Money and Credit

Question 1

Why transactions are made in money?

Answer 1

O A person holding money can easily exchange it for any commodity or service that he or she might want.
O So ppl prefer payments in money.

Question 2

Explain DOUBLE COINCIDENCE OF WANTS with an example.

Answer 2

When a shoe manufacturer wants to sell shoes in the market and buy wheat, he will first exchange the shoes for money and then exchange money for wheat !
But, it would be difficult for the shoe manufacturer if he had to directly exchange shoes for wheat without the use of money as he would have to look for a wheat growing farmer who wants to buy shoes in exchange.

Both the parties have to agree to buy and sell each other’s commodities is known as DOUBLE COINCIDENCE OF WANTS

It is an essential feature in barter system.

Question 3

Explain how does money play a major role in Double Coincidence Of Wants with an
(OR)
Explain how money acts as a medium of exchange. This is just done for no sake :)

Answer 3

In an economy where money is in use, it eliminates the need for double coincidence of wants

It acts as a crucial intermediate.

Its no longer necessary for the shoe manufacturer to look for a wheat growing farmer who will buy his shoes and at the same time sell wheat, all he have to do now is to find a buyer for his shoes, once exchanged his shoes for money, he can purchase wheat or any other commodity.

Since money acts as an intermediate in the exchange process it is called a MEDIUM OF EXCHANGE.

Question 4

What were used as money in the early ages ? and What are the modern forms of money ?

Answer 4

In the early ages Indians used :

1. grains and cattle
2. metallic coins : gold, silver and copper

This phase continued well into the last century.

The modern forms of money are :

1. paper notes
2. coins

These modern forms of money are neither made of precious coins nor they are grains and cattle’s of daily use. The modern forms of currency is without any use of its own.

Question 5

Why is money accepted as a medium of exchange even if it is without any use of its own?!

Answer 5

It is accepted as the medium of exchange because the currency is authorized by the government of the country.

O In India, RBI issues currency notes on behalf of the central government.
O As per Indian law no other individual other individual or organization is allowed to issue currency.
O The law legalizes the use of money, that it can’t be refused as a mode of payment.
O So, no individual in India can legally refuse a payment made in rupees
O Hence rupee is widely accepted as a medium of exchange.

Question 6

Who issues currency in our country?

Answer 6

O In India, RBI issues currency notes on behalf of the central government.
O As per Indian law no other individual other individual or organization is allowed to issue currency.

Question 7

Explain deposits with banks.

Answer 7

The other form in which people hold money is as deposits with banks
At a point of time, people need only some currency for their day-to-day needs.
For instance, workers who receive their salaries at the end of each month have extra cash at the beginning of the month.

They deposit it with the banks by opening a bank account in their name.
Banks accept the deposits and also pay an amount as interest on the deposits.
In this way people’s money is safe with the banks and it earns an amount as interest. People also have the provision to withdraw the money as and when they require.

Since the deposits in the bank accounts can be withdrawn on demand, these deposits are called DEMAND DEPOSITS.

Question 8

What is demand deposit ?

Answer 8

The deposits in the bank accounts can be withdrawn on demand, so these deposits are called DEMAND DEPOSITS.

Question 9

Facilities offered by demand deposits+

Answer 9

Demand deposits offer another interesting facility.
It is this facility which lends it the essential characteristics of money (that of a medium of exchange).

Payments are sometimes made by cheques instead of cash. For payment through cheque, the payer who has an account with the bank, makes out a cheque for a specific amount.

A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued.

Question 10

What is a cheque

Answer 10

A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued.

Question 11

What do the banks do with the
deposits which they accept from the
public?

OR

What is the income of the banks?

Answer 11

There is an interesting
mechanism at work here. Banks keep
only a small proportion of their
deposits as cash with themselves.

For
example, banks in India these days
hold about 15 per cent of their
deposits as cash.

This is kept as
provision to pay the depositors who
might come to withdraw money from
the bank on any given day

Since, on
any particular day, only some of its
many depositors come to withdraw
cash, the bank is able to manage with
this cash

Banks use the major portion of the
deposits to extend loans.

There is a
huge demand for loans for various
economic activities.

Banks make use of the deposits to
meet the loan requirements of the
people.

In this way, banks mediate
between those who have surplus
funds (the depositors) and those who
are in need of these funds (the
borrowers).

Banks charge a higher
interest rate on loans than what they
offer on deposits.

The difference
between what is charged from
borrowers and what is paid to
depositors is their main source of
income.

