ECONOMICS, CHAPTER 3

MONEY AND CREDIT

MONEY AS A MEDIUM OF EXCHANGE

• Definition: Money a medium of exchange in the form of coins and banknotes that is
generally accepted as payment for goods and services.
• Functions of Money:
o A Medium of Exchange: Money provides the most efficient means of
satisfying wants by overcoming the limitations of barter system. Each consumer
has a different set of wants. Money enables him (her) to decide which wants to
satisfy, rank the wants in order of urgency and capa-city (income) and act
accordingly.
o A Measure of Value: Money is the measuring rod of everything. By acting as a
common denominator, it permits everything to be priced, that is, valued in terms
of money. Thus, people are enabled to com-pare different prices and thus see
the relative values of different goods and services.
o A Store of Value: A major disadvantage of using commodities — such as
wheat or salt or even animals like horses or cows — as money is that after a
time they deteriorate and lose economic value. Money can be held over a period
of time and used to finance future payments. More-over, when people save
money, they get the assurance that the money saved will have value when they
wish to spend it in the future.
o A Unit of Account: The value of something is measured in a specific currency.
This allows different things to be compared against each other; for example,
goods, services, assets, liabilities, labor, income, expenses.

MODERN FORMS OF MONEY (From Book)

• Currency
• Deposits with Banks

LOAN ACTIVITIES OF BANKS

• Banks provide loans for various economic activities by intermediating between those
who have surplus funds and those who are in need of these funds.
• The depositors deposit (Save) money in the bank and get interest.
• Banks keep only a small proportion of the deposits with them as cash and rest is used
to meet the loan requirement.
• The borrowers borrow money and return it with interest.
• Difference between interest charged on the loan and interest provided to depositors is
the profit earned by bank in the process.

HOW RBI SUPERWISE THE FUNCTIONING OF BANK:

• The RBI monitors that the commercial banks actually maintain the required cash
balance to cater the needs of deposit holders alongside giving loan.
 • It ensures that banks give loan not only to profit making businessmen and traders but
also to low and medium-income group borrowers.
• It also ensures that banks charge reasonable rate of interest to borrowers according to
the limit set by government and central bank.
• Banks have to submit appropriate records to RBI regarding savings in demand
deposits, loans sanctioned and documentation maintained by them.
• It ensures that banks are not using any unfair means to recover the loan or harassing
the customer (demand deposit holder or loan borrower) for making profit.

Types of credit
Criteria Formal Credit Informal Credit
Sources Provided by Banks and Cooperative Provided by money lenders, land
societies owners, relatives, friends, etc
Supervision All the terms and conditions, There is no organization which
transactions and paperwork are over supervise the activities of lenders.
looked by Central Bank (Reserve
Bank of India)
Motive To provide cheap and affordable To earn maximum profit by charging
credit for both urban and rural highest possible rate of interest on
borrowers loan.
Terms of Collateral is required and mandatory These sources are very flexible and
paperwork needs to be completed. manipulative in case of terms of
credit
credits
Action on Collateral can be confiscated and Borrowers can be made as bonded
sold to recover the loan. Sources laborers or made to part with any
default of
cannot use any unfair method to property/income owned by them.
Payment recover loan. Sources usually use unfair means to
recover the loan.

Terms of Credit

1. Collateral loans: The term collateral refers to an asset that a lender accepts as security
for a loan. Collateral can be commodity or property owned by the borrower,
depending on the purpose of the loan. The collateral acts as a form of protection for
the lender. If the borrower fails to pay back the loan collateral can be confiscated and
sold to recover the amount.
2. Rate of Interest: Interest paid on the loan is basically the cost of loan borrowed.
Every loan agreement specifies an interest rate which the borrower must pay to the
lender along with the repayment of principle amount of load.
3. Documentation: Before the loan is sanctioned a set of paper work needs to be
completed and signed by both lender and borrower. Documentation consist of
identification of borrower and terms and conditions on which the loan has been given
and will be paid back.
4. Mode of Repayment: mostly loans borrowed are paid back in installments known as
EMI (Estimated Monthly Installment). How the amount will be paid, what will be the
amount of installment, for how many months, what happens if the installment is not
 paid on time, etc. are some provisions borrower and lender have to make and agree
before the loan is processed.

SELF HELP GROUP FOR THE POOR

• A typical SHG has 15-20 members, usually belonging to one neighborhood, who meet
and save regularly. Saving per member depends on the ability of the people to save.
• Members can take small loans from the group itself to meet their needs from the
savings collected.
• The group charges interest on these loans but this is still less than what the
moneylender charges. Most of the important decisions regarding the savings and loan
activities are taken by the group members.
• After a year or two, if the group is regular in savings, it becomes eligible for availing
loan from the bank. Loan is sanctioned in the name of the group and is meant to create
self-employment opportunities for the members.
• Any case of nonrepayment of loan by any one member is followed up seriously by
other members in the group. Because of this feature, banks are willing to lend to the
poor when organized in SHGs, even though they have no collateral as such.

BENEFITS OF SHG’s
• The SHGs help borrowers overcome the problem of lack of collateral.
• They can get timely loans for a variety of purposes and at a reasonable interest rate.
• Moreover, SHGs are the building blocks of organization of the rural poor. Not only
does it help women to become financially self-reliant, the regular meetings of the
group provide a platform to discuss and act on a variety of social issues such as health,
nutrition, domestic violence, etc.

ASSIGNMENT
1. Why do we need to expand formal sources of credit in India? (3)
2. Analyze the role of credit for development of economic life. (5)
3. Explain the importance of banks with respect to both individuals and economy. (5)