In situations with high risks, credit might create further problems for the borrower. Explain.
Credit (loan) refers to an agreement in which the lender supplies the borrower with money, goods or services in return for the promise of future payment. While credit can help increase earnings in favourable situations, it creates serious problems in high-risk scenarios.
In situations with high risks, such as crop failure, credit can push the borrower into a debt trap. For instance, if a farmer takes a loan for cultivation but the crop fails due to factors like climate or pests, she is unable to repay the loan. To repay her loan, she may have to sell a portion of her land, making her clearly much worse off than before.
Every loan agreement specifies an interest rate which the borrower must pay to the lender along with the repayment of the principal. Additionally, lenders may demand collateral (security) against loans. Collateral is an asset that the borrower owns—such as land, building, vehicle, livestock, or deposits with banks—which acts as a guarantee until the loan is repaid.
If the borrower fails to repay the loan due to losses, the lender has the right to sell the asset or collateral to obtain payment. This further worsens the borrower's situation.
Thus, whether credit would be useful or not depends on the risks in the situation and whether there is some support in case of loss. In high-risk situations without support, credit creates further problems for the borrower.
Explanation
This answer draws directly from the textbook context which explains two different credit situations—one where credit helps and another where it creates a debt trap. The key concepts covered are debt trap, interest rate, collateral, and the role of risk in determining whether credit is beneficial. The example of crop failure and selling land to repay loans is explicitly mentioned in the context.