What is credit? How credit can be both asset as well as a debt trap?



Credit refers to an agreement in which the lender supplies the borrower with money, goods or services in return for the promise of future payment.

(i) Example of credit as an asset: During the festival season, a shoe manufacturer has received an order of making shoes in bulk, within a month's time. To complete production, he hired some extra workers and has to purchase the raw materials. He asks the supplier to supply leather now and promises to pay him later. Then he took some advance payment from the trade. By the end of the month he is able to deliver the order, make a good profit and repay the money he had borrowed.

(ii) Example of credit as debt trap: A farmer picks up the loan from a moneylender to meet the expenses of cultivation. But unfortunately the crop is hit by the pests and fails. So he is unable to repay the loan and debt grows larger with interest. Next year, he picks up a fresh loan and is able to have a normal crop that year. But earnings are not enough to pay the earlier debt. So he is caught in a debt trap. He could be able to repay the loan, after selling a part of the land.

In shoemaker's case credit plays a vital and positive role, whereas in farmer's case credit pushes the borrower into a situation from which recovery is very painful.