Money and Credit

How does the use of money make it easier to exchange things?

Answer

Money serves as a universally accepted medium of exchange, making transactions more efficient. It provides a standard unit for measuring the value of goods and services and is easy to carry unlike materials used in barter system. In a barter system where goods are directly exchanged without the use of money, double coincidence of wants was an essential feature. Money eliminates the need for double coincidence of wants. Also, it retains its value over time. Unlike perishable goods, money can be saved for future use and can be used to accumulate wealth.

Can you think of some examples of goods/services being exchanged or wages being paid through barter?

Answer

Some examples of goods/services being exchanged or wages being paid through barter are:

1. A hairdresser can get weekly salon cleaning services in exchange for free haircuts and styling for the cleaner.
2. A math tutor can offer tutoring sessions to a music teacher's child in exchange for piano lessons for his own kid.
3. A landlord may offer rent free stay to a watchman who guards the building at night.
4. A lawyer can provide legal assistance to a real estate company in return for the use of office space within one of their properties.

M. Salim wants to withdraw Rs 20,000 in cash for making payments. How would he write a cheque to withdraw money?

Answer

In order to withdraw money from the bank, he will write 'self' or bearer's name on the cheque, fill the amount in words as well as in numerals and will sign it. The cheque is not crossed on the top corner.

Tick the correct answer. After the transaction between Salim and Prem,

1. Salim's balance in his bank account increases, and Prem’s balance increases.
2. Salim's balance in his bank account decreases and Prem’s balance increases.
3. Salim's balance in his bank account increases and Prem’s balance decreases.

Answer

Salim's balance in his bank account decreases and Prem’s balance increases.

Why are demand deposits considered as money?

Answer

Demand deposits are considered as money because:

1. Demand deposits provide easy access to funds. Individuals and businesses can withdraw money from these accounts at any time without prior notice.
2. Demand deposits serve as a medium of exchange. People use them to make purchases and pay bills.
3. Demand deposits allow easy access to cash through cheques and ATMs.

Fill the following table.

Answer

Supposing Salim continues to get orders from traders. What would be his position after 6 years?

Answer

If Salim continues to get orders from traders, he will make good profit, that can help him to further expand his business. He may open new units, hire more people and take bigger orders.

What are the reasons that make Swapna’s situation so risky? Discuss factors – pesticides; role of moneylenders; climate.

Answer

Farmers like Swapna face several risks, and their situation can be precarious due to various factors. Following are the reasons that make Swapna’s situation so risky:

1. Vulnerability due to extreme weather like famine, drought, floods etc.
2. Unpredictable rainfall
3. Attack of pests and diseases
4. Fluctuations in crop prices and exploitation by middle men while selling the produce.
5. Borrowing from informal moneylenders at high interest rates can trap Swapna in debt cycles.

Why do lenders ask for collateral while lending?

Answer

Lenders ask for collateral because it serves as a guarantee that they can recover their money in case the borrower defaults on the loan. 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.

Given that a large number of people in our country are poor, does it in any way affect their capacity to borrow?

Answer

Yes, poverty significantly impacts borrowing capacity. It is because:

1. Poor individuals may lack valuable assets to offer as collateral, making it harder for them to access credit.
2. A good credit history is essential for borrowing. Poor people with limited financial transactions may lack a positive credit record.
3. Lenders assess borrowers’ ability to repay based on stable income sources.
4. Poor individuals may have limited access to formal banking services.

Fill in the blanks choosing the correct option from the brackets.

While taking a loan, borrowers look for easy terms of credit. This means ............... (low/high) interest rate, ............... (easy/tough) conditions for repayment, ............... (less/more) collateral and documentation requirements.

Answer

While taking a loan, borrowers look for easy terms of credit. This means low interest rate, easy conditions for repayment, less collateral and documentation requirements.

List the various sources of credit in Sonpur.

