Terms of credit

Topic: Rural Credit, Microfinance and Financial Inclusion · NCERT: Class 10, Ch 3 "Money and Credit"

Meaning

Terms of credit are the full set of conditions attached to a loan: the interest rate, the collateral, the documentation requirement and the mode of repayment. These terms change with the kind of lender (bank, cooperative, moneylender, trader, landlord) and the kind of borrower (salaried worker, big farmer, landless labourer).

They matter because they decide who can borrow and at what cost. When the terms are harsh, the poor either pay too much for a loan or get no loan at all. That is why Class 10 says "Cheap and affordable credit is crucial for the country's development."

Explanation

The four components

• Credit (a loan) is an agreement. The lender gives money, goods or services now. The borrower promises to pay back later.
• Interest rate: the extra amount paid on top of the principal (the amount borrowed).
• Collateral: an asset the borrower owns and pledges as a guarantee until the loan is repaid. Examples are land, a building, a vehicle, livestock or bank deposits.
• If the borrower defaults (fails to repay), the lender has the right to sell the asset and recover the money.
• Collateral moves the risk from the lender to the borrower.

• The borrower also tries harder to repay, because they do not want to lose the asset.

• Documentation requirement: the papers the lender asks for, such as salary proof, land records or identity documents.

• Mode of repayment: how and when the loan is repaid. Examples are monthly instalments, one payment after the harvest, or payment in crop or labour.

Why the terms differ from borrower to borrower

• A salaried person with a house has both documents and collateral.

• The lender sees low risk, so the loan comes with lower interest and softer terms.

• A landless labourer has no land title, no salary slip and no deposits.

• Banks will not lend, so the labourer turns to a moneylender.

• The moneylender asks for little paperwork but charges very high interest, and may demand land, crops or labour as repayment.

• A small farmer faces three problems at the bank:

• a small plot means little collateral;
• a small loan means a high processing cost per rupee lent (the paperwork for ₹20,000 is almost the same as for ₹20 lakh);
• farm income depends on the monsoon, so the risk is high.

Worked example 1: Megha's housing loan (Class 10)

Term	Megha's loan
Loan amount	₹5 lakh
Duration	10 years
Documents	Employment records and salary proof
Interest rate	12% per year
Mode of repayment	Monthly instalments
Collateral	Papers of the new house, returned only after full repayment

• EMI (Equated Monthly Instalment) is the same fixed amount paid every month. Each payment covers part of the interest and part of the principal.
• Formula (an illustration; it is not in NCERT): EMI = P × r × (1+r)^n ÷ [(1+r)^n − 1]
• P = ₹5,00,000; r = 12% ÷ 12 = 1% = 0.01 a month; n = 10 × 12 = 120 months.
• (1.01)^120 ≈ 3.3004
• EMI = 5,000 × 3.3004 ÷ 2.3004 ≈ ₹7,174 a month

• Total repaid ≈ 7,174 × 120 ≈ ₹8.6 lakh. Interest ≈ ₹3.6 lakh, which is about 72% of the loan.

• Lesson: Megha gets these terms because she has a salary slip (the document) and a house (the collateral).

Worked example 2: why the terms decide the cost of borrowing

• Cost of borrowing = the interest plus other charges, such as processing fees, penalties and hidden charges.
• Suppose the same ₹10,000 is borrowed for one year (numbers assumed):
• Moneylender at 3% a month, compounded: 10,000 × (1.03)^12 ≈ ₹14,258. That is about ₹4,258 in interest, or about 42.6% a year.
• Bank crop loan under interest subvention (the government pays part of the interest for the farmer): the effective rate is 4% a year [2]. The interest is about ₹400.

• The informal loan costs about 10 times more in interest.

• How a high cost of borrowing does harm:

• Debt trap: the crop fails, so the borrower cannot repay. They take a new loan to repay the old one. The debt keeps rising, and land or other assets get sold.
• Less income: more of the borrower's earnings go to the lender.
• No enterprise: people do not start a business, because the expected profit is smaller than the interest.

In India

• Collateral-free farm loans (an RBI rule):
• The limit was ₹1 lakh in 2010. RBI raised it to ₹1.6 lakh on 7 February 2019. Banks may also waive the margin (the borrower's own share of the cost) up to this limit [3].
• From 1 January 2025, banks must waive collateral and margin for farm loans, including loans for allied activities, up to ₹2 lakh per borrower. The reason given was inflation and the rising cost of farm inputs [2].

