The credit activities of the informal sector should be discouraged due to the following reasons –
1. There is no organization which supervises the credit activities of lenders in the informal sector. They can lend at whatever interest rate they want and there is no one to stop them from using unfair means to get their money back.
2. Most of the informal moneylenders charge a very high rate of interest on loans in comparison to the formal lenders which in turn increases the cost of money which is to be repaid back. Sometimes the amount to be repaid is greater than the income of the borrower.
3. The high cost of borrowing discourages many people who wish to start an enterprise. It also significantly reduces the income of the borrower as much of the earnings go into repayment of the loan.
Therefore, the formal sector needs to play an increasing role in extending the facilities of credit.
NOTE - The formal sector includes banks and cooperatives while the informal sector includes moneylenders, traders, employers, relatives and friends, etc who provide loan facilities to the people.
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