MONEY AND CREDIT
In the chapter “Money and Credit” of NCERT Class 10 Economics, we delve into the significance of money and credit in our economy. We explore the different forms of money, ranging from traditional objects to modern currency, and understand how it serves as a medium of exchange. Additionally, we examine the banking system, the role of formal and informal sources of credit, and their impact on borrowers. By delving into these concepts, we gain insights into the functioning of our financial system and its influence on economic activities and development.
MONEY AS A MEDIUM OF EXCHANGE
– Money is widely used in everyday transactions, involving buying and selling goods, as well as exchanging services.
– Money simplifies transactions by serving as a universally accepted medium of exchange.
– Individuals prefer receiving payments in money as it allows them to easily exchange it for the desired commodities or services.
– Without money, the barter system requires a double coincidence of wants, where both parties agree to exchange their goods directly.
– Money eliminates the need for double coincidence of wants by acting as an intermediate step in transactions.
– The shoe manufacturer, for example, can exchange shoes for money and then use that money to purchase wheat or any other commodity in the market.
– Money is referred to as a medium of exchange because it facilitates the exchange process by providing a common means of transaction.
MODERN FORMS OF MONEY
– Money has historically taken various forms as a medium of exchange.
– In ancient times, Indians used grains and cattle as a form of money.
– The use of metallic coins, including gold, silver, and copper, emerged as a common form of money that lasted until the recent past.
Currency
– Modern forms of money include currency in the form of paper notes and coins.
– Unlike earlier forms of money, modern currency is not made of precious metals and lacks inherent value or everyday use.
– Currency is accepted as a medium of exchange because it is authorized by the government of the country.
– In India, the Reserve Bank of India is responsible for issuing currency notes on behalf of the central government.
– The law in India prohibits individuals or organizations other than the government from issuing currency.
– The use of the Indian rupee as a medium of payment is legalized and cannot be refused in settling transactions within the country.
– The widespread acceptance of the rupee as a medium of exchange is due to its legal status and government backing.
Deposits with Banks
– People hold money as deposits with banks in addition to currency.
– Workers deposit extra cash with banks, earning interest on their deposits.
– Deposits in bank accounts that can be withdrawn on demand are called demand deposits.
– Demand deposits offer the facility of making payments through cheques, allowing direct settlement without cash.
– Demand deposits, along with currency, constitute money in the modern economy.
– Banks play a crucial role in enabling demand deposits and facilitating payments by cheques.
– The modern forms of money, including currency and deposits, are closely connected to the functioning of the banking system.
LOAN ACTIVITIES OF BANKS
– Banks keep only a small portion of their deposits as cash, typically around 15%.
– The cash reserve is used to fulfill withdrawal requests from depositors.
– The majority of the deposits are used by banks to provide loans.
– There is a high demand for loans for various economic activities.
– Banks act as intermediaries by using deposits to meet the loan requirements of borrowers.
– Banks charge higher interest rates on loans compared to the interest paid to depositors.
– The difference between the interest earned from borrowers and the interest paid to depositors constitutes the main source of income for banks.
TWO DIFFERENT CREDIT SITUATIONS
(1) Festival Season
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.
– Salim obtains credit to fulfill the working capital requirements of his production activities.
– Credit allows him to cover ongoing production expenses, meet deadlines, and increase his earnings.
– In rural areas, the primary demand for credit is for crop production.
– Crop production involves costs for seeds, fertilizers, pesticides, water, electricity, equipment repair, etc.
– Farmers typically take crop loans at the beginning of the season and repay them after harvest.
– The repayment of the loan is dependent on the income generated from farming activities.
(2) Swapna’s Problem
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.
– Swapna’s case demonstrates the negative consequences of credit when the crop fails, making loan repayment impossible.
– She had to sell a part of her land to repay the loan, leaving her worse off.
– This situation is referred to as a debt trap, where credit pushes the borrower into a difficult recovery situation.
– The impact of credit on individuals depends on the risks involved and the availability of support in case of loss.
– Credit can be beneficial if it helps increase earnings and improve the borrower’s situation, but it can be detrimental if circumstances lead to a debt trap.
TERMS OF CREDIT
– Loan agreements specify an interest rate that the borrower must pay in addition to repaying the principal.
– Lenders may require collateral as security for loans, which can be assets owned by the borrower.
– If the borrower fails to repay the loan, the lender has the right to sell the collateral to recover the payment.
– Common examples of collateral include land titles, bank deposits, livestock, etc.
– The terms of credit encompass interest rates, collateral requirements, documentation, and repayment methods.
– The terms of credit vary across different credit arrangements and depend on the nature of the lender and the borrower.
Variety of Credit Arrangements
– Shyamal, a small farmer, used to borrow money from the village moneylender at an interest rate of 5% per month (60% per annum). However, he now borrows from an agricultural trader at an interest rate of 3% per month. The trader provides farm inputs on credit, and Shyamal promises to sell the crop to the trader to ensure prompt repayment.