• RBI links this relief to small and marginal farmers, who are over 86% of farmers [2].

• Cheaper interest: under the Modified Interest Subvention Scheme, short-term crop loans up to ₹3 lakh cost an effective 4% a year [2].

• Easier documents through PMJDY (Pradhan Mantri Jan Dhan Yojana, 2014):
• Zero-balance Basic Savings Bank Deposit accounts come with relaxed KYC and e-KYC [5].
• A Small Account (Chhota Khata) can be opened without legal documents. It is valid for 12 months, and for 12 more if the holder shows proof of applying for an Officially Valid Document [5].
• Account holders get an overdraft of up to ₹10,000 (the right to withdraw more than the balance, so it works as a small loan) and a RuPay card with ₹2 lakh accident cover [5].

• PMJDY had 56.16 crore accounts on 13 August 2025. Of these, 55.7% were held by women and 66.7% were in rural and semi-urban areas [6].

• Access still depends on land (NAFIS 2021-22, a NABARD survey):

• 44% of farm households had a valid Kisan Credit Card (KCC), a bank card that gives farmers short-term crop credit [4].

• The figure was 77% among households holding more than 0.4 hectare, or those that had taken a farm loan from a bank in the past year [4].

• Size of the problem: by the Agriculture Census 2015-16, small and marginal holders were about 86% of all operational holders [7]. NCERT Class 10 says "about 80 per cent".

Don't confuse with

• Collateral vs mortgage: collateral can be any asset, movable or immovable, such as gold, livestock, a vehicle or a deposit. A mortgage uses only immovable property (land or a house) as security.
• Terms of credit vs cost of borrowing: terms of credit are all four conditions of the loan. The cost of borrowing is only the money burden: interest plus fees, penalties and hidden charges.
• Collateral vs margin: collateral is an asset pledged as a guarantee. Margin is the borrower's own share of the cost of what is being financed. RBI's ₹2 lakh rule waives both [2].
• Formal vs informal lenders: both set terms of credit. Formal lenders (banks, cooperatives) are regulated by RBI and ask for collateral and papers. Informal lenders (moneylenders, traders, landlords) ask for few papers, but they are not regulated by RBI and charge very high interest.

Prelims Hooks

• Terms of credit = interest rate + collateral + documentation requirement + mode of repayment.
• Collateral-free farm loan limit: ₹1 lakh (2010) → ₹1.6 lakh (February 2019) → ₹2 lakh per borrower from 1 January 2025, with margin also waived [2][3].
• Modified Interest Subvention Scheme: short-term farm loans up to ₹3 lakh at an effective 4% [2].
• EMI = P × r × (1+r)^n ÷ [(1+r)^n − 1], where r is the monthly rate. Trap: for 12% a year, r = 0.01, not 12.
• NAFIS 2021-22 was conducted by NABARD, not RBI. It found that 44% of farm households had a valid KCC [4].
• Trap: livestock or a vehicle can be collateral, but only land or a house can be mortgaged.

Mains Points

• Collateral-based lending shuts out the poor.
• Tenants, sharecroppers and landless labourers have no land title or salary slip. Class 11 says the "vast proportion of poor rural households were automatically out of the credit network".
• So formal credit goes to people who already own assets. The poor are pushed to moneylenders, and inequality grows.

• The NAFIS 2021-22 KCC gap (44% overall against 77% for larger landholders) shows the link between land and credit [4].

• Easier terms bring trade-offs.

• Gain: the ₹2 lakh collateral-free limit and 4% subvention make credit easier to get for small and marginal farmers, who are over 86% of farmers [2].

• Risk: more bad loans (NPAs) for banks, a fiscal cost to the government, and farm loans being used for non-farm purposes. These need careful design and monitoring.

• Accounts first, credit next.

• PMJDY removed the documentation barrier, with 56.16 crore accounts by August 2025 [6].
• But having an account is not the same as getting affordable credit. The next step is to use account history (cash flow) in place of collateral, through the overdraft, KCC and Self-Help Group (SHG)-bank linkage. Cheap formal credit then works as a development tool that prevents debt traps and supports rural enterprise.

Related concepts

• Collateral
• Cost of borrowing
• Housing loan
• Mortgage

Read more

• Terms of credit: interest, collateral and why the poor are priced out