Question

Manav needs a loan to set up a small business. On what basis will Manav decide whether to borrow from the bank or the moneylender? Discuss.

Answer 1

Manav has to take this decision after carefully considering the pros and cons.

Informal Lender – Pros

• Manav may know this informal lender personally.
• It is easier to get loans from informal lenders.
• Collateral would not be required when taking loans from informal lenders.

Informal Lender – Cons

• But informal lenders tend to charge very high rates of interest, which are higher than the banks.
• When the rate of interest is very high there is a possibility of Manav falling into a debt trap.
• There are no organisations monitoring the informal sources of credit.
• Hence there is a possibility that informal lenders could end up harassing Manav if the required amount is not paid back at the right time.
• Since the cost of borrowing is very high from informal sources of credit, a large part of the earnings of Manav may likely be used to repay the loan.
• In certain cases, Manav also could end up in a situation where the amount to be repaid is greater than the income of Manav.

Bank – Pros

• The interest rates will be lesser than the interest rates charged by the informal lenders.
• As banks come under formal sources of credit, they are monitored by the Reserve Bank of India.

Banks – Cons

• It is very difficult for poor people to borrow from banks when compared to borrowing money from informal sources.
• Bank loans require proper documentation.
• Banks loans need collateral (security) against loans.
• Collateral is an asset that the borrower owns such as deposits with banks, livestocks, buildings, vehicles, and uses this as a guarantee to a lender until the loan is repaid.
• Usually poor people may not have sufficient collateral to get loans from the banks.