– Arun, a farmer with bank loans, receives an interest rate of 8.5% per annum. He plans to repay the loan after harvest and store the remaining potatoes in a cold storage facility. He can then apply for a fresh loan from the bank using the cold storage receipt as collateral.
– Rama, an agricultural laborer, relies on her employer, a medium landowner, for credit. The landowner charges an interest rate of 5% per month. Rama repays the loan by working for the landowner and often takes a new loan before the previous one is repaid. Landless people in Sonpur have limited credit options and mainly rely on landowner-employers for loans.
Loans from Cooperative
– Cooperative societies, besides banks, are a major source of affordable credit in rural areas.
– Cooperatives involve pooling resources and operating in specific areas like farming, weaving, or industrial work.
– Krishak Cooperative, located near Sonpur, has 2300 farmer members.
– Members deposit funds, which serve as collateral for obtaining a large loan from a bank.
– The Cooperative utilizes these funds to provide loans to its members for various purposes such as purchasing agricultural implements, cultivation, agricultural trade, fishery, construction of houses, and other expenses.
– Repayment of loans enables the Cooperative to offer further lending opportunities.
FORMAL SECTOR CREDIT IN INDIA
– Loans obtained from formal sources such as banks and cooperatives are categorized as formal sector loans, while loans from moneylenders, traders, employers, relatives, and friends fall under informal sector loans.
– Graph 1 depicts the various sources of credit to rural households in India.
– The Reserve Bank of India (RBI) supervises the functioning of formal lenders and ensures they maintain cash balances and provide loans to different borrowers.
– Informal lenders operate without any regulatory oversight, giving them the freedom to charge high interest rates and use unfair means for loan recovery.
– Informal loans generally have higher interest rates, resulting in a greater financial burden on borrowers and reducing their disposable income.
– High borrowing costs can lead to increasing debt and a debt trap, as seen in the case of Rama in Sonpur.
– The high cost of borrowing discourages potential entrepreneurs from starting businesses.
– Encouraging more lending by banks and cooperative societies would provide cheaper credit, boost incomes, and enable people to fulfill various needs, contribute to economic growth, and promote development in the country.
Formal and Informal Credit: Who gets what?
– Among poor households in urban areas, 85% of loans are obtained from informal sources, whereas for rich households, only 10% of loans are from informal sources.
– A similar pattern is observed in rural areas, with rich households predominantly accessing cheap credit from formal lenders, while poor households bear the burden of high-interest loans from informal sources.
– These findings suggest that the formal sector fulfills only around half of the total credit needs in rural areas, with the remaining needs being met through expensive loans from informal sources.
– Increasing lending by banks and cooperatives, particularly in rural areas, is necessary to reduce dependence on informal sources of credit and provide affordable options to borrowers.
– Besides expanding formal sector loans, it is crucial to ensure equitable distribution of these loans.
– Currently, richer households have better access to formal credit, while the poor are compelled to rely on informal sources.
– Promoting equal access to formal credit is essential to enable the poor to benefit from cheaper loans and improve their financial situation.
SELF-HELP GROUPS FOR THE POOR
– Poor households in rural areas depend on informal sources of credit due to several reasons.
– The absence of banks in many rural areas and the difficulty of obtaining loans from banks contribute to the reliance on informal sources.
– Bank loans require proper documentation and collateral, which is often lacking for the poor.
– Informal lenders like moneylenders, although charging high interest rates and practicing harassment, are more willing to provide loans without collateral.
– To address this, innovative approaches have been introduced, such as organizing rural poor, particularly women, into small Self Help Groups (SHGs) where members meet regularly and pool their savings.
– Members can borrow from the group at lower interest rates compared to moneylenders.
– After demonstrating regular savings, the SHG becomes eligible for loans from banks, sanctioned in the group’s name to create self-employment opportunities.
– Important decisions regarding savings and loan activities are made collectively within the group.
– SHGs help borrowers overcome the lack of collateral, providing timely loans at reasonable interest rates.
– Additionally, SHGs serve as a platform for discussing and addressing various social issues, empowering women and promoting financial self-reliance.
Grameen Bank of Bangladesh
– Grameen Bank of Bangladesh is a notable success story in providing credit to the poor at reasonable rates.
– It originated as a small project in the 1970s and has grown to serve over 9 million members in about 81,600 villages across Bangladesh.
– The majority of the borrowers are women from the poorest sections of society.
– These borrowers have demonstrated their reliability as borrowers and their ability to successfully initiate and manage various small income-generating activities.
SUMMING UP
– Modern forms of money are closely linked with the banking system, with depositors and borrowers playing key roles.
– Economic activities often require loans or credit, which can have both positive and negative impacts on borrowers.
– Credit can be obtained from formal or informal sources, and the terms of credit vary significantly between them.
– Currently, richer households have better access to formal credit, while the poor depend on more expensive informal sources.
– It is crucial to increase total formal sector credit to reduce reliance on costly informal credit.
– Additionally, the poor should have greater access to formal loans from banks and cooperative societies.
– These steps are essential for promoting development and improving the financial inclusion of disadvantaged individuals.
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