Author Article by Parry Singh Founder and CEO Red Fort Capital
In today’s financial landscape, credit availability is becoming increasingly important for individuals and businesses alike. When seeking financial assistance, borrowers are often faced with the decision of whether to approach formal or informal money lenders. While both options may seem viable on the surface, understanding the advantages of formal money lenders can shed light on why they are often regarded as the better choice. From legal protection and transparency to lower interest rates and institutional support, formal money lenders offer several benefits contributing to a more secure and favourable lending experience. Over the last few decades, the share of non-institutional sources has declined due to the implementation of schemes by banks for financial assistance to weaker sectors of the economy.
In this discussion, we will explore why formal money lenders are considered superior to informal money lenders and the different advantages they provide.
- Informal lenders charge high rate
The informal credit markets serve the financial needs of businesses and individuals but do so by imposing exorbitant interest rates, as they do not demand collateral. This exposes borrowers to the peril of falling into indebtedness. Consequently, businesses face jeopardy, as unmanageable interest rates can erode their profits significantly. In contrast, formal credit sources adhere to legally mandated maximum interest rates, whether collateral is involved, safeguarding borrowers from being subjected to exorbitant charges.
- Regulatory oversight
Formal lenders operate under the supervision of regulatory authorities such as the Reserve Bank of India (RBI), ensuring compliance with lending guidelines and promoting responsible lending practices. adherence to guidelines and regulations set by authorities such as the Reserve Bank of India (RBI). These guidelines include rules to prevent unfair means of loan recovery. Formal lenders are prohibited from resorting to practices such as intimidation, invasion of privacy, or making threatening calls to borrowers. Such regulations help protect borrowers from harassment and ensure a fair and respectful approach to loan recovery.
Many businesses in India fall prey to deceptive informal money lenders due to their lack of transparency and absence of legal certification. These lenders exploit borrowers by manipulating loan terms and conditions, subjecting them to various risks. In contrast, formal money lenders offer clear and transparent loan terms, informing borrowers upfront about interest rates, repayment schedules, and any additional fees, thereby ensuring no hidden costs.
- Innovative offerings to customer
Banks and financial institutions are introducing new credit products, facilitating easier access to formal lending. For instance, the government’s introduction of RuPay credit cards, which can be linked to credit cards, allows convenient QR Code-based payments. As a result, digital lending and transactions are expected to rise. Over the past four years, India has witnessed substantial growth in credit card issuance, with a compound annual growth rate (CAGR) of 20%. The number of credit cardholders surged from 29 million in March 2017 to 62 million in March 2021.
- Established reputation and Financial Guidance
Formal lenders, such as banks and reputable financial institutions, have an established reputation in the market. Borrowing from a known and credible institution instills confidence in the borrowers, knowing they are dealing with a trustworthy entity. Also, formal lenders often provide financial guidance and assistance to borrowers. They may offer advice on managing finances, investments, and other financial matters, helping borrowers make informed decisions for their financial well-being.
By and large, the advantages of formal money lenders over informal money lenders cannot be overstated. The legal protection provided by formal lenders ensures that borrowers are safeguarded against exploitation and unfair practices, while the transparency they offer fosters trust and clarity in lending transactions. Additionally, the regulated interest rates of formal lenders make borrowing more affordable and sustainable for individuals and businesses. Furthermore, the access to credit history and institutional support provided by formal lenders contributes to the overall financial well-being of borrowers. As individuals and businesses navigate the lending world, it is crucial to recognize the numerous benefits of formal money lenders and make informed choices that promote financial stability and security.