In the chapter, CBSE Notes Economics Chapter 3: Money and Credit, we will learn about the modern forms of money and also how they are connected with the banking system. In the latter part of the article, we will know about the credit system and how it impacts the borrowers, depending upon the situation, and also go through these notes for the understanding of the topics in detail.
Money and Credit
Money as a Medium of Exchange
The use of money forms a very large part of our everyday life. Money acts as an intermediary in the exchange process, hence it is called a medium of exchange. A person who holds money can exchange it easily for any commodity or service that she wants.
Example: A toy manufacturer wants to sell toys in the market & buy wheat. The toy manufacturer will first exchange toys that he has produced for money & then exchange the money for wheat. It would have been so difficult for the toy manufacturer to directly exchange toys for wheat without the exchange of money. S/he would have to look for a farmer who not only grows wheat but also wants to sell wheat & buy toys in exchange.
This is known as a double coincidence of wants, in which what a person desires to sell is exactly what the other person wishes to buy. In a barter system, double coincidence of wants is an essential feature, where goods are directly exchanged without the use of money. While in an economy, we see where all money is being used, money serves as the crucial intermediate step which eliminates the need for double coincidence of wants.
Read More: Money as Medium of Exchange and Modern Forms of Money
Modern Forms of Money
Since the early ages, it was seen that Indians used grains & cattle as money. Thereafter, we see the emergence of the use of metallic coins: gold, silver, and copper coins – this phase continued till the last century. Now, we have the modern forms of money which include currency:
- Paper notes
- Coins
The modern forms of money: currency & deposits are linked closely to the modern banking system.
Currency
- As it is authorized by the Government of India, the currency is accepted as a medium of exchange.
- On behalf of the central government, the Reserve Bank of India (RBI) issues currency notes in India. Only the RBI is allowed to issue currency in India.
- Rupee ₹ is widely accepted as a medium of exchange in India.
Deposits with Banks
- Another form in which people hold money is in the form of, deposits with banks. By opening a bank account in their name, people deposit their extra cash with the banks.
- Banks accept these deposits & also pay an amount as interest on the deposits.
- Deposits in bank accounts that are withdrawn on demand, are called demand deposits.
- Another essential feature of demand deposits is cheques. We see, at times, the payments are made by cheque instead of cash.
- 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.
Loan Activities of Banks
- It is seen that the banks keep a small proportion of the deposits as cash themselves.
- In India, the banks hold about 15% of their deposits as cash. This is done so that the bank can pay the depositors who might come to withdraw money from the bank someday.
- It is a major portion of the deposits that are used by banks to extend loans.
- Huge demand for loans can be seen for various economic activities.
- It is seen that a higher interest rate on loans is charged by banks than what they offer on deposits.
- The difference between what is charged from borrowers & what is paid to depositors serves as the main income source for banks.
Read More: Loan Activities of Banks
Two Different Credit Situations
Credit (loan): An agreement in which it is seen that the lender provides the borrower with money, goods, or services in return for the promise of payment being made in the future.
Two examples that will help us to understand workings of the credit:
Festive Season
For instance, Salim obtains credit in order to meet the working capital needs of production. This credit helps him to meet the ongoing expenses of production, complete production on time, & also increases his earnings. Here we see, how credit helps in increasing earnings & the person is in a better condition.
Swapna’s Problem
In Swapna’s case, crop failure made repayment of loans impossible. In order to repay the loan, she had to sell a part of the land. Here, in this case, credit, left Shardha in a worse situation. This is what happens in a debt trap. Credit, in the case of the debt trap, pushes the borrower into such a situation where recovery is difficult. Whether credit is useful or not, depends on the risks involved in the situation & whether in case of a loss, there is some support.
Read More: Two Different Credit Situations
Terms of Credit
- A loan agreement specifies an interest rate by which the borrower must pay the lender along with the repayment of the principal. Also, the lenders demand collateral (security) against loans.
- Collateral (security) is actually an asset that the borrower owns (like land or a building or a vehicle, livestock, or deposits with banks) which is used as a guarantee to a lender until the loan is repaid. In case the borrower fails to repay the loan, the lender as per his/her right can sell the asset or collateral to obtain payment.
- Terms of credit: Interest rate, collateral & documentation requirement & the mode of repayment, together. It varies, depending on the nature of the lender & the borrower.
Formal Sector Credit in India
For a country’s development, cheap and affordable credit is essential. Various types of loans:
Formal sector loans
- The loans taken from banks & cooperatives are called formal sector loans.
- The RBI monitors the functioning of formal sources of loans.
- Banks are required to submit information to the RBI on how much they are lending, to whom, at what interest rate, etc.
Informal sector loans
The loans taken from moneylenders, traders, employers, relatives & friends, etc. are called informal sector loans. In the informal sector, no organization is there to supervise the credit activities of lenders. There is no one to prevent them from using unfair means to get their money back.
Formal and Informal Credit
- Only about half of the total credit needs of rural people are met by the formal sector.
- The informal sources help in fulfilling the remaining credit needs. The formal credit needs to be distributed more equally so that the poor benefit from the cheaper loans provided.
- Banks & cooperatives increase their lending, especially in rural areas, so that there is a reduction in the dependence on informal sources of credit.
- While the expansion of the formal sector loans needs to be expanded, it is necessary that everyone receives these loans.
Read More: Formal Sector Credit in India
Self Help Groups for the Poor
Let us see why poor households are still dependent on informal sources of credit:-
- In rural India, banks are not present everywhere. Even if banks are present, getting a loan from a bank is much more tedious as proper documents & collateral are required.
- To overcome these problems, Self Help Groups (SHGs) are created by people. These are small groups of poor people who promote small savings among their members. Usually, an SHG has 15-20 members, who belong to one neighborhood, they meet & save regularly.
Read More: Self Help Groups
Advantages of Self Help Group (SHG)
- Borrowers’ problem of lack of collateral is met by the SHGs.
- People get timely loans for various purposes, that too at a reasonable interest rate.
- SHGs are the guiding blocks of the rural poor.
- Women with help from SHGs become financially self-reliant.
- Regular meetings of the group provide a platform for discussion & act on various social issues like health, nutrition, domestic violence, etc.
Related Links
- Money as Medium of Exchange and Modern Forms of Money
- Loans Activities of Banks
- Two different credit situations
- Formal Sector Credit in India
- Self Help Groups for the Poor
FAQs on CBSE Notes Class 10 Economics Chapter 3: Money and Credit
Q1. Why do lenders ask for collateral while lending?
Answer-
As an assurance of the repayment of the loan, collateral is asked for by lenders while lending.
Q2. Define ‘terms of credit’.
Answer-
Terms of credit- Interest rate, collateral & documentation requirement & the mode of repayment, together. It varies, depending on the nature of the lender & the borrower.
Q3. Define ‘collateral’.
Answer-
Collateral (security) is actually an asset that the borrower owns (like land or a building or a vehicle, livestock, or deposits with banks) which is used as a guarantee to a lender until the loan is repaid. In case the borrower fails to repay the loan, the lender as per his/her right can sell the asset or collateral to obtain payment.