Chapter 3: Money And Financial System

What do you mean by the barter system?

Ans: Barter system refers to the system of exchange where goods and services are
exchanged directly for other goods and services.
Define money.
Ans: Money is defined as anything which acts as a medium of exchange and possesses
the quality of general acceptability. Thus, money is anything which is widely accepted in
payments for goods or in discharge of other kinds of transactions.

What are the two categories of financial institutions?

Ans: The two categories of financial institutions are:-
(1) Formal financial institutions and
(2) Informal financial institutions.

Mention one advantage of formal sector loans.

Ans: One advantage of formal sector loans is that mode of repayment of loans is very
easy.
What is collateral?
Ans: Collateral is the security demanded by the lender against loans. Collateral may be
land, building, vehicle etc.

Define credit?
Ans: Credit refers to an agreement reached between the lender and the borrower of
money, goods and services in return for the promise of future payment.

Which are the two major sources of formal loan for rural households?
Ans: The two major sources of formal loan for rural households are:-
(1) Loans from co-operatives, and
(2) Loans from Self-Help Groups.
Define barter system. What are the limitations of this system?
Ans: Barter system refers to the system of exchange where goods and services are
exchanged directly for other goods and services.
Its limitations are stated under:-
(1) Barter system requires a double coincidence of wants on the part of those who want
to exchange goods or services. For example, a person having rice wants to exchange
it for sugar. In the barter system, he has to find a person who not only has sugar
but also wants rice in return. This creates difficulty in exchange of goods.
(2) Money has no place in this system.

State the objectives of financial institutions.

Ans: The objective of financial institutions is to collect savings from people and to give
loans to needy people.

What are the modern forms of money? Why are they accepted as a medium of
exchange?
Ans: Currency notes and coins are the modern forms of money.
The law grants currency the status of legal tender money. Thus no one can refuse
the use of currency notes and coins as medium in payments in settling transactions. That
is why currency notes and coins are accepted as a medium of exchange.

Why are demand deposits considered as money?

Ans: Demand deposits are considered as money because payments, in case of demand
deposits, can be made through cheque.

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Classify the financial system of India.
Ans: The financial system of India is classified as below:-
(1) Formal Financial Institutions.
(2) Informal Financial Institutions.

What are the differences between informal and formal sources of credit?
Ans: The differences between informal and formal sources of credit are stated under:-
Formal financial institutions are those financial institutions whose financial
transactions or dealings are governed by set of rules and regulations. The activities of
these institutions are controlled and regulated by the Reserve Bank of India. The R.B.I
monitors whether the banks are actually maintaining the cash reserves or not and whether
banks give loans to the priority sector on concessional interest rate or not. These
institutions are required to submit the periodic information of their business activities.
The financial institutions which are not regulated and controlled by any authority
are called informal financial institutions. There is no organisation to supervise the credit
activities of lenders in this sector. They charge a very high interest rate on loans. There is
no authority to control them from using unfair means to get their money back.
[MBOSE approved answer]

Why were SHGs promoted to provide loans to the poor?

Ans: SHGs were promoted to provide loans to the poor because of the following reasons:-
(1) Members of SHGs can avail small loans from the group at a reasonable rate of
interest to meet their needs.
(2) Small loans are provided to members for getting mortgaged land released, for
meeting working capital needs, for housing materials, for acquiring assets like
sewing machine, handlooms, cattle, etc.

What are the advantages of formal sectors loans?

Ans: The advantages of formal sector loans are as follows:-
(1) Loans from formal financial institutions (banks) are cheaper. Interest rate is
around 8% to 12% per annum.
(2) Mode of repayment of loan is very easy.
(3) Formal credit saves the borrower from falling into debt-trap.
(4) Many people can borrow cheaply for a variety of uses. For example, farmers can
grow crops; unemployed youth can set up small scale industries or can trade in
goods.
(5) Cheap and affordable credit is provided by formal credit institutions which prove
very crucial for the country’s development.

