CBSE Class 10 · Money and Credit

Formal and Informal Sources of Credit Class 10 Economics

Updated 14 October 2026 · Fact-checked

Formal credit comes from banks and cooperatives, supervised by the Reserve Bank of India; informal credit comes from moneylenders, traders, employers, relatives and friends, with no supervisor and usually much higher interest. In 2019, commercial banks gave 51 per cent of rural credit. Richer households get most formal loans, so formal credit must expand and reach the poor.

Formal lenders are supervised by the RBI and charge lower interest; informal lenders have no supervisor and charge more, yet still give about a third of rural c

Illustration drawn for QuestionBuddy.

Understand Formal and Informal Sources of Credit

Two groups of lenders. Loans can be grouped as:

Formal sector loans: from banks and cooperatives.
Informal sector loans: from moneylenders, traders, employers, relatives and friends, etc.

Sources of credit in rural India, 2019 (NCERT Graph 1). Commercial banks 51 per cent; moneylenders 23 per cent; cooperative banks and societies 10 per cent; relatives and friends 7 per cent; other formal agencies 5 per cent; other informal agencies 3 per cent; landlords 1 per cent. So formal sources give roughly two-thirds and informal sources the rest, with moneylenders still a large source.

Cooperatives. Besides banks, cooperative societies are a major source of cheap credit in rural areas. Members pool their resources (farmers, weavers, industrial workers cooperatives). NCERT's Krishak Cooperative has 2,300 farmer members; it accepts their deposits, uses them as collateral to get a large bank loan, and lends to members for implements, cultivation, trade, fishery, housing and other needs; once repaid, it lends again.

Supervision. The Reserve Bank of India (RBI) supervises formal lenders:

it monitors that banks maintain a minimum cash balance out of deposits;
it sees that banks lend not only to profit-making businesses and traders but also to small cultivators, small-scale industries and small borrowers;
banks periodically report to the RBI how much they lend, to whom and at what interest.

No organisation supervises informal lenders: they can charge any interest and may use unfair means to recover money.

Why informal credit is costly. Most informal lenders charge much higher interest, so a larger part of borrowers' earnings goes to repayment and they keep less (as for Shyamal). Sometimes the amount to be repaid exceeds the borrower's income, causing rising debt and a debt trap (as for Rama). High borrowing costs also stop people from starting enterprises.

Why expand formal credit. Banks and cooperatives should lend more; this would raise incomes, and many could borrow cheaply to grow crops, do business, set up small industries or trade. Cheap and affordable credit is crucial for the country's development.

Who gets what? (Graph 2, urban households). 54 per cent of loans taken by poor urban households come from informal sources; for rich urban households, only 17 per cent are informal and 83 per cent formal. A similar pattern exists in rural areas: the rich get cheap formal credit while the poor pay heavily.

Two conclusions (NCERT).
1. The formal sector still meets only about half of rural credit needs; banks and cooperatives must lend more, especially in rural areas, to reduce dependence on informal sources.
2. Formal credit must be distributed more equally so that the poor also benefit from cheaper loans.

Why the poor depend on informal lenders. Banks are not present everywhere in rural India; bank loans need proper documents and collateral, and absence of collateral is a major barrier. Moneylenders know borrowers personally and lend without collateral, even before earlier loans are repaid, but they charge very high interest, keep no records and harass poor borrowers.

Formal and Informal Sources of Credit: key facts

Formal sources: Banks and cooperatives; supervised by the RBI; Cheaper credit.
Informal sources: Moneylenders, traders, employers, relatives and friends; no supervisor; Usually much higher interest.
Rural credit sources, 2019: Commercial banks 51%, moneylenders 23%, cooperatives 10%, relatives and friends 7%, other formal 5%, other informal 3%, landlords 1%; NCERT Graph 1.
RBI's role: Monitors minimum cash balance; ensures loans to small cultivators, small industries and small borrowers; collects lending reports
Who gets formal credit (urban): Poor: 54% of loans informal; rich: 17% informal, 83% formal; Similar pattern in rural areas.
Two needs: Expand formal credit (meets only about half of rural needs) + distribute it more equally to the poor

How to answer Formal and Informal Sources of Credit questions

Questions ask for differences between formal and informal credit, the RBI's role, why formal credit should expand, and why the poor depend on informal lenders. Data items use Graphs 1 and 2.

