Money and Credit Class 10 Notes Social Science Economics Chapter 3
Money as A Medium of Exchange
The use of money spans a very large part of our everyday life. Goods are bought and sold by using money. Services are availed with money. A person holding money can easily exchange it for any commodity or service. Payments in money are thus most sought after.
When money had not been invented, people employed barter systems to buy and sell their items.
The major problem was about finding a willing buyer or seller. To buy and sell products in turn, both parties have to agree to sell and buy each other’s commodities. This is known as double coincidence of wants. This happens only when a person desires to sell is exactly what the other wishes to buy.
Frequently Asked w In a barter system where goods are directly exchanged without the use of money, double coincidence of wants is an essential feature. In contrast, in an economy where money is used, there is no need for a double coincidence of wants.
How does the use of money make it easier to exchange things?
Money acts as an intermediate in the exchange process and is called a medium of exchange.
Before the introduction of coins, Indians used grains and cattle as money. Other civilisations all across the world also used different objects as a medium of exchange.
With time, metallic coins such as gold, silver, copper coins began to be used as currency. The modern
currency is without any use of its own. It is accepted as a medium of exchange because the currency is authorized by the government of the country.
Modern forms of money include currency – paper notes and coins. Modern currency is not made of precious metals such as gold, silver and copper. They are not everyday objects like grains either.
The Reserve Bank of India issues currency notes on behalf of the central government in India. Indian law does not authorize any other individual or organisation to issue any currency. Indian Constitution and Indian law legalises the use of rupee as a medium of payment that cannot be refused in settling transactions in India.
Digital transactions are the newest forms of currency that are being encouraged and widely used these days. Bank-to-bank transfer through the internet or mobile phones, cheques, ATM cards, Credit Cards and Point of Sale (POS) swipe machines at shops.
Digital transactions are taking over cash in markets because they are hassle free and quick.
No individual in India can legally refuse a payment made in rupees.
In India, during November 2016, currency notes in the denomination ofRs. 500 and Rs. 1,000 were declared invalid. People were asked to surrender these notes to the banks by a specific period and receive new Rs. 500, Rs. 2,000 or other currency notes. This was called ‘demonetisation’.
Deposits With Banks
The other form in which people hold money is deposits with banks. Most people have a surplus amount of currency after they have used up their wages for their monthly expenditure. This extra cash is deposited by them in banks in an account of their name. Banks accept the deposits and also pay an amount as interest on the deposits to the people.
People can withdraw the money from these accounts as and when they require. These deposits are called demand deposits because they can be withdrawn on demand.
Demand deposits can also serve as a medium of exchange instead of cash. It is this facility which lends it the essential characteristics of money.
Payment is possible through cheques as well. 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.
Demand deposits share the essential features of money making it possible to directly settle payments without the use of cash. They constitute money in the modern economy. Modern currencies are cLosely linked to the working of the modern banking systems.
Banks keep only a small proportion of deposits from people with themselves. Banks in India hold about 15 per cent of their deposits as cash currently as a reserve to pay the depositors who want to withdraw. Banks mediate between depositors and borrowers. Banks charge a higher interest rate on loans than what they offer on deposits. The difference between the two rates is the source of revenue for banks.
Banks use the major portion of the deposits to extend loans for various economic activities.
Credit and Its Implications
Most transactional activities involve credit. 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.
Credit might play a vital and positive role or a negative and destructive role in lives depending upon its source and terms.
Credit is mainly required for crop production in rural areas which involves considerable costs on seeds, fertilisers, pesticides, water, electricity, repair of equipment etc. Farmers take crop loans at the beginning of the season and repay the loan after harvest because of the time period of 3-4 months between crop sowing and harvesting seasons. Repayment of the loan is crucially dependent on the income from farming. Failure of the crop might delay loan payments for which then a person has to sell his assets or even take another loan to repay. This is an example of debt-trap. The usefulness of credit depends upon the risks in the situation and whether there is some support, in case of loss.
Terms of Credit
Every loan agreement specifies an interest rate. This rate calculates the interest to be paid back to the lender along with the repayment of the principal. Most lenders demand collateral 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.
The lender can sell the collateral to reimburse his loan in case the borrower fails to repay the loan.
Property such as land titles, deposits with banks, livestock are some common examples of collateral.
Interest rate, collateral and documentation requirement, and the mode of repayment together comprise terms of credit. The terms of credit vary substantially from one credit arrangement to another.
Those vary depending upon the lender and the borrower.
The other major source of cheap credit in rural areas are the cooperative societies (or cooperatives). Members of a cooperative pool their resources for cooperation in
certain areas. Some examples of cooperatives are farmers cooperatives, weavers cooperatives, industrial workers cooperatives, etc.
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.
Fill in the following details of Megha’s housing loan.
1. Loan amount (in Rupees)
2. Duration of loan
3. Documents required
4. Interest rate
5. Mode of repayment
- Loan amount (in Rupees) 5 Lakhs
- Duration of loan-10 years
- Documents required- Bank documents showing her employment records and salary.
- Interest rate-12%
- Mode of repayment- cash and monthly installments
- Collateral- Papers of new houses
People obtain loans from various sources like employers, agricultural traders, relatives, banks and local money lenders. These loans can be categorised 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.
The Reserve Bank of India plays multiple roles:
- The Reserve Bank of India supervises the functioning of formal sources of loans.
- The RBI monitors the banks in actually maintaining cash balance for emergency purposes.
- The RBI keeps a check on the banks and ensures they give loans to small cultivators, small scale industries, to small borrowers and not just to traders, merchants etc.
