Why is a loan from informal sector costlier that the formal sector?
Answers
informal sources of credit such as moneylenders, landowners easily give loans to local farmers or labourers, but they charge lofty interest rates which are so high that the borrowers are often not able to repay.
Formal sources of credit such as banks and cooperative societies only give loans in the presence of proper documentation and collateral, hence many rural workers are not able to access them. When they do give loans they charge reasonable interest rates along with more repayment flexibility.
hence informal sources of credit are often more expensive than formal sources of credit.
The formal sector loans are given by the commercial banks under the supervision of the reserve bank of India. They have fixed rates and terms. Whereas informal loans are given by the private entities, moneylenders and merchants.
Explanation:
- The formal sector loan is given by the commercial bank and other cooperatives under the supervision of the Central Banks.
- On the other hand, the informal sector loan is given by money lenders, big merchants, and more. They give loans without any collaterals and proper documentation.
- On the other hand, the loan given by the commercial banks is given with proper documentation and collaterals. Therefore the informal sector is costlier than the formal sectors.
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