1For differences, compare lenders, supervision, interest, collateral, record-keeping and treatment of borrowers.
2For the RBI, give the three supervisory activities.
3For 'why expand formal credit', link high informal costs to lower income, debt traps and fewer enterprises.
4For 'why the poor use informal lenders', give bank absence, documents and collateral, and personal acquaintance.
5Quote one graph figure: 51 per cent banks, 23 per cent moneylenders, or 54 per cent vs 17 per cent informal.

Formal and Informal Sources of Credit in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Why the poor turn to moneylenders

Suppose a vegetable vendor needs Rs 3,000 urgently to restock after a flood. The bank branch is 15 km away and asks for income papers and collateral, which she does not have. A local moneylender, who knows her, gives the money the same day at a very high monthly interest.

Explain why she chose the moneylender and what risk she faces.

Try it first, then show the solutionSolution

No nearby bank branch; documents and collateral required.
Moneylender knows her personally and lends without collateral.
But interest is very high and there are no records.
Risk: a large share of earnings goes to repayment; possible debt trap.

Answer: Banks are not present everywhere and need documents and collateral, which she lacks. The moneylender knows her personally and lends without collateral, quickly. But informal loans carry very high interest, no records are kept and borrowers may be harassed. Much of her earnings may go to repayment, and if income falls she could slide into a debt trap.

Memory hook: Easy to borrow, hard to escape.

Tricks to remember Formal and Informal Sources of Credit

Short memory aids. Say each one aloud once, then use it on a question the same day.

B-C formal, M-T-E-R-F informal
Banks and Cooperatives are formal; Moneylenders, Traders, Employers, Relatives and Friends are informal.
Use it when: Classifying lenders.
51 and 23
Banks 51, moneylenders 23 in rural credit (2019).
Use it when: Graph 1 MCQs.
54 vs 17
Poor urban households: 54% informal; rich: 17% informal.
Use it when: Graph 2.

Formal and Informal Sources of Credit: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Who supervises formal credit · 1 mark · MCQBoard level

Which institution supervises the functioning of formal sources of loans in India?
(a) State governments
(b) Reserve Bank of India
(c) Election Commission
(d) Cooperative societies

Try it first, then show the solutionSolution

NCERT: the RBI supervises formal lenders (1 mark).

Answer: (b) Reserve Bank of India

Example 2: Formal vs informal (3 marks) · 3 marks · Short answerBoard level

Distinguish between formal and informal sources of credit on three points. (3 marks)

Try it first, then show the solutionSolution

Lenders: formal = banks and cooperatives; informal = moneylenders, traders, employers, relatives, friends (1 mark).
Supervision: formal lenders are supervised by the RBI; no organisation supervises informal lenders (1 mark).
Cost and practices: formal loans are cheaper but need collateral and documents; informal loans have much higher interest, no records and possible harassment (1 mark).

Answer: Formal credit comes from banks and cooperatives; informal credit from moneylenders, traders, employers, relatives and friends. The RBI supervises formal lenders, but no one supervises informal lenders, who can charge any interest and use unfair means. Formal loans are cheaper but need documents and collateral, while informal loans are costly, unrecorded and may involve harassment.

Example 3: Assertion-reason: richer households · 1 mark · Assertion-reasonHOTS / competency

Assertion (A): Richer households get a larger share of their loans from formal sources than poor households.
Reason (R): Formal lenders require documents and collateral, which richer households are more likely to have.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.

Try it first, then show the solutionSolution

Collateral and documents are major barriers for the poor, so the rich access formal credit more; R explains A (1 mark).

Answer: (a) Both A and R are true, and R is the correct explanation of A.

