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Money and Credit

Barter System: The barter system was used before the advent of money.
People used to exchange one thing for another in this system.
Double Coincidence of wants: The double coincidence of wants is the major
drawback of the barter system. It can be very difficult to find a person who can
fulfill this condition. Suppose you want to barter your MP3 player with a game
console, then you need to find a person who wants to barter his game console
for an MP3 player.

Money
Money is a means by which we can get something in exchange. Initially, coins
came into use. The coins were initially made of precious metals; like gold and
silver. When the precious metals became too precious, ordinary metals were
being used for making coins. Paper money or currency notes gradually took
place of coins; although coins of smaller denominations are still in use.
The currency notes and coins are issued by the government of an authorized
body. In India, the RBI (Reserve Bank of India) issues currency notes. On the
Indian currency note, you can find a statement which promises to pay the
bearer the amount which is mentioned on the currency note.
Advantages of Money:
a.

Removes the coincidence of wants.

b.

Takes less storage space and is easier to carry.

c.

Liquidity of currency is easier.

d.

Now-a-days; many instruments are available through which it is not


necessary to physically carry the currency.

Other Forms of Money


Deposits with Banks: Most of the people need only some currency for their
daily needs. Rest of the amount is usually kept as deposit in banks. Money
which is kept in a bank is safe and it even earns an interest. One can
withdraw money from his account as and when required. Since deposit in the
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bank account can be withdrawn on demand, these deposits are called


demand deposits.
One can use a cheque; instead of cash to settle payments. Moreover, one can
also buy a demand draft from a bank to make payments.
Credit: Banks keep a small proportion of their deposits as cash with
themselves. This is usually 15% of their deposits as cash. This amount is kept
as provision to pay the depositors who may come to withdraw the money on
any day. This amount is enough because only a small fraction of people come
to withdraw money on a given day. The rest of the amount is used by the
banks to give money on credit to people who need the credit. A bank charges
interest on the loan which it gives to its creditors. The interest rate charged by
a bank no loans is higher than the interest rate given by it on deposits. Thus,
interest is the main source of income for banks.
Credit/Debit Cards: Now-a-days, credit/debit cards are in vogue. A debit card
allows you to make payments from the amount which is lying in your bank
account. A credit card, on the other hand, provides money on credit. Payment
through credit/debit card is done electronically and this removes the need of
carrying cash.

Terms of Credit
People often need to borrow money for various purposes. Many businessmen
need to borrow to buy raw materials and machineries. Many farmers need to
borrow to buy seeds, fertilisers, farm equipments, etc. People usually buy
vehicles and houses by borrowing from banks. Thus, credit plays an important
role in the economy.
Every loan agreement specifies terms and conditions; regarding the rate of
interest and term of payment. In most of the cases, the banks fix an EMI
(Equated Monthly Installment) for repayment of loan.
Collateral: An asset which is owned by the borrower and is used as a
guarantee to a lender until the loan is repaid is called the collateral. Land,
house, vehicle, livestocks, deposits with banks, insurance policy, gold, etc. are
examples of assets. If the borrower fails to repay the loan, the lender reserves
the right to sell the collateral to obtain payment.
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Terms of Credit: The terms of credit include rate of interest, collateral and
mode of repayment. The terms of credit varies from one loan agreement to
another and also on the nature of the lender and the borrower.

Sources of Credit
Formal Sector: The formal Sector comprises of banks and cooperative
societies.
Informal Sector: The informal sector consists of money lenders and friends
and relatives, merchants and landlords.
The following diagram shows share of different sources of credit in rural
households in India in 2003.

Fig: Sources of Credit for Rural Households


in India in 2003

While the formal sector is bound by the rules and regulations of the RBI and
charge the prevalent rate of interest as per RBI guidelines; the informal
lenders are not bound by such rules. The informal lenders usually charge a
very high rate of interest. A higher cost of borrowing is often detrimental to the
borrower. It usually results in a debt trap for the borrower. The borrower is
seldom able to escape the never ending cycle of loan repayment.
Many people are too poor to qualify the requirements of credit-worthiness of
banks and cooperatives. There are many others who may not have enough
documents; like residential certificate or income certificate. Such people are
usually at the mercy of informal lenders.

