No Formal Credit for the Informal Sector

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The informal sector is the backbone of India’s working economy. An informal economy is one that is neither taxed nor monitored by any form of government. The Indian economy is characterized by the existence of a vast majority of informal or unorganized labour employment. Around 93% of India’s economy and about 50 percent of the national product are accounted for by the informal sector.

Bangalore, the third largest city in India is home to over 42 lakh migrants. About 74% of Bangalore’s total population is engaged in the informal sector. This sector indulges in business models that operate on a day-to-day basis. With daily earnings varying between 100 to 1500 rupees per day, these workers often find themselves in need of credit, or additional money to pay for a variety of things such as rent, children’s school fees, raw material, etc. When this happens, they prefer to borrow informally rather than approaching banks for a variety of reasons.

Harini, a buttermilk stall owner, said that she preferred to borrow from friends and family because that way she has the option of availing credit instantly at the time of need. She added that banks require paper work, formalities and procedures which takes up lots of time. She primarily uses the credit she receives to cater to immediate expenses such as house rent or to pay her children’s school fees. “Who will give us a loan for purposes like these?” she questioned.

The lack of documentation, salary slips or the knowledge of bank proceedings encourages her to turn to near and dear ones to avail credit.

Other than friends and family, people in the informal sector also rely on moneylenders and local institutions to meet their credit needs. In this process, they often end up getting exploited by the lenders as they are made to pay exorbitant interest rates.

Abdul Ahmed, a garment shop owner on Commercial Street said, “The people that come here to give money give at 20% interest rate and make a collection of Rs. 2000 from the borrowers every time they come to visit.”

Mohd. Ansar, an owner of a shop selling shoes, belts and hair accessories said, “Many shops here require money. There is a society bank that gives us loans. If we ask for a Rs. 50,000 loan, they give us a loan of Rs. 46,000, and cut Rs, 4,000 as interest initially. Then we pay Rs. 500 as interest every 90 days till we repay the loan. Banks are risky; they are not ready to give loans to people like us who own street shops. We don’t like going to the banks because banks require paperwork, passbook, account, etc and we don’t have all of that. They only lend to people they know will pay back.”

Mohd. Ansar next to his shop on Commercial Street

An anonymous moneylender admitted that he charges an interest of 18-20% for loans given against silver as collateral. According to the Moneylenders and Pawn Brokers Act, 1965, a moneylender can charge a maximum interest of 14% for secured loans and 16% for unsecured loans, which is the case here.

It is not only legally authorized moneylenders, but also the microfinance and the NBFC space that lets down people from the informal sector.

Muthoot Finance, a reputed non-banking financial institution provider recently discontinued its MSME scheme citing losses induced by covid as the reason behind it. This scheme largely benefited people who wanted to start their own businesses or set up a stall.

When even authorized credit providers fail to cater to the requirements of the informal sector, these people have no option but to turn to loan sharks and moneylenders, who exploit them to an extent where one starts questioning whether it is easier to pay the loan or sell off a part of their holdings to the creditor.

“The people who cannot afford to pay in the first place, end up paying the most.”

More often than not, people who borrow informally end up falling in a debt trap.

Prof. Channamma Kambara, Researcher and Professor at the Institute for Social and Economic Change explained the concept of a debt trap and a vicious cycle. She said, “When one credit is over, they immediately apply for another loan, and this cycle continues until they are in a debt trap. Most of the times they say they are taking the loan for business, but they take it for their personal use, which does not generate any income. Then they are unable to repay the loan and the debt cycle continues.”

Most people who fall in a debt trap often spend their whole life trying to get out of it. But, there are also some women who form self-help groups and avail credit from the bank, use it to generate profits from their businesses and repay the credit in time.

An institution called Association of Women Entrepreneurs of Karnataka or AWAKE trains these women to run their businesses and become financially independent.

Experts say that lesser borrowing and borrowing for profit generation purposes are the only ways in which someone can successfully come out of a death trap. While it is tempting to borrow from moneylenders for multiple reasons, people must refrain from doing so to protect themselves from being exploited.

Also read: The Success Story of Microfinance in Bangladesh, the country credited with the invention of joint liability group-based lending.

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