In situations with high risks, credit might create further problems for the borrower.Explain.
Answers
Answer:
The credit may lead to the borrower into a debt trap. A situation from where recovery is painful.
Explanation:
In a high-risk condition, if a person takes a loan, it won't only be harder to pay the money back but the interest applied to it may also be hard.
Let's take an example of a farmer;
He takes a loan from a moneylender for his agricultural inputs. He buys his inputs and starts his agricultural season with high expectation. Now in the midway of the agriculture season, he is hit by a devastating drought. His crops fail and all his saving are used up trying to recover from this drought.
Now another agricultural season is starting. He doesn't have any saving and has to take another loan from someone else. Before which he needs to pay the moneylender back. Since it is an informal loan, therefore, the interest rates are mostly high. He now needs to either sell some of his assets or needs to take two big loans from someone. One to pay the moneylender with his high interest and the second one to buy agricultural inputs and all year expenditure.
Question: Analyse the role of credit for development. 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...
Credit[Loan] refers to an agreement in which the lender supplies the borrower with money, goods, or services, in return for the promise of future payment...
It helps in increasing the economic activities of the country, and thus, helps in its economic development...
If credit is made available for the poor people at reasonable rates, then they can improve their economic conditions and their standard of living. Thus, these help in promoting the overall development of the country...
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