Formal and Informal Sources of Credit or Loans

Formal and Informal Sources of Credit or Loans would be the first and foremost concern of any business owner. The choice whether to obtain a formal Loan or an informal one would depend on your capacity, the need for funds, and the nature of your business or venture. While some individuals who run their own business prefer to seek for informal sources of credit, most business owners would readily opt for formal sources of loans in order to have security and credibility. They will have an easier time in getting financial assistance from banks since these are usually trustworthy lenders.

What are Formal Sources of Credit or Loans?

Formal sources of credit or loans would include banks, non-government establishments and financial institutions. These are typically recognized as credible lenders by other business enterprises, making their products and services appealing to investors. Banks are the most common formal source of loans for any business venture since they provide a wide range of financial solutions to businesses. They have a lot of financing options readily available and offer competitive interest rates which make them preferable as opposed to private lenders who charge higher interest rates and have stricter qualifications for providing financial assistance.

What are Informal Sources of Credit or Loans?

Informal sources of credit or loans refers to any moneylender who would lend you capital on a reliable and trustworthy basis. These are usually referred to as “black lenders” because their products and services lack the quality and transparency of other formal sources of credit that businesses usually require. These lenders tend to charge unrealistically high interest rates which can make it more difficult for some loan seekers to pay off their respective debts.

Difference between Formal and Informal Sources of Credit or Loans

Informal Sources of Credit or Loans have many disadvantages compared with formal ones. One would not be able to have access to better financing options at affordable interest rates if they opt for informal sources of credit instead. Some other key differences:

1) Banks usually have more credibility and security compared with informal sources of credit who have to deal with questionable clients.

2) Informal lenders may not provide you the financing options that banks can easily provide.

3) Banks are more preferable since they can disclose your financial situation to other businesses, making it easier for you to get future loans from other banks if you pay back your loans regularly.

4) Banks also offer online banking services which can make it easier for you to monitor your financial situation compared with private lenders who do not use technology and only deal with their clients directly.

5) Banks provide financial solutions to small as well as big businesses. As a result, they are able to offer financing options at competitive interest rates that make them preferable over private lenders.

6) Banks have an established credibility among other businesses, making them more likely to pay their loans back with the funds that they received.

7) Loans that you get through informal sources are not recognized in banks when you present them with the actual documents and receipts. This makes it difficult for you to get loans from formal sources of credit in future since most banks will be reluctant to lend you any more funds if given the same circumstances in the past.

8) If you fail to pay back your loans, banks would have less legal recourse to recover the funds that they gave to you. Bankers and lenders who give loans through informal sources will not be able to take legal action if the borrowers of these funds default on their obligations.

9) If you choose an informal lender, chances are that there would be no record of your loan agreements in databases that other businesses use, making it difficult for them to find out what information they had on you and your business if they need it later.

Therefore, formal sources of credit or loans should always be preferred over informal ones whenever possible because they have more benefits compared with those offered by informal sources.

Conclusion

In conclusion, the business owners who take loans from formal sources of credit or loans should always remember that banks are usually more reliable than private lenders. Banks are more credible and have a lot of financing options readily available for their clients. They also offer competitive interest rates for the kind of products and services that they offer to their clients which makes them preferable over other lenders who charge high interest rates and only focus on giving small amounts for financial assistance. Being aware of the differences between formal sources of credit or loans and informal ones will give your business a huge advantage in choosing the best lender for you.