Difference between Formal Sources of Credit and Informal Sources of Credit
Formal and informal sources of credit are both important ways to get money.
The main difference between formal and informal sources of credit is a matter of how they are obtained. Formal sources of credit are obtained through an institution, such as a bank or credit union, while informal sources of credit are achieved through family members or friends.
Before we move to the differences, let’s understand what are Formal Sources of Credit and Informal Sources of Credit:
- Formal Sources of Credit: Formal sources of credit are those that are developed and offered by financial institutions such as banks, credit unions, and other financial institutions. These sources of credit are typically considered the most reliable because they have been created and regulated by an entity that has the ability to monitor and control the use of funds.
- Informal Sources of Credit: Informal sources of credit are the type of credit you get from friends and family, or through a private loan. They’re called “informal” because they aren’t regulated by the government.
Now, let’s move to Formal Sources of Credit vs Informal Sources of Credit:
Major differences between Formal Sources of Credit and Informal Sources of Credit
| Formal Sources of Credit | Informal Sources of Credit |
|---|---|
| Formal sources of credit often have higher interest rates than informal sources of credit. | Informal sources of credit have lower interest rates than formal sources of credit. |
| Formal sources of credit are those that involve a contract and an official record of the transaction. | Informal sources of credit are those that are not recorded in any way. |
| Formal sources of credit are usually banks or other financial institutions that offer loans or lines of credit. | Informal sources of credit are more personal: family members, friends, co-workers, and even employers. |
| Formal sources of credit are loans that require you to fill out an application and meet certain criteria (such as having a steady income or being employed by the same company for at least six months). | Informal sources of credit don’t require any sort of documentation—just an agreement between two people that one will pay back the other at some point in time with interest attached if necessary. |
| Formal sources of credit are those that are recorded in some kind of database, like a bank statement or a credit report. | Informal sources of credit don’t have any such official record—they’re just the things that you’ve done that prove you can be trusted to pay back what you owe. |
That’s it.
Note that sometimes, the question might also be asked as “distinguish between Formal Sources of Credit and Informal Sources of Credit”.
Also see:
- Difference between Formal Lenders and Informal Lenders
- Difference between Article 365 and Article 356 of the Constitution of India
- Difference between SMC and SMDC
Final words
The difference between formal and informal sources of credit can be summarized as follows:
Formal sources of credit are regulated by the government, with strict regulations about who can get loans and what kind of interest rates they can charge. Informal sources of credit do not have these same restrictions, but they may be more expensive or less reliable than the formal sources because they are not regulated.
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