- Banks have to submit details about their lending practices to the RBI including the interest rates.
Banks and cooperative societies need to lend more. This would lead to higher incomes and it would encourage people to borrow cheaply for their needs.
- Cheap and affordable credit is crucial for the country’s development.
Should there be a supervisor, such as the Reserve Bank of Indio, that looks into the loan activities of informal lenders? Why would its task be quite difficult?
There is no organization to monitor and regulate the credit activities of lenders in the informal sector. They lend at interest rates of their choice. They can use unfair means to get their money back. Compared to the formal Lenders, they charge a higher interest on loans. Thus borrowers of informal loans have greater chances of falling into a debt trap. It renders the poor people even more vulnerable.
Why do we need to expand formal sources of credit in India?
People hesitate to borrow due to the high rates of interests of the informal sector. Because there are not many formal sector source to give credit, they are unable to depend on anyone to ‘ fulfill their needs hence it needs to be expanded in rural areas Higher cost of borrowing entails that a larger part of the earnings of the borrowers will be used to repay the loan. The amount to be repaid is greater than the income of the borrower. This leads to an increasing debt and debt trap. This makes people hesitant to borrow.
Formal And Informal Credit
Eighty-five per cent of the loans taken by poor households in the urban areas are from informal sources. Compared to this the rich households borrow only 10 per cent of their loans from informal sources, while they borrow 90 per cent from formal sources.
The formal sector meets only half of the total credit needs of the rural people. The remaining credit needs have to be met by the informal sectors. Most loans from informal sectors do little to increase the income of the borrowers. Banks and cooperatives should increase their lending particularly in the rural areas to reduce the dependence on the informal sector.
The formal sector needs to diversify its lending activities because it is only the rich households who receive formal credit; whereas the poor have to depend on informal sources. It is important that the formal credit is distributed more equally so that the poor can benefit from the cheaper loans.
In India, about 80 per cent of farmers are small farmers, who need credit for cultivation.
(a) Why might banks be unwilling to lend to small farmers?
Banks fear that because of the unstable nature of earning of farmers- they might not be able to pay.
(b) What are the other sources from which the small farmers can borrow?
Farmers borrow through informal sectors- money lenders, relatives or through formal sectors- cooperatives.
(c) Explain with an example how the terms of credit can be unfavourable for the small farmer.
Lenders do not have proper documentation before lending and tend to change the interest rates and time periods. This can be unfavourable for farmers.
(d) Suggest some ways by which small farmers can get cheap credit.
Farmers can borrow from Cooperatives.
Self-Help Groups For The Poor
Rural areas are heavily dependent upon informal Sectors for lending. This is because banks are not present everywhere. Lending from formal sectors is a little complicated as well. Bank loans require proper documents and collateral. Absence of collateral prevents the poor from borrowing from the bank. Informal lenders know the borrowers personally and give loans without collateral or paperwork. Moneylenders are ready to give more loans to these people without repaying any prior loans. Moneylenders charge very high rates of interest, manipulate the borrowers and have no documentation for proof.
Another way to Lend more money through the formal sector is to organise rural poor, in particular women, into small Self Help Groups (SHGs) and pool their savings. A typical Self Help Group has 15-20 members, usually belonging to one neighbourhood, 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 less than what the moneylender charges. The group becomes eligible for availing Loan from the bank if they have been regular in paying back and saving.
Loan is sanctioned in the name of the group. It helps in creating some self employment opportunities for the members. Small loans are lent for releasing mortgaged land, for meeting working capital needs, for housing materials and acquiring logistics like sewing machines, handlooms, cattle, etc.
All important decisions are taken by the members. The group judges the purpose, amount, interest to be charged, repayment schedule and grants the loans. The group is also responsible for the repayment of the loan.
Defaulters are taken and dealt with seriously in the group. This makes banks willing to lend to the poor women when organised in SHGs, even without collaterals. SHGs help these borrowers to borrow without any collateral. Timely loans at a reasonable interest rate are facilitated through this.
Read the source given below and answer the questions that follow:
Why is it so? 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. As we saw for Megha, 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.
(A) Fill in the blank by choosing the most appropriate option:
………….. are not present everywhere; hence people depend on moneylenders.
(c) Shops and Companies
(B) Which of the following institutions necessary require Collateral?
(a) Formal Sectors
(b) Informal Sector
(c) Semi-formal Sector
(d) Organised Sector
(a) Formal Sectors
(C) Why are moneylenders willing to Lend without collateral?
To encourage moneylending, Moneylenders provide loans without collateral.
(D) Assertion (A): Credit is good for people.
Reason (R): It helps in development of the people.
(a) Both (A) and (R) are true and (R) is the correct explanation of (A).
(b) Both (A) and (R) are true but (R) is not the correct explanation of (A).
(c) (A) is correct but (R) is wrong.
(d) (A) is wrong but (R) is correct.
(d) (A) is wrong but (R) is correct. Explanation: Easily available credit with low interest rates is good for people.
SHGs are the building blocks of organisation 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.
Started in the 1970s as a project, Grameen Bank in 2018 had over 9 million members in about 81,600 villages spread across Bangladesh. Majority borrowers are women from the poorest sections of society.
→ Cooperatives: Cooperative society refers to that type of business organization, wherein people work together, for a common goal, i.e. welfare of its members.
→ Currency: System of money
→ Transactions: Act of buying and selling
→ Authorise: Officially approve something
→ Terms of Credit: Terms on which credit is given
→ Debt trap: A trap where debt keeps increasing
→ Mortgage: A legal agreement by which a formal sector financing institution lends money against a collateral
→ Self-reliant: Self dependent.