Example 4: Why expand formal credit (5 marks) · 5 marks · Long answerHarder board level

'Cheap and affordable credit is crucial for the country's development.' Explain why formal sources of credit need to be expanded and made available to the poor. (5 marks)

Try it first, then show the solutionSolution

Informal lenders charge much higher interest; a larger part of borrowers' earnings goes to repayment, leaving less income (1 mark).
Sometimes repayment exceeds income, causing rising debt and debt traps; high costs discourage people from starting enterprises (1 mark).
The formal sector meets only about half of rural credit needs; banks and cooperatives must lend more (1 mark).
Formal credit goes mostly to the rich: poor urban households take 54 per cent of loans informally against 17 per cent for the rich; it must be shared more equally (1 mark).
Cheap credit lets people grow crops, do business, set up small industries and trade, raising incomes and development (1 mark).

Answer: Informal lenders charge much higher interest, so borrowers spend more of their earnings on repayment and keep less; sometimes repayment exceeds income, causing growing debt and debt traps, and high costs discourage new enterprises. Yet the formal sector meets only about half of rural credit needs, so banks and cooperatives must lend more, especially in rural areas. Formal credit also goes mainly to the rich: poor urban households take 54 per cent of their loans from informal sources, rich ones only 17 per cent. It must be distributed more equally. With cheap credit, people could grow crops, run businesses, set up small industries and trade, raising incomes and development.

Example 5: Data: rural credit sources (3 marks) · 3 marks · Short answerHOTS / competency

NCERT's Graph 1 shows sources of credit in rural India, 2019: commercial banks 51%, moneylenders 23%, cooperative banks and societies 10%, relatives and friends 7%, other formal agencies 5%, other informal agencies 3%, landlords 1%. (a) What is the total share of formal sources? (b) Which informal source is largest? (c) What does this suggest about rural credit? (3 marks)

Try it first, then show the solutionSolution

(a) 51 + 10 + 5 = 66 per cent (1 mark).
(b) Moneylenders, 23 per cent (1 mark).
(c) About a third of rural credit is still informal, much of it from costly moneylenders, so formal credit must expand and reach the poor (1 mark).

Answer: (a) Formal sources: 51 + 10 + 5 = 66 per cent. (b) Moneylenders, at 23 per cent. (c) About one-third of rural credit still comes from informal sources, mostly high-interest moneylenders, so banks and cooperatives need to lend more and reach poorer households.

Example 6: Cooperatives (3 marks) · 3 marks · Short answerHarder board level

How does a cooperative such as Krishak Cooperative provide cheap credit to its members? (3 marks)

Try it first, then show the solutionSolution

Members pool resources; Krishak Cooperative has 2,300 farmer members and accepts their deposits (1 mark).
With these deposits as collateral, it obtains a large loan from a bank (1 mark).
It lends to members for implements, cultivation, trade, fishery and housing; repaid loans fund another round of lending (1 mark).

Answer: Its 2,300 farmer members pool their savings as deposits. Using these deposits as collateral, the cooperative takes a large bank loan. It lends this money to members for implements, cultivation, agricultural trade, fishery and housing, and once loans are repaid, lends again.

Where students lose marks in Formal and Informal Sources of Credit

The slips examiners see most often, and what to write instead.

Mistake: Classifying cooperatives as informal
They seem community-based.
Wrong working
Cooperatives are informal lenders like moneylenders.
Right working
Cooperatives, like banks, are formal sources.
Do this: Banks + cooperatives = formal.
Usually costs: 1 mark.
Mistake: Saying the RBI controls moneylenders
Assuming all lending is regulated.
Wrong working
The RBI fixes moneylenders' interest rates.
Right working
No organisation supervises informal lenders.
Do this: RBI = formal sector only.
Usually costs: 1 mark.
Mistake: Misreading Graph 2
Formal and informal shares swapped.
Wrong working
Rich households take 83 per cent of loans informally.
Right working
Rich: 83 per cent formal, 17 per cent informal.
Do this: Check the colour legend.
Usually costs: 1 mark.
Mistake: Only listing differences, no consequences
5-mark answers need analysis.
Wrong working
Banks charge less, moneylenders charge more.
Right working
Add effects: lower income, debt traps, fewer enterprises.
Do this: Difference + effect.
Usually costs: 1-2 marks.