Question 12

Define Credit.

Answer 12

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.

Question 13

Explain how credit plays a +ve role ?

Answer 13

It is festival season two months from now
and the shoe manufacturer, Salim, has
received an order from a large trader in
town for 3,000 pairs of shoes to be
delivered in a month time. To complete
production on time, Salim has to hire a few
more workers for stitching and pasting
work. He has to purchase the raw
materials. To meet these expenses, Salim
obtains loans from two sources. First, he
asks the leather supplier to supply leather
now and promises to pay him later.
Second, he obtains loan in cash from the
large trader as advance payment for
1000 pairs of shoes with a promise to
deliver the whole order by the end of the
month.
At the end of the month, Salim is able to
deliver the order, make a good profit, and
repay the money that he had borrowed.

In this case, Salim obtains credit to meet the working
capital needs of production. The credit helps him to meet the
ongoing expenses of production, complete production on time,
and thereby increase his earnings. Credit therefore plays a
vital and positive role in this situation.

Question 14

Explain how credit plays a -ve role?+

Answer 14

Swapna, a small farmer, grows groundnut on her three
acres of land. She takes a loan from the moneylender
to meet the expenses of cultivation, hoping that her
harvest would help repay the loan. Midway through
the season the crop is hit by pests and the crop
fails. Though Swapna sprays her crops with
expensive pesticides, it makes little difference. She
is unable to repay the moneylender and the debt
grows over the year into a large amount. Next
year, Swapna takes a fresh loan for cultivation.
It is a normal crop this year. But the earnings
are not enough to cover the old loan.
She is caught in debt. She has to sell
a part of the land to pay off the debt.

In Swapna’s case, the failure of the
crop made loan repayment
impossible. She had to sell part of the
land to repay the loan. Credit, instead
of helping Swapna improve her
earnings, left her worse off. This is an
example of what is commonly called
debt-trap. To repay
her loan she has to sell
a portion of her land.
She is clearly much
worse off than before. Credit in this case pushes
the borrower into a situation from
which recovery is very painful.

Question 15

How is credit a -ve impactive for the ppl in rural areas

Answer 15

In rural areas, the main demand
for credit is for crop production.

There is a minimum stretch of
three to four months between the time
when the farmers buy these inputs
and when they sell the crop.

Farmers usually take crop loans at the
beginning of the season and repay the
loan after harvest.

Repayment of the loan is crucially dependent on the
income from farming.

Question 16

By what means credit would turn up to be +ve or -ve?

Answer 16

Whether credit would
be useful or not,
depends
on the risks in the
situation and whether
there is some support,
in case of loss.

Question 17

By what means credit would turn up to be +ve or -ve?

Answer 17

Whether credit would
be useful or not,
therefore, depends
on the risks in the
situation and whether
there is some support,
in case of loss.

Question 18

Define Collateral.

Answer 18

Collateral is an asset that the
borrower owns (such as land,
building, vehicle, livestocks,
deposits with banks) and uses this
as a guarantee to a lender until
the loan is repaid.

Question 19

Why does the banks ask for collateral?1

Answer 19

Lenders may demand
collateral (security) against loans.

Collateral is an asset that the
borrower owns (such as land,
building, vehicle, livestocks,
deposits with banks) and uses this
as a guarantee to a lender until
the loan is repaid. 

If the borrower
fails to repay the loan, the lender has
the right to sell the asset or collateral
to obtain payment.

Property such as
land titles, deposits with banks,
livestock are some common examples
of collateral used for borrowing.

Question 20

Explain what are the terms of credit with example.

Answer 20

Megha has taken a loan of Rs 5 lakhs from the
bank to purchase a house. The annual interest
rate on the loan is 12 per cent and the loan is to
be repaid in 10 years in monthly instalments.
Megha had to submit to the bank, documents
showing her employment records and salary
before the bank agreed to give her the loan. The
bank retained as collateral the papers of the new
house, which will be returned to Megha only
when she repays the entire loan with interest.

Interest rate, collateral and
documentation requirement, and the
mode of repayment together comprise
what is called the terms of credit.

The terms of credit vary substantially from
one credit arrangement to another.

They may vary depending on the
nature of the lender and the borrower.

Question 21

Who are the formal and informal loaners?

Answer 21

The
various types of loans
can be conveniently
grouped as formal
sector loans and
informal sector loans.

Among the former
are loans from banks
and cooperatives.

