(a) Differentiate between formal and informal sources of Credit.

(i) Banks and cooperatives are formal sources of credit while the informal include moneylenders, traders, employers, relatives, friends etc.

(ii) The Reserve Bank of India supervises the functioning of formal sources of loan whereas no organisation supervises informal sector.

(iii) Formal sources charge nominal rate of interest while Informal lenders charge a much higher interest on loans.

(iv) Mostly urban households are availing credit from formal lenders whereas the rural households avail credit from informal lenders.

(v) Collateral is an essential condition to get loans in the formal sector while it is not essential in the informal sector.

(b) How does bank work as a key component of the financial system?

(i) People hold money as deposits with banks which pay an interest rate on them.

(ii) The major portions of the deposits in banks are used to extend loans.

(iii) Banks mediate between those who have surplus funds called depositors and those who are in need of these funds called borrowers.

(iv) Banks charge interest rate on loans than what they offer on deposits.

(v) Banks facilitate different sectors of economy.