Question

Why do we need to expand formal sources of credit in India?

Answer 1

Formal sources of credit in India need to be expanded for the development of the nation. Cheap and affordable credit is a necessity for the development of the nation.

• To make sure that the poor can benefit from the cheaper loans, it is important that the formal credit is distributed more equally.
• Usually the poor have to depend on informal sources of credit and it is the richer households who receive formal credit.
• Most loans from informal lenders do very little to increase the income of borrowers as they carry a very high interest rate.
• Reserve Bank of India (RBI) makes sure that banks not only provide loans to traders and profit making businesses but also to small borrowers, small scale industries and small cultivators.

Disadvantages of Informal Sources of Credit

• In the informal sector, lenders can lend at whatever interest rate they choose.
• In the informal sector, unfair means are used by lenders to get their money back and there is no one to stop them.
• The credit activities of lenders in the informal sector are not supervised by any organisation.
• As the interest rate on loans are higher in the informal sector compared to the formal sector, the cost to the borrower of informal loans is much higher.
• To repay the loan, the larger part of the earnings of the borrowers is used up, due to higher cost of borrowing.
• As a result, less income is left in the hands of the borrowers.
• In other cases, higher interest rates means the amount that needs to be repaid by the borrower is more than his incomes, this leads to rising debts, which leads to debt trap.
• In addition, due to the high cost of borrowing, people who may have plans to start an enterprise will desist from borrowing.
• Due to the above mentioned reasons,cooperative societies and banks need to lend more.
• This would help people to borrow at cheaper rates for a variety of purposes, like setting up small scale industries, doing business, growing crops, trade in goods, and thereby helping them in increasing their incomes.