Self Help Groups


Self Help Groups (SHGs) are recent phenomena. An SHG is comprised of
small number of people; like 15 20 members. The members pool their
savings. The collection is then utilised to lend small amounts of money which
may be required by any of the members. The group charges interest on the
loan. The arrangement of loans through Self Help Groups is also known as
microfinance because the small amount of loan is involved.
It was the Grameen Bank of Bangladesh which began experimenting with
microfinance. The founder of Grameen Bank, Mohammad Yunus was
conferred with Nobel Prize in 2006 for his efforts at improving the lot of the
poor.
SHGs have helped immensely in reducing the influence of informal lenders in
rural areas. Many big corporate houses are also promoting SHGs at many
places in India.

Answer the following questions:


1. How does the use of money make it easier to exchange things?
Answer: Unlike the barter system, exchange by using money does not
need a double coincidence of wants. Hence, money makes it easier to
exchange things. Let us take example of a student who wants to sell his
old books and wants to buy a guitar in lieu of that. If he opts for the
barter system, he will have to search a person who may be interested in
giving off his guitar and in taking old books. But finding such a person
can be difficult and time consuming. On the other hand, if the student
sells his books and takes money for that, he can easily go to a shop to
buy a guitar.
2. Can you think of some examples of goods / services being exchanged
or wages being paid through barter?
Answer: Barter system does exist at some degree in our society.
Farmers often use this system of exchange to barter different types of
farm produce. Even some friends may exchange certain items among
each other. Some hawkers sell trinkets and edible stuff in lieu of old
bottles and plastic containers.
3. Why do lenders ask for collateral while lending?
Answer: The collateral is a kind of surety, which the lender can hold on
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to. In case of de debtor failing to repay the loan, the lender can recover
some money by selling the collateral.
4. Given that a large number of people in our country are poor, does it in
any way affect their capacity to borrow?
Answer: Credit is always given after properly assessing the repayment
capacity of the borrower. Since poor people do not have repayment
capacity, they are usually unable to get a loan; especially from the
formal sector. They get some loan from the informal sector but in that
case, they often fall in debt trap because of very high rate of interest.
5. Fill in the blanks choosing the correct option from the brackets.
Answer: While taking a loan, borrowers look for easy terms of credit.
This means low (low/high) interest rate, easy (easy/ tough) conditions
for repayment, less (less/more) collateral and documentation
requirements.
6. What are the differences between formal and informal sources of credit?
Answer: The formal sector gives loan only after thorough check of the
borrower. Suitable paperwork is done before giving the loan so that both
the borrower and the creditor can resort to judicial process in case of
any problem. Rate of interest is governed by the government rules when
loan is given by the formal sources. In case of informal sector, rate of
interest is usually very high and the borrower cannot go to the courts in
case of being subjected to arm-twisting tactics by the creditor. Informal
sector usually works on personal influence and relation of the borrower
and creditor.
7. Why should credit at reasonable rates be available for all?
Answer: Credit is an important aspect of economic activity. Right from a
small farmer to a big business tycoon; everyone needs to borrow at
some time to improve productivity. In case of unreasonable rates, the
borrower always runs the risk of falling in the debt trap which is not good
for the society and the economy. Hence, reasonable rates are important
for all.
8. Should there be a supervisor, such as the Reserve Bank of India that
looks into the loan activities of informal lenders? Why would its task be
quite difficult?
Answer: The informal lenders work according to their own set of rules.
They seldom maintain proper records and do not reveal their transaction
detail to the government authority. Most of the money involved in this is
black money and the lender always wants to earn windfall profits. They
will oppose every attempt to bring them into the ambit of governance.
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Hence, it would be very difficult for supervisor to look into the loan
activities of informal sector.
9. Why do you think that the share of formal sector credit is higher for the
richer households compared to the poorer households?
Answer: The formal sector credit is available to those who have good
repayment capacity. Lending money is the main source of income for
banks. They cannot afford to lend to the poor and suffer losses in the
bargain. Due to this, the share of formal sector credit is higher for the
richer households compared to the poorer households.
10.
In situations with high risks, credit might create further problems
for the borrower. Explain.
Answer: In situation of high risks, credit often creates further problems
for the borrower. To understand this, let us take an example of a
marginal farmer who holds a small plot of land. Let us assume that the
farmer borrows some money to buy seeds and fertilisers. The harvest
which he gets may not be enough to meet his familys needs. So he
never comes in a position to sell the farm produce so that he can repay
his loans. If some natural calamity; like flood or drought destroys the
crops; it even worsens the situation for him. Finally, there is no other
way than to get trapped in the never ending cycle of loans.