Answer

The various sources of credit in Sonpur are:

• Local money-lenders
• Traders
• Employer or land owner
• Bank

Underline the various uses of credit in Sonpur in the above passages.

Answer

The various uses of credit in Sonpur in the above passages are:

1. Farm inputs like seed, pesticides, fertilizer etc.
2. Rent of cold storage
3. Illness, Function

Compare the terms of credit for the small farmer, the medium farmer and the landless agricultural worker in Sonpur.

Answer

Small farmers: They are usually unable to provide collateral and given loans by local money lenders. The terms are:

• High rate of interest of five per cent per month (60% per annum).
• Repayable in a year.

Medium farmer: They provide land or farm machines as collateral. They usually avail loan from commercial banks. The terms are:

• Low rate of interest i.e. 8.5 per cent per annum
• Loan can be easily paid in the next 2-3 years.

Landless agricultural workers of Sonpur: The terms are:

• Borrowers pay their debt by working on land of their moneylenders or landowners so that in future again they will be able to borrow from that person in need.
• The rate of interest is high i.e 5% per month.

Why will Arun have a higher income from cultivation compared to Shyamal?

Answer

Following are the reasons, why Arun will have a higher income from cultivation compared to Shyamal:

1. Arun gets a loan from a commercial bank at the interest rate of 8.5% per annum, whereas Shyamal gets loan from a village moneylender at the interest rate of 5% per month (i.e., 60% per annum).
2. Arun is not restricted to sell his product at a low price. He has the benefit of selling his product at market rates.
3. He can keep his product in cold storage and wait for the prices to rise.
4. He can also avail fresh loans against his produce.
5. Arun has more land than shyamal.

Can everyone in Sonpur get credit at a cheap rate? Who are the people who can?

Answer

No, everyone cannot get credit at a cheap rate. Following people are able to get it:

• People having some collateral with them.
• People who have organised themselves into a cooperative society.

Tick the correct answer.

(i) Over the years, Rama’s debt

1. will rise.
2. will remain constant.
3. will decline.

(ii) Arun is one of the few people in Sonpur to take a bank loan because

1. other people in the village prefer to borrow from the moneylenders.
2. banks demand collateral which everyone cannot provide.
3. interest rate on bank loans is same as the interest rate charged by the traders.

Answer

(i) will rise.

(ii) banks demand collateral which everyone cannot provide.

Talk to some people to find out the credit arrangements that exist in your area. Record your conversation. Note the differences in the terms of credit across people.

Answer

I talked to a few people living in my area and asked them what are the terms and conditions when they apply for loan and from where do they borrow. Different people gave different replies:

• Few said that they don’t borrow money as they can’t afford to repay the debts on time so they stay away from borrowing and lending.
• Some of them said that they borrow money from relatives and friends as there is low rate of interest required and sometimes no rate of interest as well.
• Few of them said that they borrow money from commercial banks and bank charges high rate of interest and also ask for some collateral and many more documentation formalities etc.
• Some people still borrow from local money lenders at very high rate for short terms. It is because they provide faster loan and with least documentation.

What are the differences between formal and informal sources of credit?

Answer

Why should credit at reasonable rates be available for all?

Answer

Credit at reasonable rates should be available for all because it allows poor borrowers to access loans with lower interest rates. It helps them to become progressive, increase their income and simultaneously protect them from the clutches of local money lenders. Therefore, we can say that accessible credit at reasonable rates promotes financial stability, economic growth, and individual empowerment.

Should there be a supervisor, such as the Reserve Bank of India, that looks into the loan activities of informal lenders? Why would its task be quite difficult?

Answer

Yes, there should be a supervisor, such as the Reserve Bank of India, that looks into the loan activities of informal lenders but it comes with numerous challenges.

1. Informal lenders are numerous and operate across various professions, making it difficult to track their activities.
2. Informal lending lacks proper records, making supervision challenging.
3. There may be cultural resistance to formalising traditional lending practices, as these are often deeply rooted in local customs and practices.