The
informal lenders include
moneylenders, traders,
employers, relatives and
friends, etc

Question 22

GRAPH 1 : Sources of Credit per Rs 1000

of Rural Households in India in 2012

Answer 22

Sources of credit in rural areas :

More informal and less formal

1. Informal : money lenders, commercial banks, land lords, relatives, families, other agencies, other non agencies : 99%
2. Formal : government : 1%

Question 23

Who supervises the functioning of the banks ?

OR

What are the functions of RBI ?

Answer 23

The Reserve Bank of India
supervises the functioning of formal
sources of loans.

For instance, we
have seen that the banks maintain a
minimum cash balance out of the
deposits they receive.

Similarly the RBI sees that the banks give loans
not just to profit-making businesses
and traders but also to small
cultivators, small scale industries, to
small borrowers etc.

 Periodically,
banks have to submit information to
the RBI on how much they are
lending, to whom, at what interest
rate, etc.

There is no organization which
supervises the credit activities of
lenders in the informal sector.

Question 24

Who supervises in informal sector?

Answer 24

There is no organization which
supervises the credit activities of
lenders in the informal sector.

They can lend at whatever interest rate they choose.

There is no one to stop them
from using unfair means to get their
money back.

Question 25

Who charges a high rate of interest?

OR

Why is the cost to the borrower of informal
loans is much higher.

Answer 25

Compared to the formal lenders,
most of the informal lenders charge a
much higher interest on loans.

Thus,
the cost to the borrower of informal
loans is much higher.

Question 26

Why should banks and cooperative societies lend more?

Answer 26

Compared to the formal lenders,
most of the informal lenders charge a
much higher interest on loans.

Thus, the cost to the borrower of informal
loans is much higher.

Higher cost of borrowing means a
larger part of the earnings of the
borrowers is used to repay the loan.

Hence, borrowers have less income
left for themselves .

In certain cases, the high interest rate for
borrowing can mean that the amount
to be repaid is greater than the
income of the borrower.

This could lead to increasing debt and debt trap.

Also, people who might wish to start an
enterprise by borrowing may not do
so because of the high cost of
borrowing.

For these reasons, banks and
cooperative societies need to lend
more.

This would lead
to higher incomes
and many people
could then borrow
cheaply for a variety
of needs. 

They could grow crops, do
business, set up
small-scale industries
etc.

Cheap
and affordable credit
is crucial for the
country’s development.

They could set up
new industries or
trade in goods

Question 27

Loans taken by formal and informal sources for ppl living in rural and urban areas?

Answer 27

85% of the ppl of poor households takes loan from the informal source of credit and only 15% of the ppl takes formal source of credit.

While on the other hand, only 10% of the ppl in urban areas take informal source of credit, while 90% of the ppl takes loans from formal source of credit.

The rich households are
availing cheap credit from formal
lenders whereas the poor households
have to pay a large amount for
borrowing.

All this suggests that, 
  1. The formal sector still meets only about
half of the total credit needs of the
rural people. The remaining credit
needs are met from informal sources.

2. Most loans from informal lenders
   carry a very high interest rate and do
   little to increase the income of the
   borrowers.

Thus, it is necessary
that banks and cooperatives
increase their lending particularly
in the rural areas, so that the
dependence on informal sources
of credit reduces.

Secondly, while formal sector
loans need to expand, it is also
necessary that everyone receives
these loans.

At present, it is the richer
households who receive formal credit
whereas the poor have to depend on
the informal sources. It is important
that the formal credit is distributed
more equally so that the poor can
benefit from the cheaper loans.

Question 28

What are the ways in which we can do for the formal sources of credit to reach all ppl or distributed equally?

Answer 28

1. The formal sector still meets only about
   half of the total credit needs of the
   rural people. The remaining credit
   needs are met from informal sources.
2. Most loans from informal lenders
   carry a very high interest rate and do
   little to increase the income of the
   borrowers.

Thus, it is necessary
that banks and cooperatives
increase their lending particularly
in the rural areas, so that the
dependence on informal sources
of credit reduces.

Secondly, while formal sector
loans need to expand, it is also
necessary that everyone receives
these loans.

At present, it is the richer
households who receive formal credit
whereas the poor have to depend on
the informal sources. It is important
that the formal credit is distributed
more equally so that the poor can
benefit from the cheaper loans.

Question 29

Poor households are still
dependent on informal sources of
credit. Why is it so?

OR

Why ppl prefer informal sources of credit than formal sources ?

OR

What are the difficulties faced by the ppl in getting formal sources of credit?

