Why is formal sector credit considered more beneficial for borrowers compared to informal sector credit in India?
Generated by claude-sonnet-4-6 · 2026-06-26 13:22 · grounding rag
Model Answer
Formal sector credit is more beneficial for borrowers due to the following reasons:
- Lower interest rates: Formal lenders like banks and cooperatives charge much lower interest rates (e.g., 8.5% p.a.) compared to informal lenders like moneylenders (up to 60% p.a.), reducing the burden on borrowers.
- RBI supervision: The Reserve Bank of India supervises formal lenders, ensuring fair practices. No such body monitors informal lenders, who can use unfair means to recover money.
- Prevents debt trap: Lower repayment burden means borrowers retain more income, avoiding the risk of a debt trap that high informal interest rates create.
Source: Chapter 3 — Money and Credit, Formal Sector Credit in India
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Explanation
Examiners look for three distinct points for 3 marks — one point per mark. The key contrast is always: lower cost → less burden → no debt trap, plus RBI regulation. Avoid writing lengthy paragraphs; use numbered points for clarity. Always support with figures from the text (e.g., 8.5% vs 60%) to show textbook grounding.