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Formal and Informal Credit

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Formal and Informal Credit - Lesson Summary

The different sources of credit are:
  • Banks
  • Traders
  • Cooperative societies
  • Landlords
  • Moneylenders
  • Relatives and friends

Banks and cooperative societies constitute the formal sector of credit. Landlords, moneylenders, traders, relatives, friends and other sources of credit constitute the informal sector of credit.

The formal sector provides only marginally more credit than the informal sector currently. The credit activities of the formal sector are supervised by the Reserve Bank of India. The RBI gives credit to all at low interest rates.

In the informal sector there is no supervisory body. The credit activities of this sector are only driven by profit with much higher interest rate. A high rate of interest means that a borrower spends more money to repay the loan and is left with less money for himself. This also leads to a debt trap.

The rich at present have more access to cheaper credit from the formal sector, while the poor still have to depend on loans at higher rates of interest from the informal sector. Cheaper credit is essential for development in a country. The formal sector offers more affordable credit and so it must increase its lending to more and more people, especially in the rural areas.

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