Chapter 3: Money and Credit

Answer:
This chapter explains why money is used as a medium of exchange, how modern forms of money such as currency and demand deposits work, how banks accept deposits and give loans, how credit can be useful or harmful, what terms of credit mean, and why formal sources of credit must be expanded. It also discusses Self Help Groups and the importance of affordable credit for poor households.

Answer:
Money is anything that is generally accepted as a medium of exchange. It allows people to buy and sell goods and services without directly exchanging one good for another. In modern economies, money mainly includes currency notes, coins and demand deposits with banks.

Answer:
Money is called a medium of exchange because it acts as an intermediate in the process of buying and selling. A person can sell goods or services for money and then use that money to buy any other good or service. This removes the difficulty of directly finding someone who wants exactly what one wants to sell and has exactly what one wants to buy.

Answer:
Double coincidence of wants means that both parties in an exchange must agree to sell and buy each other’s goods. For example, a person who has shoes and wants wheat must find a wheat farmer who wants shoes. This is difficult in a barter system. Money removes this problem by acting as a common medium of exchange.

Answer:
Banks accept deposits from people and pay interest on them. They keep only a small portion of deposits as cash to meet withdrawal needs. The major portion of deposits is used to give loans to borrowers. Banks charge a higher interest rate on loans than what they pay on deposits. The difference between these two rates is the main source of income for banks.

Answer:
Credit or loan is an agreement in which the lender supplies the borrower with money, goods or services in return for the promise of future payment. Credit can help people increase income and production, but it can also push borrowers into a debt trap if they cannot repay.

Answer:
Terms of credit include the interest rate, collateral, documentation requirement and mode of repayment. These terms vary from one credit arrangement to another. Borrowers prefer easy terms of credit, such as low interest rate, easy repayment conditions, less collateral and simple documentation.

Answer:
Money makes exchange easier because it removes the need for double coincidence of wants. A person can sell goods or services for money and use that money to buy anything else. For example, a shoe seller can sell shoes for money and then use the money to buy wheat, clothes or any other item.

Suggested Answer:
Examples of barter include a farmer giving wheat to a tailor in exchange for stitching clothes, a potter giving pots to a farmer in exchange for grain, or a labourer being paid in foodgrains instead of money. In some villages, services such as repair work, farm labour or animal care may also be exchanged for food, fodder or other goods.

Answer:
Salim would write a cheque in his own name or write “Self” in the payee section. He would write the amount as Rs 20,000 in figures and Rupees Twenty Thousand Only in words. Then he would sign the cheque and present it at the bank to withdraw cash.

Answer: (ii) Salim’s balance in his bank account decreases and Prem’s balance increases.

Explanation: Salim issued the cheque to Prem. Therefore, money is transferred from Salim’s account to Prem’s account.

Answer:
Demand deposits are considered money because they can be withdrawn on demand and can be used to make payments through cheques, cards or digital transfers. Like currency, they are widely accepted as a means of payment.

Answer:
If all depositors demanded their money at the same time, banks would face a serious crisis because they keep only a small portion of deposits as cash. Most deposits are given out as loans. Banks may not be able to repay everyone immediately, causing panic and loss of trust in the banking system.

Answer:
If Salim continues to receive orders and uses credit productively, his business may grow. He may earn higher profits, buy more raw materials, hire more workers, repay loans on time and expand production. In this case, credit plays a positive role in increasing his income and business capacity.

Answer:
Swapna’s situation is risky because farming depends on uncertain factors such as pests, rainfall, climate and crop prices. She borrowed from a moneylender who may charge a high interest rate. If the crop fails, her income falls and she cannot repay the loan. The debt increases and she may have to borrow again or sell land. This can push her into a debt trap.

Answer:
Lenders ask for collateral as security against the loan. If the borrower fails to repay, the lender can sell the collateral to recover the money. Collateral reduces the lender’s risk. Common examples include land, building, vehicle, livestock and bank deposits.

Answer:
Yes, poverty affects people’s capacity to borrow from formal sources. Poor people often do not have collateral, regular income or required documents. Therefore, banks may refuse loans to them. As a result, many poor households depend on informal lenders such as moneylenders, traders, employers and relatives, often at high interest rates.

Answer:
While taking a loan, borrowers look for easy terms of credit. This means low interest rate, easy conditions for repayment, less collateral and documentation requirements.

Answer:
Self Help Groups are small groups of poor people, usually 15 to 20 members, who pool their savings regularly. Members can take small loans from the group at reasonable interest rates. After the group becomes regular in savings and repayment, it may get loans from banks without collateral. SHGs help poor people, especially women, become financially independent.

