What Is the Difference between Formal and Informal Sources of Credit

Figure 2 shows the importance of formal and informal sources of credit for people living in urban areas. People are divided into four groups, from the rich to the poor, as shown in the figure. You can see that 85% of loans taken out by poor households in urban areas come from informal sources. Compare that to wealthy urban households. What do you think? Only 10% of their loans come from informal sources, while 90% come from formal sources. A similar trend can also be observed in rural areas. Rich households take out cheap loans from formal lenders, while poor households have to pay a large amount to borrow. (ii) The RBI shall supervise the operation of formal sources of credit. (a) Loans granted by banks and cooperative institutions are referred to as the formal credit sector. 2. Why should a balance be available to everyone on reasonable terms? 3.

Should there be a regulator like the Reserve Bank of India that deals with the lending activities of informal lenders? Why should his task be difficult enough? (i) You follow the sources of credit registered by the government and required to follow its rules and regulations. 4. Why do you think the share of credit in the formal sector is higher for the richest households than for the poorest households? Figure 2: What percentage of all loans taken out by urban households were formal and what percentage were informal? Most loans from informal lenders have a very high interest rate and do little to increase borrowers` income. It is therefore necessary for banks and cooperatives to increase their lending, especially in rural areas, in order to reduce dependence on informal sources of credit. Second, while credit to the formal sector needs to be expanded, it is also necessary for everyone to receive these loans. Currently, it is the richest households that receive formal loans, while the poor depend on informal sources. It is important that formal credit be distributed more evenly so that the poor can benefit from cheaper loans. We have seen in the examples above that people get loans from different sources. The different types of loans can be grouped into loans from the formal sector and loans to the informal sector.

The former include loans from banks and cooperatives. Informal lenders include lenders, traders, employers, relatives and friends, etc. Figure 1 shows the different sources of credit for rural households in India. Does more credit come from the formal sector or the informal sector? What does all this indicate? First, the formal sector still covers only about half of the total credit needs of the rural population. Other credit needs are covered by informal sources. There is no organization that oversees lenders` loans in the informal sector. They can lend at any interest rate they choose. No one is stopping them from using unfair means to get their money back.

For these reasons, banks and cooperatives need to lend more. This would lead to higher incomes and many people would then be able to borrow money at a lower cost for a variety of needs. They could cultivate, do business, build small industries, etc. They could build new industries or trade goods. Cheap and affordable loans are crucial for the country`s development. The Reserve Bank of India oversees the operation of formal sources of credit. For example, we have seen banks maintain a minimum cash balance from the deposits they receive. The RBI supervises the banks in the effective maintenance of the cash balance. Similarly, the RBI finds that banks lend not only to profitable businesses and traders, but also to small producers, small industries, small borrowers, etc.

At regular intervals, banks must provide the RBI with information on how much they lend, to whom, at what interest rate, etc. What are the differences between formal and informal sources of credit? Compared to formal lenders, most informal lenders charge much higher interest rates on loans. Thus, the cost to the borrower of informal loans is much higher. Higher borrowing costs mean that more of borrowers` income is used to repay the loan. As a result, borrowers have less income for themselves (as we saw for Shyamal in Sonpur). In some cases, the high interest rate on the loan may mean that the amount to be repaid is greater than the borrower`s income. This could lead to an increase in debt (as we saw with Rama in Sonpur) and a debt trap. Also, people who want to start a business by borrowing may not do so due to the high cost of borrowing. . (c) You can lend money at any interest rate and use any means to get your money back. i) This includes small, dispersed entities that are largely beyond the control of the government.

. c) These institutions are required to communicate to the RBI the interest rate, the amount of the loan, etc. d) The borrower is required to provide guarantees and documents. Example: lenders, traders, employees, relatives and friends, etc. (b) The operation of these banks and cooperative institutions is supervised by the Reserve Bank of India – RBI. b) They are not supervised by the Reserve Bank of India – RBI. Figure 1: Sources of credit for Rs 1000 of rural households in India in 2012. . . .