Answer the following questions:


1. How do banks mediate between those who have surplus money and
those who need money?
Answer: Banks take deposits from different people. People, who have
surplus money, maintain a healthy deposit in banks. There are many
who may be looking for loan. Such people go to the bank if they want to
borrow from the formal sector. The bank provides them loan from the
deposit which is lying with the bank. Thus, banks serve as a conduit
between those who have surplus money and those who need money.
2. Look at a 10 rupee note. What is written on top? Can you explain this
statement?
Answer: The following statement is written on the note, I promise to
pay the bearer the sum of ten rupees. This is followed by the signature
of the RBI Governor. This statement shows that the central bank of India
has fixed a certain value on the currency note and the value applies to
everybody and at everyplace in the country.
3. Why do we need to expand formal sources of credit in India?
Answer: Around 48% credit in India comes through the informal sector.
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There are many people who do not have access to the formal credit
sources. Such people often fall in the hands of moneylenders who
resort to all sorts of methods to suppress the poor. To help such people
out of the economic mess, it is necessary to reach the formal sources of
credit to them. It will also help in improving the socioeconomic
conditions in villages and remote areas.
4. What is the basic idea behind the SHGs for the poor? Explain in your
own words.
Answer: Self Help Groups are made to help those poor who do not
have access to the formal sources of credit. There are various reasons
for their inability to secure a loan from banks or cooperatives. These
people are so poor that they fail the creditworthiness. Moreover, the
amount borrowed by them is too small to even recover the cost of
administration of loan. Illiteracy and lack of awareness further
compounds the problems for them. The SHGs help them in providing
micro finance so that they can sustain their livelihood. Moreover, SHGs
also facilitate the development of a repayment culture among such
people.
5. What are the reasons why the banks might not be willing to lend to
certain borrowers?
Answer: A bank usually lends to a person who has repayment capacity.
Banks avoid lending for a risky venture. These are the reasons, banks
might not be willing to lend to certain borrowers.
6. In what ways does the Reserve Bank of India supervise the functioning
of banks? Why is this necessary?
Answer: RBI is the central bank of India. It formulates policies for the
banking sector in India. Proper rules and regulations are necessary for
the banking system because the banks affect the overall economy in a
great way. By regulating the functioning of banks, RBI not only keeps a
check on the banking and finance but also on the overall economy so
that economic crisis does not erupt.
7. Analyse the role of credit for development.
Answer: Credit plays a crucial role in development. For most of the
businesses, credit becomes necessary for expansion at some time or
the other. Without credit, a small company cannot be changed into a big
corporate house. Farmers cannot go for large scale farming in the
absence of credit. Majority of people shall never be in a position to buy
a house or a car in the absence of loan. Demand of car and houses
helps in developing the economy in a significant way.
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8. Manav needs a loan to set up a small business. On what basis will


Manav decide whether to borrow from the bank or the moneylender?
Discuss.
Answer: Manay needs to compare the rates of interest by various
lenders. He also needs to compare the demand for collateral and
repayment terms and conditions. The creditor who is asking for a low
interest rate, less collateral and easier terms of repayment would be the
preferable creditor.
9. a. Why might banks be unwilling to lend to small farmers?
Answer: Small farmers do not have enough assets; either in cash or
kind; which can be given as collateral. There is no guarantee of regular
income for the small farmer. Hence his repayment capacity would
always be questioned by the bank.
10.
b. What are the other sources from which the small farmers can
borrow?
Answer: A small farmer can borrow from friends and relatives,
zamindar and the local moneylender. He can also go the SHGs.
11.c. Explain with an example how the terms of credit can be unfavourable
for the small farmer.
Answer: If the creditor wants that the farmer can utilize his farm
produce only after repaying the loan amount, it can be a problem for the
farmer. If the creditor wants a very high interest rate or wants the
interest to be paid on a monthly basis, then it can be a problem for the
farmer.
12.
d. Suggest some ways by which small farmers can get cheap
credit.
Answer: Microfinance; on the lines of Grameen Bank of Bangladesh;
can be a good way to help small farmers. Many Self Help Groups are
being formed in various parts of the country to help out small farmers.
Question.1: What is money ?
Answer: Money is a medium of exchange and measure of
value.

13.
14.
15.
16.

Question.2: What are the different


kinds/types/forms of money ?
17.
Answer: Money can be classified into the following types
or forms:
18.

