Money and Credit
Formal and informal credit
Compare formal and informal credit and explain who gets which.
Credit in one village: Sonpur. Two students, Rohit and Ranjan, talk to people in Sonpur, a small irrigated village growing potatoes.
- Shyamal, a small farmer, once borrowed from the moneylender at 5 per cent a month (60 per cent a year). Now he borrows farm inputs from a trader at 3 per cent a month, but must sell his crop to the trader. Prices are low at harvest, so the trader buys cheap and sells later at a profit.
- Arun, with seven acres, gets a bank loan at 8.5 per cent a year, repayable any time within three years. He can even get a fresh loan against his cold storage receipt.
- Rama, a farm labourer, borrows from her landowner-employer at 5 per cent a month for daily needs and illness, and repays by working for him. She owes Rs 5,000 and keeps taking new loans before the old ones are paid. For the landless, the landowner is the only source of credit.
Cooperatives. Besides banks, cooperatives are a major source of cheap credit in villages. Members pool their resources. The Krishak Cooperative near Sonpur has 2300 farmer members. It accepts their deposits, uses them as collateral to get a big bank loan, and lends to members for farm tools, cultivation, trade, fishing and houses. When those loans are repaid, it lends again.
Formal and informal credit.
- Formal lenders: banks and cooperatives.
- Informal lenders: moneylenders, traders, employers, relatives and friends.
The RBI supervises formal lenders. It checks that banks keep their minimum cash balance, makes sure they lend not only to profitable businesses but also to small farmers, small industries and small borrowers, and requires regular reports on whom they lend to and at what interest. Nobody supervises informal lenders: they charge whatever interest they like and can use unfair means to get their money back.
Why costly loans hurt. Informal lenders mostly charge much higher interest. So a bigger part of the borrower's earnings goes in repayment, leaving less income (like Shyamal). Sometimes the amount owed becomes more than the borrower earns, and debt keeps growing (like Rama): a debt trap. High interest also stops people from borrowing to start a business. That is why credit that is cheap and affordable matters so much for India's development.
Who gets which loans?
- Rural India, 2019 (Graph 1): commercial banks gave 51 per cent of loans, cooperatives 10 per cent, other formal agencies 5 per cent; moneylenders 23 per cent, relatives and friends 7 per cent. So formal lenders meet only about half of rural credit needs.
- Towns (Graph 2): 54 per cent of loans to poor households come from informal sources, but only 17 per cent for rich households, who get 83 per cent formally. Villages show a similar pattern.
So two things are needed: more formal credit, and formal credit shared more fairly, so the poor also get cheaper loans.
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