Exam tips

Learn Graph 1 shares (banks 51, moneylenders 23, cooperatives 10).
For the RBI, give three supervisory roles and one reason.
Link informal credit to debt traps using Rama or Shyamal from Sonpur.
Economics in 2026-27 has 1-, 3- and 5-mark questions.

Practice questions on Formal and Informal Sources of Credit

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
In 2019, the largest source of credit for rural households in India was:
(a) moneylenders
(b) commercial banks
(c) relatives and friends
(d) landlords
Hint
51 per cent.
Answer
(b) commercial banks
Q2 · 3 marks · Short answerBoard level
In what ways does the Reserve Bank of India supervise banks? Why is this necessary? (3 marks)
Hint
Cash balance, small borrowers, reports.
Answer
The RBI monitors whether banks maintain a minimum cash balance out of deposits, ensures they lend not only to profit-making businesses and traders but also to small cultivators, small industries and small borrowers, and collects periodic reports on how much they lend, to whom and at what interest. This protects depositors and ensures credit reaches those who need it.
Q3 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Informal lenders keep detailed records and are supervised by the RBI.
Reason (R): Moneylenders know borrowers personally and may lend without collateral.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.
Hint
Who supervises informal lenders?
Answer
(d) A is false, but R is true.
Q4 · 3 marks · Short answerHOTS / competency
Suppose Manav needs a loan to set up a small business. On what basis should he decide between a bank and a moneylender? (3 marks)
Hint
Terms of credit and risk.
Answer
He should compare terms of credit: the bank charges much lower interest and keeps records but needs documents and collateral; the moneylender lends easily without collateral but charges very high interest, keeps no records and may harass. If Manav can provide collateral and documents, the bank is cheaper and safer; high-cost informal credit could eat his profits and create a debt trap.
Q5 · 3 marks · Short answerHOTS / competency
Why would it be difficult for a supervisor like the RBI to regulate informal lenders? (3 marks)
Hint
Who they are and how they lend.
Answer
Informal lenders are many and scattered: moneylenders, traders, employers, relatives and friends. They lend personally, often without records or written agreements, at whatever interest they choose. Without records or registration, it would be very hard for any supervisor to know how much they lend, to whom and on what terms.
Q6 · 5 marks · Long answerHOTS / competency
'At present, it is the richer households who receive credit from formal sources whereas the poor have to depend on informal sources.' Analyse the causes and consequences, and suggest two remedies from the chapter. (5 marks)
Hint
Graph 2; collateral; costs; SHGs and expansion.
Answer
Graph 2 shows that poor urban households take 54 per cent of their loans from informal sources, while rich households take only 17 per cent; the same pattern holds in villages. The causes: banks are not present everywhere, and bank loans need documents and collateral, which the poor lack, while moneylenders lend personally without collateral. The consequences: the poor pay very high interest, keep less of their earnings, risk debt traps and harassment, and cannot start enterprises, while the rich borrow cheaply. Remedies: banks and cooperatives should expand lending, especially in rural areas, and formal credit should reach the poor, for example through self-help groups, which help borrowers overcome the lack of collateral.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Name two formal sources of credit.Show answer
Banks and cooperatives.
2.What share of rural credit came from moneylenders in 2019?Show answer
23 per cent.
3.How many members does Krishak Cooperative have?Show answer
2,300 farmers.
4.What share of rural credit needs does the formal sector meet?Show answer
Only about half.
5.Why do moneylenders lend without collateral?Show answer
They know the borrowers personally.

Formal and Informal Sources of Credit: frequently asked questions

What are formal and informal sources of credit?

Formal: banks and cooperatives, supervised by the RBI. Informal: moneylenders, traders, employers, relatives and friends, with no supervisor.

Why is informal credit harmful?

It usually carries much higher interest, leaves borrowers less income, can lead to debt traps, and lenders may keep no records and harass borrowers.

How does the RBI supervise banks?

It checks minimum cash balances, ensures lending to small borrowers, and collects reports on lending.

Why do the poor rely on informal credit?

Banks are not everywhere and need documents and collateral, which the poor often lack.