Why do you think that the share of formal sector credit is higher for the richer households compared to the poorer households?

Answer

The share of formal sector credit is higher for the richer households compared to the poorer households because:

1. Richer households can offer collateral to formal sectors while poor households usually do not have any asset to offer as collateral.
2. Formal loans require extensive documentation (e.g., proof of income, tax returns, business records). Richer households are better able to provide these documents, while poorer households might struggle with this requirement.
3. Richer households are more aware of the products and services offered by formal financial institutions. This knowledge gap can limit poorer households' ability to access formal credit.
4. Richer households typically have more stable and higher incomes, making them more attractive to formal lenders. Poorer households may have irregular and lower incomes, increasing the perceived risk for formal lenders.
5. Poorer households may have longstanding relationships with informal lenders and may trust them more than formal institutions. Richer households are more likely to have established relationships with banks and other formal lenders.

In situations with high risks, credit might create further problems for the borrower. Explain.

Answer

In risky situations, borrowing money can make things worse. For example, a small farmer takes a loan to buy seeds, but a drought destroys the crops. With no income, the farmer can't repay the loan, gets into more debt due to high interest, and might lose their land used as collateral for the loan. This worsens their financial problems and can trap them in a cycle of debt and poverty.

How does money solve the problem of double coincidence of wants? Explain with an example of your own.

Answer

In a barter system where goods are directly exchanged without the use of money, double coincidence of wants is an essential feature. For a successful barter transaction, both parties needed to want what the other had to offer. Money provides the crucial intermediate step that eliminates the need for double coincidence of wants. Money serves as a common medium of exchange. Instead of directly swapping goods, people use money to buy and sell. This eliminates the need to find someone who is offering the goods that is needed and in turn offer him the goods that he wants. For example, a man wants to sell books in the market and buy wheat. It is difficult to directly exchange books for wheat without the use of money. He would have to look for a wheat growing farmer who not only wants to sell wheat but also wants to buy the books in exchange. Thus, money solves this problem of finding the right person.

How do banks mediate between those who have surplus money and those who need money?

Answer

People with surplus money deposit their money in banks into savings accounts or fixed deposits. Banks keep only a small proportion of their deposits as cash with themselves. They use the major portion of the deposits to extend loans. There is a huge demand for loans for various economic activities. In this way, banks mediate between those who have surplus funds (the depositors) and those who are in need of these funds (the borrowers).

Look at a 10 rupee note. What is written on top? Can you explain this statement?

Answer

• “Reserve Bank of India”
• “Guaranteed by the Central Government”
• “I promise to pay the bearer the sum of Ten Rupees”

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

Why do we need to expand formal sources of credit in India?

Answer

Most loans from informal lenders carry a very high interest rate and do little to increase the income of the borrowers. The private lenders often exploit their borrowers and trap them in a vicious cycle of debt. Formal sources of credit provide loans at an affordable interest rate and help in the economial growth of an individual. Therefore, 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.

What is the basic idea behind the SHGs for the poor? Explain in your own words.

Answer

The basic idea behind Self-Help Groups (SHGs) for the poor is to provide a platform where marginalized individuals, especially women, can come together. These groups pool their resources, access credit, engage in income-generating activities, and enhance their overall well-being. SHGs help overcome the problem of lack of collateral faced by poor borrowers. They offer timely loans for various purposes at reasonable interest rates, fostering self-employment opportunities and financial empowerment

What are the reasons why the banks might not be willing to lend to certain borrowers?

Answer

Banks might not be willing to lend to certain borrowers for following reasons:

1. Lack of Collateral: Some borrowers may not have valuable assets to pledge as collateral. Banks often require collateral to secure loans.
2. Poor Repayment History: Individuals with a history of non-repayment of loans are considered risky borrowers. Banks hesitate to lend to such individuals.
3. Unstable Income or Employment: Borrowers who cannot provide proof of stable income or employment may face challenges in securing loans.
4. Inadequate Documentation: Very often poor people are not able to provide proper documents.
5. Existing high loan: They are already burdened by high loans.

