Page 74 - Understanding Economics for Class 10

forMaL sector credit in india
There are various sources from which people can obtain loans. Various types of loans can be
grouped as formal sector loans and informal sector loans.
Goyal Brothers Prakashan
Formal sector loans- It includes the loans from the Banks and the Cooperatives.
Informal sector loans- It includes the loans from money lenders, traders, employers, relatives
and friends etc.
The graph shows the various sources of credit to rural households in India.
 The functioning of formal sources Sources of Credit per `1000 of
of loans is supervised by the Rural Households in India in 2012
Reserve Bank of India. Other Institutional
 For example, out of the deposits Government 1% Agencies 5%
received by banks, a minimum Cooperative
cash balance is maintained. It is Money Society/Banks 25%
monitored by RBI whether banks Lender 33%
are maintaining it or not.
 RBI also makes sure that banks Commercial
are giving loans not only to profit- Banks 25%
making businesses and traders Relatives and
but also to small cultivators, Friends 8% Other non Institutional Landlords 1%
small scale industries, to small Agencies 2%
borrowers etc (Courtesy: NCERT)
 Periodically, information on how much banks are lending, to whom, at what interest rate,
etc. have to be submitted to the RBI by banks.

 In the informal sector, there is no organisation which supervises the credit activities of
lenders.
 Money lenders can charge any interest rate on the lending done by them. No one is there
who can stop them from using unfair means to get their money back.
 Informal lenders charge a much higher interest on loans than formal lenders which makes
the cost higher for the borrower of informal loan.
 When the cost of borrowing increases, a greater portion of the borrower’s earnings is
allocated towards loan repayment. Consequently, borrowers are left with a reduced income
for their own use.
 In certain cases, the amount to be repaid is greater than the income of the borrower because
of the high interest rate charged. This could lead to increasing debt (as we saw for Rama
in Sonpur) and debt trap.
 High cost of borrowing also discourages those who might want to start a new business.
 For these reasons, more lending should be done by banks and cooperative societies.
 As a result, individuals would experience increased income, enabling them to access
affordable loans for various purposes such as for growing crops, doing business, setting
up a small-scale industry etc. They could set up new industries or trade in goods
 For the country’s development cheap and affordable credit is crucial.

Formal and Informal Credit: Who gets what?
Importance of formal and informal sources of credit for people in urban areas is shown by the
above graph.

Economics Class X E-65