(i) Coins such as gold, silver, copper coins. (ii) Paper notes, (iii)
Fiat money, (iii) Credit money or deposits with Banks, and (iv)
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Commodity money in the form of grains, cattle etc.


Question.3: What is the meaning of double
coincidence of wants ?
Answer: When two parties agree to sell and buy each others
commodities, this situation is known as double coincidence of
wants. That is, what a person desires to sell is exactly what the
other wishes to buy. In a barter system, where goods are
directly exchanged for another type of goods or service without
the use of money, double coincidence of wants is a must.

19.

Question.4: What is Barter System ?


Answer: It is the system in which one type of goods or
service is directly exchanged for another type of goods or
service without the use of money. Double coincidence of wants
is an essential feature of this system. Before the evolution of
money, exchange was done through this system.

20.
21.

Question.5: Why money is called a medium of


exchange?
23.
Answer: Since money acts as an intermediate in the
exchange process, it is called a medium of exchange.
22.

24.
25.

Question.6: Define - (a) Credit (b) Terms of Credit


(c) Collateral (d) Fiat Money (e) Cheque (f) Demand
Deposits
26.
Answer:
27.
28.

Credit : Credit or 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. Credit is a crucial
element in economic life and plays an important role in the
development of the country.
29.
Terms of Credit : The interest rate, collateral,
documentation requirement and the mode of payment are the
various factors which together comprise the Terms of Credit.
30.
Collateral : Collateral is an asset that the borrower owns
and uses this as a guarantee to a lender until the loan is
repaid. Collaterals can be land, building, vehicle, stocks, cattle,
bank deposits etc.
31.
Fiat Money : The Fiat Money is meant for that money
which serves as money on the basis of fiat or order of
government.
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Cheque : A cheque is a paper instructing the bank to pay


a specific amount from the persons account to the person in
whose name the cheque has been made.
33.
Demand Deposits : The deposits in the bank account
which can be withdrawn on demand are known as Demand
Deposits.
32.

34.
35.
36.
37.

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Question.7: How does the use of money make it


easier to exchange things ?
38.
Answer: As we know, in a barter system where goods are
directly exchanged without the use of money, double
coincidence of wants is a necessary condition. By serving as a
medium of exchange, money removes the need for double
coincidence of wants and the difficulties associated with barter
system. In this way, the use of money makes it easier to
exchange things.
Question.8: Can you think of some examples of
good services being exchanged or wages being paid
through barter ?
40.
Answer: Yes, in rural areas generally crops and foodgrains are directly exchanged without the use of money.
Similarly, agricultural labourers are normally paid not in cash
but in kind, e.g. 5kg. wheat or rice per day
41.
Question.9: Mr. Salim wants to withdraw Rs 20,000
in cash for making payments. How would he write a
cheque to withdraw money ?
42.
Answer: Mr.Salim would write date on the space given. He
would instruct the bank to pay Self and also write Twenty
thousands only further to Rupees and fill up the amount and
account number e.g. 20000/-etc. at the proper spaces as
mentioned over the cheque. Then he would have to put his
signature on the right hand lower side of the cheque. Now he
would submit it on the counter of the bank.
39.

43.
44.

Question.10: Why were demand deposits


considered as money ?
45.
Answer: Since demand deposits are accepted widely as a
means of payment along with currency, they are also
considered as money in the modern economy. See Answers of
Q. Nos. 1-10
46.
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47.
48.
49.

NCERT In-text Questions

Question.11: What would happen if all the


depositors went to ask for their money at the same
time ?
50.
Answer: Bank would not be able to give money to the
depositors if they all went to ask for their money all at the
same time. This is because, banks keep only about 15% and
would have already used the balance d portion of their
deposits to extend loans.
51.
52.

Question.12: What were the reasons that make


Swapnas situations so risky ? Discuss factors:
pesticides, role of money lenders, climate.
53.
Answer: Pest attack, exploitation by money lenders and
lack of monsoon are the reasons that make Swapnas situation
so risky.
54.
Pesticides Pest attack can be controlled by pesticides.
55.
Role of Moneylenders Generally moneylenders exploit
farmers. They charge very high rate of interest and keep them
in debt-trap.
56.
Climate Nearly 60% of our agricultural land area are still
un-irrigated. Our farmers heavily depend on rainfall. So,
climate plays a vital role in agriculture.
57.
58.
59.
60.

