The Credit Gap in Financial Inclusion: Rising Reliance on Informal Loans by India's Poor

 The Credit Gap in Financial Inclusion: Rising Reliance on Informal Loans by India's Poor

Current Affairs Analysis for UPSC by Suryavanshi IAS, Lucknow

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📚 Context

While 96% of Indian households now have access to formal bank accounts under financial inclusion programmes like Pradhan Mantri Jan Dhan Yojana, low-income households are increasingly turning to non-institutional credit sources such as moneylenders, chit funds, shopkeepers, and friends.

This trend raises concerns over access to affordable credit, risks of debt traps, and the ineffectiveness of formal credit mechanisms for the financially vulnerable.

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🧾 Key Highlights from the Latest Data (2018–2025)

Income Category	Trend in Institutional Borrowers	Trend in Non-Institutional Borrowers
₹1–2 lakh/year	–4.2% (decline)	+5.8% (increase)
₹2–5 lakh/year	+10.4%	+12.6%
₹5–10 lakh/year	Positive	Growth even higher than institutional

Why Are the Poor Moving Away from Formal Credit?

1. Credit Scores and Risk Perception

   "Institutional lending is based on credit score. Low-income groups often lack a strong score." – Madan Sabnavis, BoB Economist

2. High Risk Aversion by Lenders

   Blue-collar and agricultural workers face hesitancy from formal lenders despite having urgent liquidity needs.

3. Easy but Costly Alternatives

   Non-institutional sources often do not ask for collateral or documents, but charge interest rates of 40–50% or higher.

4. Microfinance Loan Defaults Rising

   • Overdue loans >90 days:

     • 1.8% (Dec 2022) → 3.6% (Mar 2025)

   • A proxy indicator of financial stress among the poor

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💡 Understanding the Credit Puzzle

✅ Progress Made:

• 96% of population has a bank account (as of 2021)

• Massive push via PMJDY, Digital India, and UPI adoption

❌ Gaps Remain:

• Progress largely on liability side (deposits), not asset side (credit)

• Financial inclusion not translating into credit inclusion

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🚨 Risks of Non-Institutional Borrowing

• Debt Trap: Borrowers take loans to repay previous ones

• Exorbitant Interest: As high as 50% annually

• No Regulatory Safeguards

• Social Harassment: Coercive recovery tactics in absence of formal contracts

• Data Invisibility: Defaults and stress not tracked or recorded

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🧠 UPSC Mains GS3 Linkages

GS3 Topics:

• Inclusive Growth

• Financial Sector Reforms

• Indian Economy and Issues Relating to Planning, Mobilization of Resources

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📝 Model Mains Question & Answer

Q. Despite major advances in financial inclusion, access to affordable credit remains a challenge for India’s poor. Analyse.

Model Answer Structure:

Introduction:

• Define financial inclusion and outline the progress (bank account penetration, Jan Dhan, DBTs, UPI).

Body:

• Highlight credit access lag (data from CMIE, Sa-Dhan)

• Reasons for preference for informal credit:

  • Poor credit scores

  • Institutional reluctance

  • Urgent liquidity needs

• Risks of informal borrowing

• Rising microfinance defaults as proxy for financial stress

Suggestions:

• Expand credit guarantee schemes

• Promote SHGs, community lending with safeguards

• Build alternative credit scoring systems

• Strengthen financial literacy

• Regulate NBFCs and digital lenders

Conclusion:

• Inclusion must be holistic — beyond account ownership. True empowerment comes from safe, affordable, and accessible credit.

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📖 UPSC Previous Year Questions

GS3 Mains 2022

Financial inclusion is a prerequisite for inclusive growth in India. Comment.

📝 Answer Hint:

• Mention PMJDY, DBT, UPI growth

• Explain credit access challenges

• Suggest reform strategies

Prelims 2020

With reference to digital payments in India, consider the following statements:

1. BHIM app allows money transfer between different banks.

2. UPI is only available for smartphone users.

3. USSD-based mobile banking works without Internet.
   Which are correct?
   Answer: ✅ 1 & 3

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