DELHI PUBLIC SCHOOL BULANDSHAHR

CLASS- X
ECONOMICS NOTES
CHAPTER- 3
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 intermediate in the
exchange process & it is called medium of exchange. In many of our day to day transactions, goods are
being bought & sold with the use of money.

Money is referred to as a medium of exchange because it serves as an intermediary in the exchange

process. The reason as to why transactions are made in money is that, a person holding money can easily
exchange it for any commodity or service that he or she wants.

Double Coincidence of Wants: It occurs when both parties agree to sell and buy each other's
commodities at the same time in the trade. Double coincidence of wants is a key element of the barter

system.
Example: Suppose a person has a cow and he want to exchange it for a bicycle. However, finding someone
who both has a bicycle and wants a cow can be quite challenging. The double coincidence of wants problem
arises because the person who has a bicycle may not be interested in owning a cow, or they may not have
anything you desire in exchange for your cow. Therefore, it becomes a complex and time-consuming process
to find a suitable trading partner who has what you want and wants what you have.
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.

Barter System
Barter refers to the direct exchange of goods and services. In this way, the barter system refers to the system
by which one commodity is exchanged for another without the use of money.
Difficulties of Barter System

• Double coincident of wants is an essential feature

• Lack of standard measurement of value
• Difficult to store or keep the things Money in Economy
• Problem of divisibility
• Deferred payment was not possible

Modern Forms of Money

In the early ages, Indians used grains and cattle as money.

Thereafter came the use of metallic coins, such as gold, silver, copper coins, which lasted well into the

twentieth century.

Now, the modern forms of money include currency – paper notes, coins and deposits. The modern
forms of money – currency and deposits – are closely linked to the workings of the modern banking system.

Currency

In India, the Reserve Bank of India issues currency notes on behalf of the Central Government. No
other individual or organisation is allowed to issue currency or print money. The rupee is widely accepted as
a medium of exchange in India.

Modern currency or rupee is accepted as a medium of exchange because:

(i) Modern currency is authorised by the government of a country.

(ii) In India, the Reserve Bank of India issues all currency notes on behalf of the Central Government.
 (iii) No other individual or organisation is allowed to issue currency.
(iv) The law legalises the use of rupee as a medium of payment that cannot be refused in settling transactions
in India.
(v) No individual in India can legally refuse a payment made in rupees.
Deposits in Banks

The other form in which people hold money is as deposits with banks. People need only some currency for
their day to day needs. People deposit their extra cash with the banks by opening a bank account in their
name. Banks accept the deposits and also pay an amount as interest on the deposits.

 The deposits in the bank accounts can be withdrawn on demand; these deposits are called demand
deposits. Another essential feature of demand deposits is cheques. At times, the payments are made by
cheque instead of cash.
A 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.

Features of demand deposit:

(i) Banks accept the deposits and also pay an interest rate on the deposits. In this way, people’s money is
safe with the banks and it also earns interest.
(ii) The facility of cheques 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 modern economy.
(iii) It is authorised by the government of the country.
Loan Activities of Banks
Banks keep only a small proportion of their deposits as cash with themselves. In India, banks now
maintain approximately 15% of their deposits in cash. This is kept as a provision to pay the depositors
who might come to withdraw money from the bank on any given day. Banks use the major portion of the
deposits to extend loans. In this way, banks mediate between those who have surplus money and those
who need money.

There is a huge demand for loans for various economic activities. Banks charge a higher interest rate on
loans than what they offer on deposits. The difference between what is charged by borrowers and what
is paid to depositors is their main source of income for banks.

Two Different Credit Situations

Credit (loan) refers to an agreement in which the lender supplies the borrower with money,
goods or services in return for the promise of future payment. Credit is the activity of
borrowing and lending money between two parties.
Here are two examples which help you to understand how credit works.
Festive Season:
In this case, Salim obtains credit to meet the working capital needs of production. The credit
helps him to meet the on-going expenses of production, complete production on time, and
thereby increase his earnings. In this situation, credit helps to increase earnings, and
therefore, the person is better off than before.

Swapna’s Problem:
In Swapna’s case, the failure of the crop made loan repayment impossible. She had to sell
part of the land to repay the loan. Credit, instead of helping Swapna improve her earnings,
left her worse off. This is an example of debt-trap. Credit, in this case, pushes the borrower
into a situation from which recovery is very painful. Whether credit would be useful or not
depends on the risks in the situation and whether there is some support in case of loss.

Different situations of loan for both Salim and Swapna -

Loans played a positive role for Salim. He also made profit and also repaid the
loan. While, loan had a negative role for Swapna. She was unable to repay the loan
and earn profit. She got caught in the debt trap, she had to sell the land.

How do farmers get into debts trap?

 Failure of the crop makes loan repayment impossible.

 Downfall of crop prices also makes loan repayment impossible.
 Higher interest makes life difficult. Credit in such a condition pushes the borrowers
into a situation from which recovery is painful and they get into the debt trap.

