Question

Why do you think that the share of formal sector credit is higher for the richer households compared to the poorer households?

Answer 1

The richer households have a higher percentage of formal sector loans than poorer households because:

1. Richer households can offer collateral to the formal sector, whereas poor households typically do not have any assets to provide as collateral.
2. Formal loans require extensive documentation. Richer homes are better equipped to offer these documents, whereas poorer households may struggle with this requirement.
3. Richer households are more aware of the products and services offered by formal financial organisations. This knowledge gap may impede poorer households’ ability to obtain formal loans.
4. Richer households tend to have steadier and greater earnings, making them more appealing to formal lenders. Poorer households may have irregular and low incomes, which raises the perceived risk for formal lenders.
5. Poorer households may have long-standing contacts with informal lenders and place greater trust in them than in formal institutions. Wealthier households are more likely to have established contacts with banks and other formal lenders.