30 August 2015

Chapter – 3 Money and Credit

CBSE NCERT Class X (10th) | Social Studies | Economics

Chapter – 3 Money and Credit

Definition and Modern Forms of Money

IN the early times, people used to exchange one commodity for another, depending on their requirement under the barter system. However, exchanging goods in the barter system required double coincidence of wants.
However, money eliminates the need for double coincidence of wants. Since money enables the exchange process, it is also called a medium of exchange. Early forms of money were things of daily use.

Modern currency:
  • Uses paper notes and coins made of relatively inexpensive metals
  • Has no value of its own
  • Has a value only because it is authorised by the government of a country

In India, the Reserve Bank of India is the only legal authority that can issue currency notes and coins on behalf of the central government. The Rupee is India’s currency and nobody can refuse to accept a payment made in rupees in India.

Bank - Types of Deposit

People deposit their extra cash in bank. A bank in addition to keeping the money also pays interest on the deposit to the depositor. Thus bank deposits are also called demand deposits.

A person simply needs to have an account with the bank to deposit money. A cheque can be used to make payment directly from a bank deposit without using cash.

A cheque is a written instruction to a bank by an account holder to pay a specific sum to a specific person from his deposit. A cheque has all the information about the person to whom payment is to be made, the amount and date of payment and signature of account holder issuing the cheque.

Credit and Terms of Credit

As per the Reserve Bank of India, banks hold about 15% of their deposits as cash to arrange for daily withdrawals by depositors.

A major portion of the remaining deposits is used by banks to give loans to people. The depositors of a bank are allowed to withdraw their deposits on demand and are paid interest on their deposits. The borrowers taking loans repay it to the bank along with interest.

The interest charged on loans is more than the interest paid by the banks on deposits. The difference between the interest charged on loans and the interest paid on deposits is the bank’s income or profit.

The loan given by a bank is also referred to as credit.

A loan or credit is subject to certain conditions that the borrower must agree to. These conditions are called terms of credit and include:
  • A specified rate of interest
  • Security against the loan to recover the money if the borrower fails to repay it. This security is called collateral
  • The assets accepted as collateral are land or property, vehicles, livestock, standing crops and bank deposits
  • A borrower needs to submit certain documents like proofs of identity, residence, employment and income to avail a loan
  • The lender reserves the right to sell the collateral in case of non-repayment to recover the loan amount.

A loan is usually given for a specific duration of time and needs to be completely repaid by a specified date. The borrower repays the loan in cash, by cheque or by card in instalments, or as a one-time repayment, as specified in the mode of repayment.

Collateral is the security provided by a borrower against a loan, and it can be sold in case of non-payment. Credit can bring about a positive or a negative change in a person’s life.

Formal and Informal Credit

The different sources of credit are:
  • Banks
  • Traders
  • Cooperative societies
  • Landlords
  • Moneylenders
  • Relatives and friends

Banks and cooperative societies constitute the formal sector of credit. Landlords, moneylenders, traders, relatives, friends and other sources of credit constitute the informal sector of credit.

The formal sector provides only marginally more credit than the informal sector currently. The credit activities of the formal sector are supervised by the Reserve Bank of India. The RBI gives credit to all at low interest rates.

In the informal sector there is no supervisory body. The credit activities of this sector are only driven by profit with much higher interest rate. A high rate of interest means that a borrower spends more money to repay the loan and is left with less money for himself. This also leads to a debt trap.

The rich at present have more access to cheaper credit from the formal sector, while the poor still have to depend on loans at higher rates of interest from the informal sector. Cheaper credit is essential for development in a country. The formal sector offers more affordable credit and so it must increase its lending to more and more people, especially in the rural areas.

SHEG (Self Help Groups)

Poor households in India largely depend on the informal sector for their credit requirements. Banks demand collateral against a loan that the poor people are unable to provide.

To cater to this problem is organising self-help groups. A group of 15-20 members save regularly to create a savings pool. Members of the group can take small loans from their combined savings. The loans bear interest at low rates.

After saving regularly for a few years, a self-help group becomes eligible for a loan from a bank without providing any collateral. The bank loan is used to generate more income and employment opportunities for the members of the group.

The members of a self-help group make all the decisions jointly and are jointly responsible for the repayment of loans.

Banks also extend loans to poor women organised in self-help groups. Self-help groups allow poor people access to affordable and easy credit. The Grameen Bank of Bangladesh is a brilliant example of meeting the credit needs of the poor at affordable rates.