Question

Why is indirect finance much larger than direct finance?

Answer 1

As financial intermediaries take responsibility for approaching investors and carrying out the due diligence process, indirect financing is often the faster way to raise money for businesses. In many countries, indirect financing takes a front seat compared to direct financing methods, as financial intermediaries are very efficient in reducing the costs of lending related information. This is done by economies of scale and know-how. They can quickly curb asymmetric information related problems; that too, at a lower cost.

Financial intermediaries have more expertise and are investing in multiple lending. Whatever money we put into the banks, a huge section of borrowers are deployed through. There is a diversification of pooled funds into many different instruments. That diversifies the risk associated with that. Intermediaries such as mutual funds and commercial banks have the resources to employ risk management experts who look into alternative investment risk and return ratios and take appropriate action. Banks are taking losses from default loans and still guaranteeing back deposits.