Question

Differentiate between Formal and Informal Credit. Discuss main sources of Formal Credit in rural India.

Hint:

Access to formal credit leads to better financial planning, lower interest rates, and financial stability, while informal credit may lead to higher debt burdens.

Answer 1

Formal Credit vs Informal Credit:
1. Formal Credit:
- Formal credit is provided by government-approved financial institutions such as banks, cooperatives, and micro-finance institutions.
- The interest rates on formal credit are generally lower, and the terms of repayment are clearly stated.
- Formal credit is regulated by government laws and institutions, ensuring transparency and legal protection.
- It is usually accessed through proper documentation, such as credit scores, income proofs, and collateral.
Examples:
- Commercial banks (like SBI, ICICI)
- Rural Banks
- Co-operative societies and credit unions
2. Informal Credit:
- Informal credit is provided by private lenders or non-institutional sources, such as moneylenders, relatives, or local traders.
- The interest rates on informal credit are often much higher than formal sources and may be unregulated.
- Informal credit is usually given without formal documentation or any legal protection.
- Borrowers often rely on social relations or informal networks to obtain loans.
Examples:
- Moneylenders
- Friends and family
- Local traders or shopkeepers
Sources of Formal Credit in Rural India:
1. Commercial Banks: Commercial banks in rural areas offer a wide variety of credit products like agriculture loans, crop loans, and personal loans to farmers, small businesses, and rural households. They also provide direct credit facilities under government schemes like the Kisan Credit Card.
2. Cooperative Banks: Co-operative banks play a significant role in rural credit, as they operate at the local level. They offer affordable loans to farmers and rural artisans for agriculture and rural development.
3. Microfinance Institutions: These institutions provide small loans to low-income individuals who do not have access to traditional banking services. They focus on providing financial services to rural women and entrepreneurs for small-scale business ventures.
4. Government Schemes: The government offers various schemes like NABARD, PMGKY, and other rural credit programs to provide low-interest loans and credit facilities to farmers, including subsidies for crops and agricultural inputs.
Conclusion:
Formal credit is an essential source for empowering rural India by providing structured financial support, while informal credit, though widely used, can lead to exploitation. Efforts to promote formal credit can improve financial inclusion and rural development.