MONEY AND CREDIT

Q1) Why is money seen as a medium of exchange?

i) A person holding money can easily exchange it for any commodity or
service that they want.
ii) Everyone prefers to receive payments in money and then exchange the
money for things they want.
iii) For example, in the case of a shoe manufacturer, he may exchange shoes for
money and use this money to buy wheat.
iv) Money can retain its worth over some time, it can be stored and preserved.
v) It acts as a unit of account; it measures the worth of goods and services
traded.
Q2) What is a double coincidence of wants?
i) In double coincidence of wants, both parties, buyer and seller, have to agree
to buy and sell each other’s commodities.
ii) In a barter system where goods are directly exchanged without using
money, double coincidence of wants is essential.
Q3) How does money solve the problem of double coincidence of wants?
Explain with an example.
i) Money eliminates the need for double coincidence of wants.
ii) In the case of a shoe manufacturer who wants wheat in exchange for his
shoes, he does not need to search for a farmer who is willing to exchange
his wheat for shoes.
iii) All the shoe manufacturer has to do is search for a buyer for his shoes, and
the money given to him will be used to buy wheat.
iv) Money acts as an intermediate in medium of exchange.
Q4)Why is the currency accepted as a medium of exchange?
i) It is accepted as a medium of exchange as the currency is authorized by the
government of the country.
ii) The Reserve Bank of India issues currency notes on behalf of the central
government.
iii) No individual body or organization is legally allowed to issue currency.
iv) The law legalizes the use of rupees as a medium of payment that cannot be
refused.
v) Hence, the rupee is widely accepted as a medium of exchange.
Q5) Look at a 10 rupee note, what does it say on top and what does it signify?
i) At the top of the note, Reserve Bank of India and Guaranteed by
government is written.
ii) This signifies that the currency is issued by the Reserve Bank of India on
the behalf of the central government.
iii) So, these statements signify that the currency is authorized by the central
government.
Q6) How can one deposit money to the bank? What are demand deposits.
i) People with extra cash can deposit it into the bank by opening a bank
account in their name.
ii) The banks accept the deposits and pay an amount of interest on them.
iii) In this way, the people’s money is safe, and they also earn interest.
iv) The money deposited can be withdrawn at any time.
v) Since the deposits in the bank accounts can be withdrawn by demand, it is
also known as a demand deposit.
Q7) What are the advantages of demand deposits?
i) Deposits can be withdrawn at any time by demand.
ii) The facility of cheques against demand deposits makes it possible to
directly settle payments without the use of cash.
iii) A cheque is a paper that instructs the bank to pay a specific amount from
the person’s account to the person whose name the cheque is issued to.
Q8) What are the sources of income for the bank?
i) Banks keep a small portion of the deposits for themselves.
ii) Banks in India these days hold about 15% of their deposits as cash.
iii) This is kept as a provision to pay the depositors who have come to
withdraw their money.
iv) The main source of income for the bank is the difference between the
interest charged from the borrowers and the interest they provide to the
depositors.
v) Banks charge a higher rate of interest to the borrowers than the interest that
they pay to the depositors.
Q9) How do banks mediate with those who have surplus money and those who
don’t?
i) Banks use a major portion of the deposits to extend loans to those who need
money.
ii) There is a huge demand for loans due to various economic activities.
iii) Banks charge a higher rate of interest to those who borrow money than that
of the interest that they offer to the depositors.
 iv) The difference between the interest given by the borrowers and the interests
given to the depositors is their main source of income.
v) Hence, by giving deposits and advancing loans, banks mediate between
those who have surplus funds and those who are in need of funds.
Q10) What would happen if all depositors went to ask for their money at the
same time?
i) Banks only hold 15% of the deposits they get from depositors in cash.
ii) This cash is used to pay the depositors who have come to withdraw their
money.
iii) As not many depositors come to withdraw money at once, this amount of
cash is sufficient.
iv) However, if many depositors come at once, the bank will not be able to pay
them back.
v) There would be a cash crisis.
Q11) In situations with high risks, credit might create further problems.
Explain.
i) Credit can help increase earnings, making a person more well off than
before.
ii) However, because of unfavorable conditions, credit can push the person into
a debt trap.
iii) An example- the time when farmers purchase the inputs needed for growing
crops and the time in which they sell their crops after harvest has a
minimum gap of 3-4 months.
iv) As producing crops requires a considerable amount of expenses on
electricity, water, fertilizers, pesticides, etc., farmers take crop loans at the
beginning of the harvest season.
v) After the harvest season, farmers repay their loans.,
vi) The farmer’s ability to pay the loan is dependent on the income that they
get.
vii) In case of crop failure, it becomes hard for the farmer to repay their loan.
viii) To repay the loan, farmers will end up having to sell their land.
ix) Thus, in this way credit has made the situation worse instead of helping the
farmer.
x) Recovery from this situation may be very painful.
Q12) Why do lenders ask for collateral while lending?
i) Lenders as for collateral while lending, as a security for the loans they give
to the borrower.
ii) They keep it as an asset until the loan is repaid.
iii) Collateral is an asset or a form of physical wealth that is owned by the
borrower, such as a vehicle, land, house, livestock, etc.
iv) It is against these assets the banks provide loans to the borrower.
v) The collateral serves as a security measure for the lender.
Q13) What are the terms of credit?
i) Interest rate.
ii) Collateral
iii) Documentation requirement
iv) Mode of payment
v) Terms of credit vary depending on the nature of the lender and the
borrower.
Q14) Differentiate between formal sources of credit and informal sources of
credit.
Formal Sources of Credit Informal Sources of credit
It includes banks and cooperatives. It includes money lenders, employees,
friends, family, traders, etc.
Formal sources require collateral and Does not require much documentation but
proper documentation for setting up a repeated borrowing may lead to a debt
loan. trap.

