The credit from the informal source is getting loans from institutions that do not come under the purview of any legal entity. Credit from these sources moneylenders, friends, relatives, traders and employer can be included under the informal sources of credit. Taking credit from informal sources has the following limitations:
- A high rate of interest: The informal sources like moneylenders will charge any rate of interest which will lead to huge cost the borrowers to repay and lenders can easily exploit the borrowers. On the other hand, formal sources have a fixed rate of interest for different types of loans.
- Fewer savings: The informal sources like moneylenders will charge any rate of interest which will lead to huge cost the borrowers to repay and lenders can easily exploit the borrowers. Thus only less income would be left with them after paying their loans back. Thus the savings with them would be minimal.
- Unfair means of extortion: The informal sources will not have any code of conduct and lenders can easily exploit the borrowers. They can use any illegal means to get their loans back. They may use their muscle power for the collection of loans. On the other hand, formal sources use only legal means in their dealings.
Because of all these, there should be a supervisory body that should supervise the activities of the informal sector. Also, a large segment of the rural population is largely dependent on informal sources. But the task of supervising them would be very difficult.
This is mainly because of the following reasons:
- Vast reach: 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. This gives them a wide reach in the economy. Thus it will be difficult to control them.
- Influence: The moneylenders and other informal lenders will be highly powerful and influential in society. Thus it would be very difficult to control their activities.
