It is important to open more banks in the rural areas as formal sector of credit is missing. The practise of borrowing from the informal sector that currently exists in rural areas, for example local moneylenders, has a number of disadvantages.
(i) The informal sector charges a higher rate of interest. Informal sector make loans very expensive as there are no external organizations controlling the credit activities of lenders.
(ii) Informal sector involves high degree of risk as there are no proper set of rules for repayment and there is a lot of exploitation of poor farmers.
(iii) Lenders may exploit the borrowers, they may engage in threats and intimidation to ensure repayment of loans. There is no written agreement between the lender and the borrower. There is no legal recourse in case of informal sources of credit.
OR
Formal sector :
(i) This sector is mainly supervised by the RBI.
(ii) It includes banks and cooperatives, thus every clause is in writing and clear to comprehend.
(iii) In this sector of credit, collateral is required.
(iv) It provides loans comparatively at lower rates.
(v) It doesn't lead to a debt trap.
Informal sector :
(i) No external organisation supervises this sector.
(ii) The lenders are mainly moneylenders, friends, relatives, traders and landowners etc.
(iii) Collateral is not required, thus it involves risk.
(iv) This sector charges higher interest rates without any rules or regulation.
(v) This could lead to a debt trap.