A reasonable rate of interest is charged Unreasonable and comparatively higher

Apart from profit making they also have
an objective of social welfare.
The Reserve Bank of India supervises the
bank’s functioning.
rates are charged.
Their only motive is to extract profit as
much as possible.
Banks do not supervise the functioning of
informal sources of credit.

Q15) In what ways does the Reserve Bank of India supervise the functioning of
banks? Why is it necessary?
i) The Reserve Bank of India supervises the formal sources of loans.
ii) They also monitor if banks maintain a minimum cash balance out of the
deposits they receive.
 iii) RBI sees that banks give loans not just to profit-making businesses and
traders but also to small cultivators, small-scale industries, small borrowers,
etc.
iv) Periodically, banks have to submit a report on how much they lend, to
whom, at what interest rate, etc to the RBI.
v) This is necessary for the development of the nation; cheap and affordable
credit is necessary.
vi) They ensure that the poor can also benefit from cheaper loans.
vii) It is important that the formal credit is distributed more equally.
Q16) Why do we need to expand formal sources of credit in India?
i) To save people from the exploitation of the informal sector.
ii) Compared to formal lenders, informal lenders charge a higher rate of
interest on loans.
iii) Thus, the cost of informal loans is much higher.
iv) Higher cost of borrowing means that the borrowers' income is mainly
focused on repaying their loans.
v) They have less income left for themselves.
vi) Debt ensues when the amount to be repaid is higher than the income of the
borrower.
vii) People who wish to start an enterprise by borrowing will not be able to do
so because of the high cost of borrowing.
viii) Thus, banks and cooperative societies need to lend more.
ix) Cheap and affordable credit is crucial for development, as it helps people
to grow crops, set up industries and businesses, and thus earn a stable
source of income.
x) Loans from informal lenders do little to increase the income of borrowers,
thus cooperatives and banks must increase their lending to rural areas, so
that the dependency on informal credit reduces.
xi) It is also important that formal credit is distributed more equally among the
rich and poor.
Q17) What are the reasons banks might not be willing to lend to certain
borrowers?
i) Banks require proper documents and collateral as security against loans.
ii) Some people fail to meet these requirements.
iii) The borrowers who have not paid previous loans, the banks might not be
willing to lend them further loans.
iv) Banks might not be willing to lend money to entrepreneurs who are going
to invest in businesses with high risks.
Q18) Why are poor households still dependent on informal sources of credit?
i) Banks are not present everywhere in India.
ii) Bank loans require proper documents and collateral.
iii) Absence of collateral is one of the major reasons why the poor are unable to
get loans from banks.
iv) Informal lenders know the borrowers personally and are willing to give
loans without collateral.
v) In some cases, they can approach lenders for loans without repaying their
old ones.
vi) However, moneylenders charge high rates of interest, keep no record of
transactions, and harass poor borrowers.
Q19) What is the basic idea behind self-help groups?
i) The main objective of self-help groups is to provide financial resources for
the poor, by organizing them, especially women, into self-help groups.
ii) They provide timely loans with a reasonable rate of interest without
collateral.
iii) They also provide a platform to discuss and act on a variety of social issues,
such as education, health, nutrition, domestic violence, etc.
iv) A typical SHG has 15-20 members, who regularly meet and save money.
v) They save about 25-100 rupees, based on the ability of the people to save.
vi) If the group is regular in savings, they can become eligible to get loans from
the bank.
Q20) Who takes up the important decisions in self-help groups?
i) The decisions are taken up by the members of the self-help groups,
regarding savings and loan activities taken.
ii) The group decides the purpose of the loan granted, the amount of interest to
be charged, the repayment schedule, etc.
iii) As the entire SHG is responsible for the repayment of the loan, banks are
willing to lend to poor women when organized in SHGS.
Q21) How does SHG help borrowers?
i) They get timely loans that are backed by a reasonable rate of interest.
ii) SHGs are the building blocks of rural organizations of the poor.
iii) It helps women to become financially self-reliant.
iv) It also provides a platform to discuss various social issues, such as domestic
violence, education, health, etc.