Step 1: Separate the two categories.
Formal credit comes from institutions like banks and cooperative societies, while informal credit comes from moneylenders, traders, employers, relatives and friends.
Step 2: Compare regulation and rates.
Formal lenders are supervised by the RBI and charge reasonable, fairly fixed interest rates, whereas informal lenders answer to no regulator and often charge steep or arbitrary rates.
Step 3: Compare fairness and purpose.
Formal institutions follow set rules on approval and repayment and aim to support economic development, while informal lenders can impose unfair terms and mainly look to profit off the borrower.
Hence, formal sources are the regulated, cheaper and more reliable option, while informal sources are unregulated, costlier and riskier for the borrower.