Chapter 3 Money and Credit
In situations with high risks, credit might create further problems for the borrower. Explain
Whether a credit would be useful or not, will depend on a number of factors like – risks involved, whether there is some support against a loss, terms of credit, etc. It is a fact that in situations with high risks, credit might create further problems for the borrower. For example, credit taken by farmers for cultivation might create problems for the farmer at some times. Crop production involves high costs on inputs such as HYV seeds, fertilizers, pesticides, irrigation etc.
Farmers generally take loans at the beginning of the season and repay the loan after harvest. But the failure of the crop makes loan repayment impossible. Then in order to repay the loan sometimes, they become bound to sell part of their land. So, their situations become worse than before. The incidences of farmers’ suicides especially in Maharashtra are the burning examples of this situation. Thus, whether credit would be useful or not, depends on the various risks involved in the situation.
How does money solve the problem of double coincidence of wants ? Explain with an example of your
own. [CBSE 2016]
- Money solves the problem of double coincidence of wants because it acts as an intermediate in the exchange process.
- People may purchase anything with money.
- There is no need to have any goods or commodities for exchange.
- Money acts as a medium of exchange.
For example, a person working as an engineer in a government department gets salary from his office. With that money (salary) he purchases different goods from the market according to the requirements of his family. He makes payment in cash and does not need any product for exchange as required under the double coincidence of wants. Thus, money acts as an intermediate in the exchange process.
How do banks mediate between those who have surplus money and those who need money?
What does the Bank do with the deposits which they accept from the public ?
We know that banks accept deposits from the people who have surplus money and also pay interest on the deposits.
But banks keep only a small portion (15 percent in India) of their deposits as cash with themselves. This is kept as a provision to pay the depositors who might come to withdraw money from their accounts in the bank on any day. They use the major portion of the deposits to extend loans to those who need money. In this way, banks mediate between those who have surplus money and those who need money.
Look at a 10 rupee note. What is written on top ? Can you explain this statement ?
The following words are written at the top of a 10 rupee note :
“Reserve Bank of India Guaranteed By The Central Government”
“I promise to pay the bearer the sum of Ten Rupees.” Governor.
- It implies that the notes are issued by the Reserve Bank of India.
- The Governor of the Reserve Bank promises to pay tjie bearer the sum of ten rupees.
- The notes have been guaranteed by the Central Government and in case of failure of the currency e. Ten Rupee notes, people can claim tile amount from the Central Government.
- It also implies that the use of rupee is a legal currency and no one can refuse payment made in it.
- It is medium of exchange in India.
Why do we need to expand formal sources of credit in India ?
We need to expand formal sources of credit in India for many reasons:
- Compared to formal lenders, most of the informal lenders charge much higher interest rates on loans like 3% to 5% per month i.e. 36% a year.
- Besides the high-interest rate, informal lenders impose various other tough conditions. For example, they make the farmers promise to sell the crop to him at a low price. There is no such condition in the formal sector.
- Informal lenders do not treat well with the borrowers. On the other hand, there is no such situation in the formal sector.
- The Reserve Bank of India supervises the functioning of formal sources of loans. In contrast, there no organization which supervises the credit activities of lenders in the informal sector.
- Loans taken by poor people from informal lenders sometimes, lead them to debt-trap because of high-interest rates.
- The formal sources of credit in India still meets only about half of the total credit needs of rural people.
So, it is necessary that the formal sources of credit expand their lending, especially in rural areas so that the dependence on informal sources of credit reduces as this will also help in the development of the country.
What is the basic idea behind the SHGs for the poor? Explain in your own words.
- The basic idea behind the SHGs (Self-Help Groups) is to organise rural poor, in particular women, so that they may pool their savings and help them to borrow money without collateral.
- The banks are not present in every village. Even if there is a bank in rural area, getting a loan from a bank is much more difficult that taking a loan from informal sources because the bank loans require proper documents and collateral.
- So to solye the problems of cheaper loans without collateral in rural areas SHGs have been formed.
What are the reasons why the banks might not be willing to lend to certain borrowers ?
Bank loans require proper documents and collateral. People who do not apply for loan with proper documents and collateral are refused loans by the banks. Generally, the poor fall in this category and absence of collateral is one of the main reasons for not sanctioning loans to them.
In what ways, does the Reserve Bank of India supervise the functioning of banks ? Why is this
necessary ? ,
(1) The Reserve Bank of India supervises the functioning of banks in the following ways :
- The RBI monitors that the banks actually maintain the required cash balance.
- It sees that the banks give loans not-just to profit-making businesses and traders but also to small cultivators, small-scale industries, small-borrowers.
- The banks submit information to the RBI about loans sanctioned to different categories of persons along with terms and conditions of the loans. In this way, RBI sees that the loans are sanctioned to all including the poor.
(2) The supervision of the Reserve Bank of India over the functioning of the banks is necessary. It is to know how much the banks are lending, to whom and at what interest rate. It is to ensure that the banks do not exploit the borrowers like the moneylenders in the rural areas.
Analyse the role of credit for development.
Credit plays a crucial role in a country’s development. By sanctioning loans to developing industries and trade, banks provide them with the necessary aid for improvement. This leads to increased production, employment, and profits. However, caution must be exercised in the case of high risks so that losses do not occur.
This advantage of loans also needs to be manipulated and kept under an administrative hold because loans from the informal sector include high-interest rates that may be more harmful than good. For this reason, it is important that the formal sector gives out more loans so that borrowers are not duped by moneylenders, and can ultimately contribute to national development.
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.
Manav will decide to borrow from the bank or the moneylender on the following basis :
- Rate of interest.
- Terms for repayment of loan,
- Other conditions such as collateral.
Wherever the above conditions favour him or are more satisfactory, he will take loan from
them accordingly. Generally, in India, the terms and conditions that are offered in the formal sector i.e., the banks and cooperatives are better than the informal sector i.e., moneylenders who charge much higher rate of interest.
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.
(a) Banks might not be willing to lend to small farmers because they don’t have collateral security to deposit in the bank. Some of these farmers are not in the position of paying the loan, due to already existing loans.
(b) The other sources of borrowing are from moneylenders, employer, self-help group, landlord, etc.
(c) For example, if a person takes a loan from his/her landlord on the basis of security of his/her land. At the end, be/she is not able to pay the loan then the landlord can sell the land and get his money back.
(d) Small farmers can get cheap credit with the help of a self-help group (SHGs) from the bank and they can repay the loan easily after 3 or 4 years. The rate of interest is also low as compared to other sources of credit.
Fill in the blanks :
- Majority of the credit needs of the_____________ households are met from informal sources.
- ___________ costs of borrowing increase the debt-burden.
- __________ issues currency notes on behalf of the Central Government.
- Banks charge a higher interest rate on loans than what they offer on ___________
- _______ is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.
- Reserve Bank of India
Choose the most appropriate answer :
(1) In an SHG most of the decisions regarding savings and loan activities are taken by
(c) Non-government organization
(d) Formal sources of credit does not include
(1) (b) Members