Formal source of credit includes all the sources for raising the credit from the institutions which are functioning under the guidelines of RBI or which work with specific rules and regulations. They are more reliable than informal sources. Banks and cooperatives are the main formal sources of credit. The share of formal sector credit is higher for the richer households compared to the poorer households because:
• Most of the formal sources of credit will be cheap compared to informal sources. Even though banks advance the loans with cheaper interest rate poor households are not able to avail that loan due to terms of credit and formalities.
• The requirement of collateral for taking loans from institutional sources makes it impossible for the poor to take loans from banks and other institutions. Thus they have to rely on other informal sources.
• Rural poor are not aware of the banking system because of the lack of education and awareness. Therefore they are forced to acquire a loan from the informal sources. Most of the people in rural areas don't have access to native bankers and other financial institution, this increases the share of informal sources of credit among the poor households.
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