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Definition: Indirect Loan
The financial system allows for 2 kinds of lending: Direct lending which takes place through financial markets. Another kind of lending is Indirect lending which takes place through different financial intermediaries like banks, financial institutions and mutual funds.
In Direct loan, borrower and lender meet each other and exchange funds in return for financial assets. One such example is the borrowing of money from one individual from another in exchange of promissory notes ( signed by the borrower) against money ( given by the lender) . The process is explained below with the help of the following diagram:
In the indirect form of loan, one financial intermediary comes in between lenders and borrowers. The financial intermediaries performs the following functions:
• The financial intermediary accepts money from the surplus budget unit in the form of deposits. In return of the money deposited, the financial intermediary issues secondary security. Since most of the financial intermediaries are regulated by financial regulations in terms of financial strength, lenders are more willing to accept this secondary security as gains the primary securities issued by the borrower himself.
• The financial intermediary finds out the deficit budget units for giving loans and collects money from the borrowing unit. The information and searching cost are reduced.
In the process of financial disintermediation, the role of financial intermediary has been eliminated and the borrowers can raise the fund directly from the lender with the help of either public issue or private placement of securities. This can be performed with the help of stock exchanges. Though the financial disintermediation has been progressing rapidly in the developed and matured financial markets like USA, UK etc, it is yet to take momentum in Indian market. This is due to the fact that to work financial disintermediation, stock market has to perform to the satisfaction of the lenders. Considering the maturity stage of our stock market, it is yet a long road to go for establishing financial disintermediation as an established procedure.