Key Concepts
- 1What is the difference between formal and informal sources of credit?
Important Formulas & Facts
Formal: Banks, cooperatives. Regulated by RBI, lower interest rates (8-15%), proper documentation, follow rules, mostly in urban areas. Informal: Moneylenders, traders, landlords, relatives. No RBI regulation, very high interest rates (24-60%+), no documentation, can be exploitative, mostly in rural areas. 85% of rural loans from informal sources. Problems: debt trap, bonded labour, farmer suicides. Solutions: Expand bank branches in rural areas, simplify loan procedures, SHGs (Self-Help Groups) — women pool savings and lend at reasonable rates.
Must-Know Questions
Q1What is the role of the Reserve Bank of India (RBI)?
RBI (central bank of India) functions: (1) Issues currency notes (has monopoly over currency printing). (2) Supervises and regulates commercial banks — sets interest rates, CRR, SLR. (3) Acts as banker to the government. (4) Controls money supply and inflation. (5) Manages foreign exchange reserves. (6) Ensures banks maintain minimum cash reserves. (7) Ensures banks give loans to underserved sectors (priority sector lending — agriculture, small business).
Q2What is the difference between formal and informal sources of credit?
Formal sources: (1) Banks and cooperatives. (2) Supervised by RBI — must follow rules. (3) Lower interest rates (8-15%). (4) Transparent terms. (5) Proper documentation. (6) Report to credit bureaus. Example: SBI loans, cooperative society loans. Informal sources: (1) Moneylenders, traders, employers, relatives. (2) NOT supervised by RBI — no regulation. (3) Much higher interest rates (36-60% or more). (4) Often exploitative terms. (5) No proper documentation. (6) Can lead to debt trap. Example: village moneylender, landlord loans. About 85% of rural credit comes from informal sources — this needs to change.
Q3What is a Self Help Group (SHG)?
SHGs are groups of 15-20 members (usually women) from similar backgrounds who save small amounts regularly. Features: (1) Pool their savings. (2) Give small loans to members at reasonable interest. (3) After regular saving, they can borrow from banks — bank gives loan to SHG, SHG gives to members. (4) No collateral needed. (5) Decision-making is collective. Benefits: financial inclusion, women's empowerment, reduces dependence on moneylenders. Example: Grameen Bank (Bangladesh), SHGs in India.
Q4What is collateral?
Collateral is an asset (land, property, vehicle, gold) that the borrower pledges to the lender as a guarantee for the loan. If the borrower fails to repay, the lender can sell the collateral to recover the money. Poor people often cannot get bank loans because they lack collateral — this pushes them to informal sources.
Q5Why are informal sources of credit preferred in rural areas despite high interest rates?
Rural people prefer informal credit because: (1) No collateral required (banks demand property papers). (2) Easy and quick access — no paperwork. (3) Banks are often far from villages. (4) Banks require documentation (ID, income proof) that poor people may lack. (5) Personal relationship with moneylender. (6) Flexible repayment (though exploitative). This is why expanding formal credit to rural areas is crucial.
Practice Money and Credit
Reinforce what you just revised with practice questions