profitability and increase their reliance on wholesale funding, which can be less stable.

For the financial system, disintermediation can shift risk from banks to markets and to other institutions. It can improve the efficiency of allocation, by reducing the cost of intermediation, and it can increase the transparency of prices. It can also create new sources of vulnerability, particularly when the new channels are less regulated or less well understood.

For the economy, disintermediation can affect the availability and the cost of credit, and thereby investment and growth. It can improve the allocation of capital, and it can expose the economy to new sources of instability.

Policy

Policy questions concern the regulation of intermediation, the protection of savers, and the stability of the financial system. As intermediation shifts from banks to markets, the regulatory framework must adapt, to ensure that risks are identified and managed and that the system is resilient.

The response includes extending regulation to new intermediaries, improving disclosure, and strengthening the resolution framework for failing institutions. The design of policy must balance the benefits of competition and of innovation against the risks of instability and of consumer harm.

Financial Innovation and Technology

Financial innovation and technology have been major drivers of disintermediation. The growth of electronic trading, of payment systems, and of online lending platforms has reduced the need for traditional intermediaries and has altered the structure of finance.

Peer-to-peer lending platforms, for example, match savers and borrowers directly, bypassing banks. Crowdfunding platforms allow firms to raise funds from many small investors, bypassing traditional intermediaries. These innovations can reduce the cost of finance and can broaden access, but they also raise questions about the protection of investors and about the stability of the system.

Technology also enables new intermediaries to emerge. Payment providers, digital wallets, and platform-based financial services occupy positions in the value chain that were previously held by banks. The result is a restructuring of the financial system rather than a simple removal of intermediaries.

Implications for Bank Business Models

Disintermediation has implications for the business models of banks and other financial intermediaries. As deposits migrate to money market funds and to other instruments, banks lose a source of stable funding and become more reliant on wholesale markets, which can be more volatile.

In response, banks have diversified their activities, expanding into fee-based services, including advisory, underwriting, and asset management. These activities are less capital-intensive and less exposed to interest rate risk, but they are exposed to market conditions and to reputational risk.

The shift in business models has implications for stability. Fee-based activities are less exposed to runs, but they can amplify shocks through the market channel. The composition of bank activities therefore affects the resilience of the system to different types of shocks.

The Rise of Market-Based Finance

The growth of market-based finance has shifted the balance of the financial system from banks to markets. More funding is raised through securities markets, and more risk is held by institutional investors, including pension funds, insurance companies, and asset managers.

Market-based finance has advantages. It can diversify risk and can allocate capital more efficiently, and it can provide an alternative source of funding when banks are constrained. It also has risks. Market-based finance can be more procyclical, and it can transmit shocks through the pricing of securities and through the behaviour of investors.

The regulation of market-based finance is therefore a priority for authorities. The framework must ensure that risks are identified and managed, that leverage is monitored, and that the system is resilient to stress. The design of the framework must adapt to the evolution of finance and to the emergence of new instruments and new institutions.

Summary

Disintermediation is driven by technology, regulation, and the preferences of savers and borrowers, and it has reshaped the financial system. Its implications for bank business models, for the balance between banks and markets, and for the regulation of finance are central to contemporary debates.

See also

• Banking
• Financial Asset
• Money Market