In situations with high risks, credit might create further problems for the borrower. Explain.
Answers
It is true that in situations with high risks, credit might create problems for the borrower, e.g., a small farmer takes a loan to meet the expenses of cultivation, hoping that his harvest would help him to repay the loan. But if his crop fails due to shortage of rain or for any other reason, he will be unable to repay the loan.
In such situations a small farmer has to sell a part of his land to repay the loan. Such cases have high risks because the payment of loan entirely depends on good a crop which in turn depends on good rain. HYV seeds fertilizers, pesticides and other factors. This type of loan pushes the farmer into a debt-trap in the case of crop failure and the position of the farmer becomes worse off than before..
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Question: Why do banks and cooperative societies need to lend more?
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Why do we need to expand formal sources of credit in India?
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Describe the bad effects of informal sources of credit on borrowers. In situations with high risks, credit might create further problems for the borrowers. Explain.
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Describe the importance of formal sources of credit in the economic development.
Answer:
There is no organisation with supervises the credit activities of lenders in the informal sector...
They charge whatever interest rates they want...
There is no one to stop them from using unfair means to get their money back...
The high interest rate for borrowing leads to increased debt, and eventually, the situation of a debt trap...
Thus, it is necessary that banks and co-operatives increase their lending, particularly in the rural areas, so that the dependence on informal sources of credit reduces. Cheap and affordable credit is crucial for the country's development...
Let us take the case of a farmer. If he has to take a loan from a lender for crop production, and due to certain unavoidable factors there is a crop failure, then he will not be able to repay the loan...
Now either the farmer has to take a fresh loan, or sell some portion of his land, for instance, to repay the loan...
Thus, in high risk situations credit may create further problems for the borrower just as the farmer has fallen into the situation of a debt trap...
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