In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this necessary?

Answer

The Reserve Bank of India supervises the functioning of formal sources of loans. The RBI monitors the banks in maintaining cash balance. 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.

Analyse the role of credit for development.

Answer

Credit plays a crucial role in a country’s development:

1. Credit allows businesses to invest in new technologies, expand operations, and increase productivity. This leads to higher output, job creation, and economic growth.
2. Access to credit enables entrepreneurs to start new ventures, fostering innovation and competition.
3. Credit is used to finance large infrastructure projects such as roads, schools, and hospitals. These projects improve public services and contribute to long-term economic growth.
4. Farmers can use credit to purchase seeds, equipment, and technology, leading to higher yields and more efficient agricultural practices.
5. Credit enables families to invest in education, healthcare, and housing, improving their quality of life and economic potential.

Manav needs a loan to set up a small business. On what basis will Manav decide whether to borrow from the bank or the moneylender? Discuss.

Answer

Manav will decide whether to borrow from the bank or the moneylender by considering some factors like:

1. Ease of availing loan: Manav will assess whether he meets the bank’s eligibility requirements, such as credit history, business experience, and annual revenue. Moneylenders may have more lenient eligibility criteria but may lack transparency.
2. Interest rate applicable : Formal banks typically offer lower interest rates compared to moneylenders. Moneylenders may charge higher interest rates due to their informal nature.
3. Collateral demanded : Banks usually require collateral (such as property or assets) to secure the loan. Moneylenders may accept personal guarantees or other forms of security.
4. Repayment facilities : Manav will consider collateral requirements, and repayment terms set by the bank. Banks have standardized procedures. Moneylenders may have simpler processes but could impose stricter terms.
5. Documentation : He will also consider paper work involved in the process of availing loan. Bank has to strictly follow the KYC norms.
6. Existing high loan : Existing loans can stop him to avail fresh loan from banks.

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?

(b) What are the other sources from which the small farmers can borrow?

(c) Explain with an example how the terms of credit can be unfavourable for the small farmer.

(d) Suggest some ways by which small farmers can get cheap credit.

Answer

(a) Banks might be unwilling to lend to small farmers because they usually cannot offer collateral security. Also, their income is highly uncertain.

(b) Small farmers usually borrow from relatives, friends, employer or local money lenders.

(c) The terms of credit can be unfavourable for the small farmer as they have to pay a very high interest rate, repayment period is less and their business is highly uncertain. For example, if a farmer borrows Rs 50,000 from a money lender at an interest rate of 5% per month, he will have to pay back Rs 15000 interest money and Rs 50000 principal at the end of 6th month. If his crop fails, he will still have to pay Rs 65000 to the money lender.

(d) Following are the ways by which small farmers can get cheaper credit:

1. Borrowing from Self Help Groups.
2. Borrowing from Cooperative societies.

Fill in the blanks:

(i) Majority of the credit needs of the ............... households are met from informal sources.

(ii) ............... costs of borrowing increase the debt-burden.

(iii) ............... issues currency notes on behalf of the Central Government.

(iv) Banks charge a higher interest rate on loans than what they offer on ...............

(v) ............... is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.

Answer

(i) Majority of the credit needs of the poor households are met from informal sources.

(ii) High costs of borrowing increase the debt-burden.

(iii) Reserve Bank of India (RBI) issues currency notes on behalf of the Central Government.

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

(v) Collateral is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.

Choose the most appropriate answer.

(i) In a SHG most of the decisions regarding savings and loan activities are taken by

1. Bank.
2. Members.
3. Non-government organisation.

(ii) Formal sources of credit does not include

1. Banks.
2. Cooperatives.
3. Employers.

Answer

(i) Members.

(ii) Employers.