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Question.13: Why do lenders ask for collateral


while lending ?
61.
Answer: Lenders ask for collateral as security against
loans. If the borrower fails to repay the loan, the lender has the
right to sell the asset or collateral to recover the payment.
62.
63.

Question.14: Given that a large number of people


in our country are poor, does it in any way affect their
capacity to borrow?
64.
Answer: Lenders ask for collateral as security against
loans. If the borrowers fail to repay the loan, the lender has the
right to sell the asset or collateral to recover the loan amount.
65.
66.

Question.15: Fill in the blanks choosing correct


option from the brackets:
67.
While taking a loan, borrowers look for easy terms
of credit. This means _________ (low/high) interest rate,
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______ (easy/tough) conditions for repayment, ____________


(less/more) collateral and documentation requirements.
68.
Answer: low, easy, less.
69.
70.
71.
72.

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Question.16: List the various sources of credit in


Sonpur.
73.
Answer: The various sources of credit in Sonpur are
74.
1. village moneylender
75.
2. agricultural trader
76.
3. landowner-employers.
77.
4. bank.
78.
79.

Question.17: Why will Arun have higher income


from cultivation compared to Shyamal ?
80.
Answer: Arun will have higher income from cultivation
compared to Shyamal. This has following reasons:
81.
1. Arun has 7 acres of land compared to 1.5 acres land of
Shyamal.
82.
2. Arun received bank loans at an interest rate of only
8.5% per annum. On the other hand Shyamal has received loan
at an interest rate of 36% per annum which is much higher
than Aruns.
83.
3. Arun has to repay loan anytime in the next three years
while Shyamal will have to repay within 3-4 months.
84.
4. Shyamal received loan under the condition that he will
sell the crop to the trader at a lower price than the market
price while there no such condition with Arun.
85.
86.

Question.18: Can everyone in Sonepur get credit at


a cheap rate ? Who are the people who can ?
87.
Answer: No, everyone in Sonepur can not get credit at a
cheap rate. This is because, collateral is required for taking
bank loan at cheap rate.
88.
Only those people, who can fulfill collateral and
documentation requirements, get credit from bank at a much
rate.
89.
90.
91.
92.

Page 50

Question.19: What are the differences between


formal and informal sources of credit ?
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Answer: The various differences between formal and


informal sources of credit are shown in the following table:

93.

Formal Sources of Credit


Informal Sources of Credit
1. They cover those sources of credit 1. They include those small and scattered
which are registered by the
units which are outside the control of the
Government and have to follow its
Government e.g. individual
rules and regulations e.g. Banks,
moneylenders, traders, employers, etc.
Cooperatives.
2. There is no organizational supervision
2. The RBI supervises the functioning or adherence to rules and regulations in
of formal sources of credit.
the credit extending activities in this
3. Apart from profit-making, they
sector.
have also an objective of social
3. Their only motive is to extract profit as
welfare.
much as possible.
4. The rate of interest charged by
4. They charge random and much higher
formal sources is always much lower interests in comparison to formal sectors.
than that of informal sources.
5. They impose very tough and
5. The terms of credit are also fair
sometimes even, unreasonable terms of
and reasonable.
credit on the borrower.
94.
Question.20: Why should credit at reasonable rates
be available for all ?
95.
Answer: Credit should be available at reasonable rates for
all as other wise it will not be useful for the borrower. Higher
cost of borrowing means a larger part of the earnings of the
borrowers is used to repay the loans. Credit given at high
interest rate can sometimes result into the amount to be
repaid is greater than the income of the borrower. This could
lead to increasing debt and debt-trap as we saw for Rama in
Sonpur.
96.
Credit is a crucial element in economic activities. It has a
major role in the development of the country as it helps people
in setting up their business, in increasing their earnings and
social status. Therefore, cheap and affordable credit is crucial
for the countrys development.
97.
98.

Question.21: Why do you think that the share of


formal sector credit is higher for the richer households
as compared to the poorer households ?
99.
Answer: Undoubtedly, the share of formal sector credit is
for the richer households as compared to the poorer
households. It is because; poverty affects poor households
capacity to borrow. Formal sector credit requires proper
documents and collateral as security against loans. But poor
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people lack in providing such things which affect their capacity


to get loans from formal sector.
100.
That is why, the formal sector are sometimes, unwilling to
lend to poor households and thus, their share of formal sector
credit is lower than the rich households

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