Answer:
In high-risk situations, credit can create problems if the borrower is unable to repay the loan. For example, a small farmer may take a loan for cultivation, but if the crop fails due to pests or drought, the farmer may not earn enough to repay. Interest keeps increasing, and the borrower may have to sell land or assets. Thus, instead of improving income, credit can push the borrower into a debt trap.

Answer:
Money solves the problem of double coincidence of wants by acting as a medium of exchange. In a barter system, both parties must want each other’s goods. For example, a rice farmer who wants shoes must find a shoemaker who wants rice. This is difficult. With money, the farmer can sell rice for money and then buy shoes from any shoemaker. Thus, money makes exchange easier.

Answer:
Banks accept deposits from people who have surplus money and pay them interest. Banks keep a small portion of deposits as cash and use the major portion to give loans to people who need money. Borrowers repay loans with interest. Banks charge higher interest on loans than what they pay on deposits. In this way, banks act as intermediaries between depositors and borrowers.

Answer:
On a 10 rupee note, “Reserve Bank of India” is written on top. The note also carries a promise by the Governor of the Reserve Bank of India to pay the bearer the sum of ten rupees. This means the currency note is authorised by the government and issued by the Reserve Bank of India on behalf of the Central Government. Therefore, it is legally accepted as a medium of payment in India.

Answer:
We need to expand formal sources of credit because formal credit is generally cheaper, safer and regulated. Informal lenders often charge very high interest rates, which increases the debt burden of borrowers. Formal sources such as banks and cooperatives can provide loans at reasonable rates and help people invest in farming, business, education and housing. Expanding formal credit reduces dependence on moneylenders and supports economic development.

Answer:
The basic idea behind Self Help Groups is to help poor people save regularly and access small loans without depending on moneylenders. Members pool their savings and lend to each other at reasonable interest rates. SHGs also help members get bank loans without collateral. They promote self-reliance, women’s empowerment, financial discipline and collective decision-making among poor households.

Answer:
Banks may not be willing to lend to certain borrowers because:
1. They may not have collateral.
2. They may not have regular income.
3. They may not have proper documents.
4. Their repayment capacity may be doubtful.
5. They may have a poor credit history.
6. The purpose of the loan may appear risky to the bank.

Answer:
The Reserve Bank of India supervises banks by ensuring that they maintain minimum cash reserves, give loans not only to profit-making businesses but also to small cultivators, small industries and small borrowers, and submit information about lending, interest rates and borrowers. RBI also monitors whether banks follow rules.

This supervision is necessary to protect depositors, ensure fair lending, prevent misuse of funds, maintain trust in the banking system and make formal credit available to different sections of society.

Answer:
Credit plays an important role in development because it helps people invest in production, trade, farming, education, housing and small businesses. A farmer can buy seeds and fertilisers; a small business owner can buy raw materials; a student can finance education; and a household can buy or repair a house.

When credit is available at reasonable interest rates and easy terms, it increases income and productivity. However, expensive credit from informal lenders can create a debt trap. Therefore, development requires cheap, timely and formal credit for all, especially poor households and small farmers.

Answer:
Manav should decide on the basis of the terms of credit. He should compare the interest rate, repayment period, collateral requirement, documentation, flexibility and risk of exploitation. A bank loan is usually better because it has lower interest and is regulated, but it may require documents and collateral. A moneylender may give a loan quickly without documents, but may charge very high interest. If Manav has documents and collateral, he should prefer a bank loan. If not, he may explore cooperatives or SHGs instead of moneylenders.

Answer:

(a) Why might banks be unwilling to lend to small farmers?
Banks may be unwilling because small farmers often lack collateral, proper documents, regular income and assured repayment capacity. Farming is also risky due to crop failure, pests and rainfall uncertainty.

(b) What are the other sources from which small farmers can borrow?
Small farmers can borrow from moneylenders, traders, employers, relatives, friends, cooperatives, SHGs and microfinance institutions.

(c) Explain with an example how the terms of credit can be unfavourable for the small farmer.
A small farmer may borrow from a moneylender at a high interest rate. The moneylender may also force the farmer to sell the crop to him at a low price. If the crop fails, the farmer cannot repay and the debt keeps increasing.

(d) Suggest some ways by which small farmers can get cheap credit.
Small farmers can get cheap credit through banks, cooperatives, Kisan Credit Cards, SHGs, government schemes, crop insurance, simplified documentation and expansion of rural banking.

Answer: (b) Members

Explanation: SHGs are member-based groups. Members collectively decide savings, loans, interest and repayment matters.

Answer: (c) Employers

Explanation: Banks and cooperatives are formal sources of credit. Employers are an informal source of credit.

Criterion used: People with regular income, documents, collateral and repayment capacity are more likely to get bank loans. People with irregular income, no collateral and uncertain employment may face difficulty.