Chapter 3. Money and Credit

• A person holding money can easily exchange it for any commodity or service that he or she might want.
• Thus, everyone prefers to receive payments in money and then exchange money for things that they want.
• When both parties have to agree to sell and buy each other’s commodities this is called a double coincidence of wants.
• In a barter system where goods are directly exchanged without use of money, ‘double coincidence of wants’ is an essential feature.
• Before introduction of coins, a variety of objects was used as money. Indians used grains and cattle as money. Thereafter came use of metallic coins, like gold, silver, & copper coins.
• In contrast, in an economy where money is in form of use, money, by providing crucial intermediate step, eliminates need for double coincidence of wants.
• Since money acts as an intermediary in exchange process, it is known as a medium of exchange.
• Modern forms of money include currency in form of paper notes and coins. Modern currency is not made of precious metals such as gold, silver, & copper.
• Money is accepted as a medium of exchange because currency is authorised by government of country.
• In India, Reserve Bank of India issues currency notes on behalf of Central Government.
• law legalises use of rupee as a medium of payment that cannot be refused in settling transactions in India. No individual in India can legally refuse a payment made in rupees. Hence, rupee is widely accepted as a medium of exchange.
• other form in which people hold money is as deposits with banks.
• When people open a bank account in their name, they can put money in it. Banks take deposits and give interest on those deposits. People’s money is safe with banks this way, and it earns interest.
• People have provision to withdraw money as and when they require it. Since deposits in bank accounts can be withdrawn on demand, these deposits are known as demand deposits.
• A cheque is a paper instructing bank to pay a specific amount from person’s account to person in whose name cheque has been issued.
• facility of cheques against demand deposits makes it possible to directly settle payments without use of cash.
• Banks use major portion of deposits to extend loans. There is a huge demand for loans for various economic activities.
• Banks make use of deposits to meet loan requirements of 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.
• difference between what is charged from borrowers and what is paid to depositors is their main source of income.
• modern form of money, currency, & deposits are closely linked to workings of modern banking system.

• A large number of transactions in our day-to-day activities involve credit in some form or other.
• Credit [loan] refers to an agreement in which lender supplies borrower with money, goods, or services in return for promise of future payment.
• In one case, Salim a merchant obtains credit to meet working capital needs of production. credit helps him to meet ongoing expenses of production, complete production on time, and thereby increase his earnings. Credit, therefore, plays a vital and positive role in this situation.
• In case of Swapna, a farmer, failure of crop made loan repayment impossible. She had to sell part of land to repay loan. Credit, instead of helping Swapna improve her earnings, left her worse off. It is an example of what is commonly known as a debt trap. Credit in this case pushes borrower into a situation from which recovery is very painful.
• Every loan agreement specifies an interest rate that borrower must pay to lender along with repayment of principal. In addition, lenders may demand collateral [security] against loans.
• Collateral is an asset that borrower owns [such as land, building, vehicle, livestock, deposits with banks] and uses this as a guarantee to a lender until loan is repaid.
• If borrower fails to repay loan, lender has right to sell asset or collateral to obtain payment.
• Property such as land titles, deposits with banks, and livestock are some common examples of collateral used for borrowing.
• Interest rate, collateral and documentation requirement, and mode of repayment together comprise what is known as terms of credit.
• terms of credit vary substantially from one credit arrangement to another. They may vary depending on nature of lender and borrower.
• Besides banks, other major source of cheap credit in rural areas is cooperative societies [or cooperatives].
• Members of a cooperative pool their resources for cooperation in certain areas. There are several types of cooperatives possible such as farmers’ cooperatives, weavers’ cooperatives, industrial workers’ cooperatives.
• various types of loans can be grouped as formal sector loans and informal sector loans.
• Among former sector are loans from banks and cooperatives. informal lenders include moneylenders, traders, employers, relatives, friends.
• Reserve Bank of India supervises functioning of formal sources of loans. RBI monitors banks in actually maintaining cash balance.
• RBI sees that banks give loans not just to profit-making businesses and traders but to small cultivators, small-scale industries, small borrowers.
• No organisation supervises credit activities of lenders in 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.
• Compared to formal lenders, most informal lenders charge higher interest on loans. Thus, cost to borrower of informal loans is much higher.
• A higher cost of borrowing means a larger part of earnings of borrowers is used to repay loan.
• Cheap and affordable credit is crucial for country’s development. This is necessary that banks and cooperatives increase their lending, particularly in rural areas, so dependence on informal sources of credit reduces.

Self-Help Groups
• In recent years, people have tried out some newer ways of providing loans to poor. idea is to organise rural poor, in particular, women, into small Self-Help Groups [SHGs] and pool [collect] their savings.
• An SHG has 15-20 members, generally belonging to one neighbourhood, who meet & save regularly. Saving per member varies from ` 25 to ` 100 or more, depending on ability of people to save.
• Members can take small loans from group itself to meet their needs. group charges interest on these loans but this is still less than what moneylender charges.
• After a year or two, if group is regular in savings, it becomes eligible for availing loan from bank.
• loan is sanctioned in name of group and is meant to create self-employment opportunities for members.
• Most of important decisions regarding savings and loan activities are taken by group members. group decides as regards loans to be granted — purpose, amount, interest to be charged, repayment schedule. This is group that is responsible for repayment of loan.
• Any case of non-repayment of a loan by any one member is followed up seriously by other members in group.
• SHGs help borrowers overcome problem of lack of collateral. They can get timely loans for a variety of purposes and at a reasonable interest rate. SHGs are building blocks of organisation of rural poor.

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