10 Differences Between formal and informal sources of credit

Difference between Formal and Informal Sources of Credit

Difference between Formal and Informal Sources of Credit

What are Formal Sources of Credit?

Formal sources of credit refer to regulated and organized financial institutions that provide credit facilities. These institutions follow specific guidelines and maintain transparency in their operations. They are licensed by regulatory authorities and offer various financial products and services.

Examples of Formal Sources of Credit

  • Commercial banks
  • Cooperative banks
  • Microfinance institutions
  • Credit unions
  • Government-backed lending programs

Uses of Formal Sources of Credit

Formal sources of credit are commonly used for:

  • Business investments
  • Education purposes
  • Home loans
  • Automobile loans
  • Credit card facilities

What are Informal Sources of Credit?

Informal sources of credit, also known as non-institutional sources, are not regulated by any authority. These sources are based on mutual trust and personal relationships. Informal credit systems exist in traditional societies, rural areas, and among small communities.

Examples of Informal Sources of Credit

  • Moneylenders
  • Friends and family
  • Trade credits
  • Chit funds
  • Rotating savings and credit associations

Uses of Informal Sources of Credit

Informal sources of credit are typically utilized for:

  • Emergency financial needs
  • Short-term loans
  • Small-scale businesses
  • Local trade activities and services
  • Seasonal agricultural expenses

Differences between Formal and Informal Sources of Credit

Difference Area Formal Sources of Credit Informal Sources of Credit
Regulation Regulated by authorities and follow specific guidelines Not regulated by any authority
Availability Widely available through branches and online platforms Availability depends on personal networks and relationships
Interest Rates Interest rates are standardized and often lower Interest rates are typically higher and may vary
Documentation Requires extensive documentation and verification Minimal documentation and relies on trust
Repayment Terms Fixed repayment terms and schedules Flexible repayment terms
Loan Size Offers larger loan amounts Usually limited to smaller loan amounts
Accountability Compliance with regulatory and legal frameworks Lack of formal accountability
Target Audience Generally aimed at a broader range of borrowers Primarily serves local or specific communities
Risk Assessment Follows formal risk assessment procedures Risk assessment may be based on personal judgment
Government Support Can benefit from government-backed programs and schemes No government support or guarantees


The formal and informal sources of credit differ significantly in terms of regulation, availability, interest rates, documentation, repayment terms, loan sizes, accountability, target audience, risk assessment, and access to government support. Choosing between the two depends on the borrower’s requirements, credibility, and the availability of appropriate financial resources.

People Also Ask:

Question 1: What are the advantages of formal sources of credit?

Answer: Formal sources of credit offer lower interest rates, larger loan amounts, regulatory protection, and long-term financial relationships.

Question 2: Are informal sources of credit always reliable?

Answer: Informal sources of credit may lack transparency and legal protection, making them potentially risky for borrowers.

Question 3: Can formal and informal sources of credit coexist?

Answer: Yes, borrowers may utilize both formal and informal sources of credit based on their specific needs and circumstances.

Question 4: How can informal sources of credit be beneficial?

Answer: Informal sources of credit can be more easily accessible and helpful for individuals who do not have access to formal financial institutions.

Question 5: Are formal sources of credit suitable for small businesses?

Answer: Yes, formal sources of credit have specific products and services tailored for small businesses, such as microloans and business lines of credit.

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