Terms of Credit

Interest rate, collateral and documentation requirement, and the mode of repayment together
comprise what is called the terms of credit. It may vary depending on the nature of the
lender and the borrower.

Collateral (Security) is an asset that the borrower owns (such as land, building, vehicle,
livestock, 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.

 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.
 Every loan agreement specifies an interest rate which the borrower must pay to the
lender along with repayment of the principal.
 In addition, lender may demand collateral, i.e., as asset that the borrower owns and
uses this as a guarantee until the loan is repaid.
 If the borrower fails to repay the loan, the lender has the right to sell the collateral
to obtain payment.
 Formal Sector Credit in India
There are two categories of sources of credit sector
 Formal Sector Credit and
 Informal Sector Credit.
Cheap and affordable credit is crucial for the country’s development. The various types of
loans can be grouped as follows:

Formal Sector Loans:

These are the loans from banks and cooperatives. The RBI oversees the operation of
formal sources of loans, which includes banks and cooperatives. To ensure that the
bank maintains a minimum cash balance and that loans are given not just to profit-
making businesses and dealers, but also to small growers, small scale industries, small
borrowers, and so on. Banks are required to report their actions to the RBI on a regular
basis.
Features of Formal Sector Credit:-

 It provides loans comparatively at a lower rate.

 Collateral security is required to obtain loans.
 This sector is mainly supervised by Reserve Bank of India.
 It includes banks and cooperative societies.
Informal Sector Loans:

These are the loans from moneylenders, traders, employers, relatives and friends, etc. There
is no organisation which supervises the credit activities of lenders in the informal sector.
There is no one to stop them from using unfair means to get their money back.

Features of Informal Sector Credit:-

 It charges comparatively high interest rate.
 Sometime collateral is not needed while obtaining loan.
 It is supervised by none of the institutions.
 Can use any unethical means to recover their money.

Formal sector Informal sector

Rate of Interest is lower. Higher rate of Interest.

Collateral is must for getting loan. Ready to give loans without any collateral too.

RBI supervises them. No organization to supervise them.

More documentation is required. It involves many

Less documentation, less formalities.
formalities.

Examples:- Moneylender, traders, friends, retailers

Example:- Banks and co-operatives.
and so on.
Formal and Informal Credit
The formal sector meets only about half of the total credit needs of rural people. The
remaining credit needs are met from informal sources. It is important that formal credit is
distributed more equally so that the poor can benefit from cheaper loans. It is necessary that
banks and cooperatives increase their lending, particularly in rural areas, so that the
dependence on informal sources of credit reduces. While the formal sector loans need to
expand, it is also necessary that everyone receives these loans. For the development of a
country, cheap and affordable credit is crucial. Therefore, the government should
facilitate formal sources of credit basically in rural areas.
Formal and Informal Credit: Who gets what?

Self Help Groups for the Poor

Poor households are still dependent on informal sources of credit because of the following
reasons:

 Banks are not present everywhere in rural India.

 Even if banks are present, getting a loan from a bank is much more difficult as it
requires proper documents and collateral.
To overcome these problems, people created Self Help Groups (SHGs). SHGs are small
groups of poor people who promote small savings among their members. A typical SHG has
15-20 members, usually belonging to one neighbourhood, who meet and save regularly.
Saving per month varies from 25-100 rupees or more depending upon the ability of the
people. Members take small loans from group itself to meet their needs.

Its basic idea is to provide financial resources for the poor through organizing the rural poor
especially women into small help groups. It collects saving of the members. It provides
loans without collateral. It provides timely loans at reasonable rate of interest. It also
provides a platform to discuss various social issue..

Advantages of Self Help Groups (SHG)

1. It helps borrowers to overcome the problem of lack of collateral.

2. People can get timely loans for a variety of purposes and at a reasonable interest rate.
3. SHGs are the building blocks of the organisation of the rural poor.
4. It helps women to become financially self-reliant.
 5. The regular meetings of the group provide a platform to discuss and act on a variety
of social issues such as health, nutrition, domestic violence, etc.
6. The organisation also provides self-employment opportunity for the member by the
way of sanctioning the group.
7. For example, small loans are provided to the members for releasing mortgaged land,
for meeting working capital needs, for housing materials, for acquiring assets.
8. There is also a group for repayment of loan.
9. In case of any non-repayment by the one member is followed by the other member of
the organisation

Grameen Bank of Bangladesh

Grameen Bank of Bangladesh tells one of the biggest success stories of reaching the
poor to meet their credits needs at reasonable rates. It was founded by professor
Muhammad Yunus who won the Nobel Prize for peace in 2006. Grameen Bank of
Bangladesh in 2018 has over 9 million member in about 81,600 villages spread across
Bangladesh. The poor women have proved to be reliable borrowers, as they have
started and run a variety of small income- generating activities successfully.