Give a hypothetical example, explaining the double coincidence of wants.

Ans: In the barter system, it is necessary for a person who wants to trade his goods or
services to find other person who is not only willing to buy his goods or services, but also
possesses goods which the former wants. This is known as double coincidence of wants. For
example, a person having rice wants to exchange it for sugar. In the barter system, he has
to find a person who not only has sugar but also wants rice in return.

Write a short note on private finance company.

Ans: Private finance company operates in the country’s unregulated credit market. There
is no information about the amount of lending business done by them. The principal source
of their funds is deposits from the members. The loans are given at reasonable rates of
interest for various purposes like purchase of car, house construction etc. and are secured.
How does Reserve Bank of India keep a check on the functioning of banks?
Ans: The Reserve Bank of India keeps a check on the functioning of banks in the
following manner:-

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 (1) Banks are required to keep a minimum proportion of deposits as reserve to meet the
cash requirements of their depositors.
(2) The Reserve Bank of India monitors whether the banks are actually maintaining
the cash reserves or not.
(3) The R.B.I. sees whether banks give loans to the priority sector on concessional
interest rate or not.
(4) Banks are required to submit the periodic information of their business activities to
the RBI.
What is double coincidence of wants? Why is it not required in an economy
where money is in use?
Ans: In the barter system, it is necessary for a person who wants to trade his goods or
services to find other person who is not only willing to buy his goods or services, but also
possesses goods which the former wants. This is known as double coincidence of wants. For
example, a person having rice wants to exchange it for sugar. In the barter system, he has
to find a person who not only has sugar but also wants rice in return.

It is not required in an economy where money is in use because of the following

reasons:-
(1) Money eliminates the need for double coincidence of wants.
(2) Money acts as an intermediate in the exchange process, hence it is called as a
medium of exchange.
(3) Money serves as a unit of account. Everybody prefers payments in money because a
person holding money can easily exchange it for any commodity or service that
he/she may desire.
Explain the term ‘credit’. How does credit work in a difficult situation?
Ans: Credit refers to an agreement reached between the lender and the borrower of
money, goods and services in return for the promise of future payment.
In difficult situation, credit works in the following ways:-
(1) Credit helps borrowers to meet the ongoing expenses of production.
(2) Credit helps in completing production on time.

Describe the evolution of money as a medium of exchange.

Ans: Initially, money was in the form of commodity money. Commodities like grain,
cattle and tobacco were used as money. Later on, due to lack of uniformity,
standardisation, indivisibility, perishable nature of goods and difficulty in storing, precious
metals like gold and silver were used as money. However, on account of bulkiness, a large
sum of money in terms of metals was not easily portable. Moreover, it was also unsafe to
carry precious metals from one place to another. This problem leads to the introduction of
paper money which is now commonly known as money.
Why do you think that the share of formal sector credit is higher for the richer
households compared to the poor households?
Ans: The share of formal sector credit is higher for the richer households as compared to
the poor households because of the following reasons:-
(1) Banks are not found everywhere in rural areas.
(2) Bank loans require proper documentation and collateral. Lack of collateral is the
major reason which prevents poor households from availing loans from formal credit
institutions.
(3) Local moneylenders are mostly ready to offer loans without security. The borrower
can approach the moneylender even in the state of non-repayment of earlier loan.

List any four non-institutional sources of finance in India. Why do poor

households in India still depend on informal sources of credit?
Ans: Four non-institutional sources of finance in India are listed below:-
(1) Moneylenders.
(2) Indigenous bankers.
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(3) Chit funds.
(4) Finance companies.
Poor households in India still depend on informal sources of credit because of the
following reasons:-
(1) Banks are not found everywhere in rural areas.
(2) Bank loans require proper documentation and collateral. Lack of collateral is the
major reason which prevents poor households from availing loans from formal credit
institutions.
(3) Local moneylenders are mostly ready to offer loans without security. The borrower
can approach the moneylender even in the state of non-repayment of earlier loan.

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