JAC Board Class 10 Social Science Notes Economics Chapter 3 Money and Credit
→ Money as a Medium of Exchange
- A person holding money can exchange it for any commodity or service that he or she might want.
- Thus everyone prefers to receive payments in money and then exchange the money for things that they want.
- Both parties have to agree to sell and buy each other’s commodities. This is known as Double Coincidence of Wants.
- What a person desires to sell is exactly what the other wishes to buy.
- In a barter system where goods are directly exchanged without the use of money, the Double Coincidence of Wants is an essential feature.
- In an economy where money is in use, by providing the crucial intermediate step it eliminates the need for Double Coincidence of Wants.
- Money acts as an intermediate in the exchange process. It is called a medium of exchange. This is known as Barter System.
→ Modern Forms of Money
- Money acts as a medium of exchange in transactions.
- Before the introduction of coins, a variety of things were used as money.
- For example, since the very early ages, Indians used grains and cattle as money.
- Modem forms of money include currency – paper notes and coins.
- Money is accepted as a medium of exchange because the currency is authorized by the government of the country.
- In India, the Reserve Bank of India issues currency notes on behalf of the government of India.
- As per Indian law, no other individual or organization is allowed to issue currency.
- No individual in India can legally refuse payment made in rupees.
→ Deposits with Bank
- The other form in which people hold money is ‘deposits with the bank’.
- People deposit money with the banks by opening a bank account in their name.
- Banks accept deposits and also pay an amount as interest on the deposits.
- People also have the provision to withdraw the money as and when they require.
- Since the deposits in the accounts can be withdrawn on demand, these deposits are called demand deposits.
- Some payments are made by cheques instead of cash. For payment by cheque, the buyer who has an account with the bank, prepares a cheque for a specific amount.
- A cheque is a paper instructing the bank to pay a specific amount from the holder’s account to the person in whose name the cheque has been issued.
- The facility of cheque against demand deposits makes it possible to directly settle payments without the use of cash.
- Since demand deposits are accepted widely as a means of payment, along with currency, they constitute money in the modem economy.
- But for the banks, there would be no demand and no payments by cheques against these deposits. The modem forms of money – currency and deposits – are closely linked to the working of the modem banking system.
→ Loan Activities of Banks
- Banks keep only a small proportion of their deposits as cash with themselves.
- This is kept as a provision to pay the depository who might come to withdraw money from the bank on any given day.
- Since, on any particular day, only some of its many depositors come to withdraw cash, the bank is able to manage with this cash.
- Banks use the major portion of the deposits to extend loans to the individuals for their requirements.
- There is a huge demand for loans for various economic activities.
- Banks mediate between those who have surplus funds and those who are in need of these funds.
- Banks charge a higher interest rate on loans than what they offer on deposits.
- The difference between what is charged from the borrowers and what is paid to the depositors is their main source of income.
→ Terms of Credit
- Every loan agreement specifies an interest rate which the borrower must pay to the lender along with the repayment of the principal amount, lenders may demand collateral against the loan.
- Collateral is an asset that the borrower owns and uses this as a guarantee to a lender until the loan is repaid.
- The interest rate, collateral, documentation requirement, and the mode of repayment is called the terms of credit.
→ Formal Sector Credit in India
- People obtain loans from various sources.
- The various types of loans can be grouped as formal sector and informal sector loans.
- Between these two sectors, former sector includes loans from banks and cooperatives.
- The informal lenders include moneylenders, traders, employers, relatives and friends, etc.
- The Reserve Bank of India supervises the functioning of formal sources of loans.
- For instance, we have seen that the banks maintain a minimum cash balance out of the deposits they receive.
- The RBI monitors the banks in actually maintaining a cash balance.
- Periodically, banks have to submit information to the RBI on how much they are lending, to whom, at what interest rate, etc.
- There is no organization that supervises the credit activities of lenders in the 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 the formal lenders, most of the informal lenders charge a much higher rate of interest on loans.
- Thus, the cost to the borrower of informal loans is much higher.
- The higher cost of borrowing means that, a large part of the earnings of the borrowers is used to repay the loans.
- Cheap and affordable credit is crucial for the country’s development.
→ Formal and Informal Credit
- 85% of the loans taken by the poor households in the urban areas are from informal sources.
- Urban households take only 10% of loans from informal sources, while 90% from formal sources.
- The rich households avail a cheap credit from the formal sources whereas the poor households have to pay a large amount of borrowing.
- The formal sources still meet only about half of the total credit needs of the rural people.
- The remaining credit needs are fulfilled by the informal sources.
- Thus, 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.
- While formal sector loans need to expand, it is also necessary that everyone receives these loans.
- It is important that the formal credit is distribute^ more equally so that the poor can benefit from the cheaper loans.
→ Self-Help Groups for the Poor
- Poor -households are still dependent on informal sources of credit.
- Banks are not present everywhere in rural India.
- Even when they are present, getting a loan from a bank is much more difficult than getting a loan from informal sources.
- The absence of collateral is one of the major reasons which prevents the poor from getting bank loans.
- Informal lenders such as moneylenders, know the borrowers personally and are often willing to give a loan without collateral.
- However, the moneylenders charge very high rates of interest, keep no records of the transactions and harass the poor borrowers.
- In recent years, people had tried out some newer ways of providing loans to the poor like Self Help Groups (SHGS), Grameen Banks, etc.