Amrita is a government employee and belongs to a rich urban household whereas Rani works as a helper on a construction site and comes from a poor rural household. Both have a crisis at home and wish to take loan. Create a list of arguments explaining who between the two would successfully be able to get the loan from a formal source. Why?

Amrita, a government employee who belongs to a rich urban household would be successful in getting a loan from a formal source as compared to Rani who comes from a poor household and works as a helper on a construction site. This is because there are certain terms of credit which need to be fulfilled in the formal sector-

1. Collateral – It is an asset that the borrower owns (example – land, building, livestock, vehicles etc.) and uses as a guarantee to a lender until the loan is repaid. If the borrower fails to repay the loan, the lender can obtain his payment by selling that particular asset.

2. Documentation – A formal source of credit functions according to certain rules and regulations. In extending loans, they demand a set of formal documents of the borrower for identity and security purposes. The interest rate charged on loans along with the mode of repayment is also specified in formal documents.

3. Financial Capability – The formal source of credit needs to ensure the financial independence of the borrower.

The poor often fail to get loans from these sources because of the lack of various terms of credit.

NOTE – The terms of extending credit facilities vary substantially between the formal and the informal sector. In comparison to the formal sources, informal sources (moneylenders, friends, relatives) do not ask for any documents or collateral and are also often willing to extend loans before the repayment of the previous loan.