Answer 29

Banks are not
present everywhere in rural India.

Even when they are present, getting a
loan from a bank is much more
difficult than taking a loan from
informal sources.

Bank loans require proper
documents and collateral.

Absence of
collateral is one of the major reasons
which prevents the poor from getting
bank loans.

Informal lenders such as
moneylenders, on the other hand,
know the borrowers personally and
hence are often willing to give a
loan without collateral.

The borrowers
can, if necessary, approach the
moneylenders even without repaying their earlier loans.

However, the
moneylenders charge very high rates
of interest, keep no records of the
transactions and harass the poor
borrowers.

Question 30

Explain SHG’s

Answer 30

In recent years, people have tried
out some newer ways of providing
loans to the poor.

The idea is to
organize rural poor, in particular
women, into small Self Help Groups
(SHGs) and pool (collect) their
savings. 

A typical SHG has 15-20
members, usually belonging to one
neighborhood, who meet and save
regularly.

Saving per member varies
from Rs 25 to Rs 100 or more,
depending on the ability of the people
to save.

Members can take small loans
from the group itself to meet their
needs.

The group charges interest on
these loans but this is still less than
what the moneylender charges

Question 31

Can SHG’s get bank loans without collateral?

Answer 31

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.

For instance, small loans are
provided to the members for
releasing mortgaged land,
for meeting working capital
needs e.g. buying seeds,
fertilizers, raw materials etc...

Question 32

Who’s in charge of SGH’s

Answer 32

Most of the important
decisions regarding the
savings and loan activities
are taken by the group
members. 

The group
decides as regards the loans to be granted — the purpose, amount,
interest to be charged, repayment
schedule etc.

Also, it is the group
which is responsible for the repayment
of the loan.

Any case of non-repayment 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 women when
organized in SHGs, even though they
have no collateral as such.

Question 33

How does the SHGs help borrowers
overcome the problem of lack of
collateral.

Answer 33

In recent years, people have tried
out some newer ways of providing
loans to the poor.

The idea is to
organize rural poor, in particular
women, into small Self Help Groups
(SHGs) and pool (collect) their
savings. 

A typical SHG has 15-20
members, usually belonging to one
neighborhood, who meet and save
regularly.

Saving per member varies
from Rs 25 to Rs 100 or more,
depending on the ability of the people
to save.

Members can take small loans
from the group itself to meet their
needs.

The group charges interest on
these loans but this is still less than
what the moneylender charges

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.

For instance, small loans are
provided to the members for
releasing mortgaged land,
for meeting working capital
needs (e.g. buying seeds,
fertilizers, raw materials
like bamboo and cloth), for
housing materials, for
acquiring assets like sewing
machine, handlooms, cattle,
etc...

Thus, the SHGs help borrowers
overcome the problem of lack of
collateral.

Question 34

Example of a successful SHG

Answer 34

Grameen Bank of Bangladesh is one of the biggest success stories in reaching the poor to meet their credit needs at reasonable rates.

Started in the 1970s as a small project,
Grameen Bank in October 2014 has over 8.63 million members in about 81,390 villages spread across Bangladesh.

Almost all of the borrowers
are women and belong to poorest sections of the society.

These borrowers have proved that
not only are poor women reliable borrowers, but that they can start and run a variety of small income-generating activities successfully.

Question 35

SUMMARY

Answer 35

In this chapter we have looked at the
modern forms of money and how they
are linked with the banking system.
On one side are the depositors who
keep their money in the banks and on
the other side are the borrowers who
take loans from these banks. Economic
activities require loans or credit. Credit,
as we saw can have a positive impact,
or in certain situations make the
borrower worse off.
Credit is available from a variety of
sources. These can be either formal
sources or informal sources. Terms of
Grameen Bank of Bangladesh
“If credit can be made available to
the poor people on terms and
conditions that are appropriate and
reasonable these millions of small
people with their millions of small
pursuits can add up to create the
biggest development wonder.”
Professor Muhammad Yunus,
the founder of Grameen Bank,
and recipient of 2006 Nobel Prize for Peace
SUMMING UP
credit vary substantially between
formal and informal lenders. At
present, it is the richer households
who receive credit from formal sources
whereas the poor have to depend on
the informal sources. It is essential
that the total formal sector credit
increases so that the dependence on
the more expensive informal credit
becomes less. Also, the poor should
get a much greater share of formal
loans from banks, cooperative
societies etc. Both these steps are
important for development.