Concept:
- The root of every problem with informal credit is the same, that nobody supervises these lenders while the Reserve Bank of India monitors the formal sources.
- Tracing the consequences of that single absence explains all the harms in turn.
Step 1: The absence of supervision sets the stage.
Banks and cooperatives have to report how much they lend, to whom and at what rate, and the Reserve Bank of India checks that they lend fairly. Moneylenders, traders and employers answer to no one and can fix any terms they wish.
Step 2: The first consequence is a very high interest rate.
With no ceiling and often no alternative source available to a poor borrower, informal lenders charge far more than the formal sector. The borrower accepts because there is nowhere else to go.
Step 3: The second consequence is that income drains away in repayment.
A high rate means a large part of whatever the borrower earns goes back to the lender. Less remains for the family, so the loan makes the household poorer over time rather than better off.
Step 4: The third consequence is a debt trap.
If the amount to be repaid grows larger than the income of the borrower, recovery becomes extremely painful. A farmer whose crop fails may have to sell land or cattle to clear the debt, and losing that asset destroys the future earning capacity itself.
Step 5: The fourth consequence is a loss to the whole economy.
People who might have started a small enterprise do not begin, because the cost of borrowing is too high to be covered by the business. Along with unfair recovery practices, this keeps the poorest borrowers from ever moving up.
That is why the growth of formal credit and of self-help groups matters so much.
Final Answer: Because no authority supervises informal lenders, they charge very high interest, which drains the earnings of the borrower, can push a family into a debt trap and stops new enterprises from starting, while leaving borrowers unprotected against unfair means of recovery.