People obtain loans from various sources. The two sources of credit are formal sources and informal sources and can be differentiated on the basis of following features:
Formal sources of credit:
• Banks and cooperative societies fall under the formal sector. One can obtain loans from banks or cooperative societies.
• The Reserve Bank of India supervises the functioning of formal sources of loans.
• Bank loans require documentation and collateral (collateral is an asset such as land, building, vehicle, livestock, deposits with the bank, etc.). This is used as a guarantee to the lender until the loan is paid back.
• Formal sources cannot charge any rate of interest from the borrowers according to their whims.
• The rich households avail cheap credit from formal lenders as 90 per cent of the rich urban households take credit from formal sources.
(any 3 points of both the sources)
• In the informal sector money can be borrowed from a person, friend, relative, moneylender, traders, employers, etc.
• No organization checks or supervises the activities of lenders in the informal sector.
• Loans from informal sources do not require any such collateral.
• They charge a very high rate of interest on loans as they do not require any collateral.
• Poor households pay a large amount for borrowing as they take credit from informal sources. About 85 per cent of the loans taken by poor households in urban areas are from informal sources.