Formal And Informal Sector Credit In India

The various types of loan can be conveniently grouped as formal sector loans and informal sector loans

FORMAL SECTOR:

• Among the formal sectors are loans from banks and cooperatives.
• The Reserve Banks of India supervises the functioning of formal sources of loans.
• For instance, we have seen that the banks maintain a minimum cash balance out of the deposits they receive.
• The RBI monitors the banks in actually maintaining cash balance.
• Similarly, the RBI sees that the banks give loans not just to profit-making businesses and traders but also to small cultivators.

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• Small scale industries, to small borrowers etc.
• Periodically, banks have to submit information to the RBI on how much they are lending, to whom, at what interest rate, etc.
• This sector charges very low rate of interest.

INFORMAL SECTOR:

• There is no organization which supervises the credit activities of lenders in the informal sector.
• They can lend at whatever interest rate they choose. There is no one to stop them from using unfair means to get their money back.
• Compared to the formal lenders, most of the informal lenders charge a much higher interest on loans.
• Thus, the cost of the borrower of informal loans is much higher.
• Higher cost of borrowing means a larger part of the earnings of the borrowers is used to repay the loan. Hence, borrowers have less income left for themselves.
• In certain cases, the high interest rate of borrowing can mean that the amount to be repaid is greater than the income of the borrower.
• This could lead to increasing debt and debt trap.
• For these reasons, banks and cooperative societies need to lend more.
• This would lead to higher incomes and many people could then borrow cheaply for a variety of needs.
• They could grow crops, do business, set up small-scale industries etc.
• They could set up new industries or trade in goods. Cheap and affordable credit is crucial for the country’s development.

Related Topics

• Formal and Informal Credit : Who gets what?
• Modern Forms of Money
• Important Terms of Money and Credit