The argument that the credit activities of the informal sector should be discouraged is supported by several compelling reasons:
1. Exorbitant Interest Rates: Unlike the formal sector which is regulated and bound by official interest rate guidelines, the informal sector often charges significantly higher interest rates. This makes borrowing from such sources a costly affair.
2. Impact on Savings and Financial Health: High interest rates mean that borrowers end up repaying substantially more than they borrowed. This not only strains their financial health but also results in reduced savings, limiting their future financial security and investment opportunities.
3. Lack of Regulatory Oversight: The informal sector operates without stringent regulatory oversight. This means borrowers are at a higher risk of falling into debt traps, facing unfair practices, and not having legal recourses in case of disputes.
4. Potential for Exploitative Practices: Without standardized regulations, the informal sector is more susceptible to exploitative practices such as usury or loan sharking, which can have severe consequences for vulnerable borrowers.
5. Impact on National Economy: An unchecked informal lending sector can lead to a proliferation of unrecorded and potentially bad debts. This lack of transparency and accountability can pose systemic risks to the nation’s broader financial system.
6. No Institutional Support: Unlike formal financial institutions which often provide additional support, guidance, and financial literacy initiatives to borrowers, informal lenders are primarily profit-driven, often neglecting the broader well-being of their clients.
7. Deters Use of Formal Channels: Proliferation of informal lending can deter individuals from using formal banking channels. This can limit the spread of financial literacy and the benefits associated with formal banking, such as credit history building.
In light of these reasons, it becomes evident that discouraging the credit activities of the informal sector is not only beneficial for individual borrowers but also crucial for the health and stability of the broader economic and financial system.