MP Board · Class 10 · Social Science · Economics: Money and CreditExplain the two major sources of formal and informal credit in India. What are the major difficulties faced by poor households in getting loans from formal sources like banks, and why is the role of Self-Help Groups (SHGs) crucial in overcoming these problems?

Introduction to Credit Sources\nCredit (loan) refers to an agreement in which the lender supplies the borrower with money, goods, or services in return for the promise of future repayment. In India, credit sources are broadly classified into two categories: Formal Sources and Informal Sources.

1. Formal Sources of Credit

• Definition: Formal sources include loans from banks and cooperatives.
• Regulation: The Reserve Bank of India (RBI) supervises the functioning of formal sources. The RBI monitors whether banks maintain minimum cash balances and lend to small cultivators, small industries, etc., not just profit-making businesses.
• Interest Rates: They generally charge a much lower rate of interest compared to informal lenders.

2. Informal Sources of Credit

• Definition: Informal sources include moneylenders, traders, employers, relatives, and friends.
• Regulation: There is no organization that supervises the credit activities of lenders in the informal sector. They can lend at whatever rate they choose.
• Interest Rates: They charge very high rates of interest, leading to debt traps.

Difficulties Faced by Poor Households in Getting Formal Loans

• Lack of Collateral: Collateral is an asset that the borrower owns (such as land, building, vehicle, livestock, deposits with banks) and uses this as a guarantee to a lender until the loan is repaid. Poor households often lack valuable assets to offer as collateral.
• Absence of Documentation: Formal institutions require proper documentation, identity proofs, address proofs, and income certificates, which illiterate or poorly informed rural poor find extremely difficult to arrange.
• Rigid Terms of Credit: The interest rate, collateral, documentation requirement, and the mode of repayment together comprise the terms of credit. Poor people cannot meet these stringent terms.
• Physical Accessibility: Banks are often not present in rural areas as frequently as local moneylenders, making travel and loan processing costly and time-consuming.

Role of Self-Help Groups (SHGs) in Overcoming Problems

• Overcoming Collateral Absence: SHGs consist of 15-20 members, usually women, who pool their savings. A typical SHG meets regularly and saves small amounts ranging from Rs. 25 to Rs. 100 or more per member depending on their ability. Members can take small loans from the group itself to meet their needs without any collateral.
• Low Interest Rates: The group charges interest on these loans, but it is still much less than what the moneylenders charge.
• Timely Credit and Easy Terms: Since the group is responsible for loan recovery, non-repayment of loans by any member is dealt with seriously, ensuring high repayment rates. This builds trust, and after a year or two, if savings are regular, the SHG is eligible for taking loans from the bank, which is sanctioned in the name of the group.
• Empowerment of Women: It creates a platform for women to discuss and act on a variety of social issues like health, nutrition, domestic violence, etc., making them financially self-reliant.