Question

In situations with high risks, credit might create further problems for the borrower. Explain.

Answer 1

Credit helps to increase earnings and therefore the person is better off than before. In another situation, because of the crop failure, credit pushes the person into a debt trap and further aggravates the problems.

Example of High Risks – More Problems from Credit

• Between the time when the farmers purchase the inputs needed for growing crops and the time for selling their crops, there is a minimum continuous gap of three to four months.
• Producing crops incurs considerable expenses on electricity, water, fertilisers, pesticides, seeds, equipment repair, etc.
• Generally at the beginning of the season, farmers take crop loans.
• Usually after the harvest season, the loans are repaid by the farmers.
• Income from farming is the major source of money for farmers, hence the farmers ability to repay loans is dependent on farming income.
• In many cases of farmers, the failure of the crops makes it impossible for farmers to repay the loan.
• Hence, to repay loans farmers will end up selling their farming lands.
• Ultimately, instead of helping farmers prosper, the credit made the situation worse.
• This is a well-known example of what is usually known as debt-trap.
• In the above case recovery of the borrower is very painful.
• Hence, to estimate whether the credit will be useful or not depends on the existence of support in case of loss and the risks associated with the situation.