Money and Credit

Q1. Explain the term ‘double coincidence of wants’.

A1. ​‘Double coincidence of wants’ means that both parties have to agree to buy
and sell each other’s commodities. What a person desires is exactly what the
other person wants to sell.

Example: ​If a shoe manufacturer had to directly exchange shoes for wheat
without the money, he could have to look for a person who not only wants to buy
shoes, but also has excess wheat which he wants to sell.

Q2. How does money act as a medium of exchange?

A2. ​In an economy where money is in use, money, by providing a crucial

intermediate step, eliminates the need for a double coincidence of wants. It is no
longer necessary for a manufacturer to look for a wheat farmer who would buy
his shoes as well as be willing to well his wheat. All he has to do is to find a buyer
for his shoes. Once he has exchanged his shoes for money, he can buy wheat or
any other commodity form the market. Since money acts as an intermediate in
the exchange process, it is called a medium of exchange.

Q3. Why is money accepted as a medium of exchange?

A3. ​It is accepted as a medium of exchange because the currency is authorized

and recognized by the government of the country.

Q4. Why is the rupee accepted as a medium of exchange in India?

OR

What is the importance of rupee as a medium in India?

A4. ​In India, the Reserve Bank of India (RBI), issues currency on behalf of the
Indian government. As per Indian law, no other individual or organisation is
allowed to issue currency. Moreover, the law legalises the use of rupee as a
medium payment that cannot be refuted in settling transactions in India. No
individual in India can legally refuse a payment made in rupees. Hence, rupee is
the widely accepted medium of exchange in India.
Q5. What is a cheque?

A cheque is a paper instructing the bank to pay a specific amount from the
person’s account to the one in whose name the cheque is written.

Q6. How do banks operate between depositors and borrowers?

A6. ​Banks operate between depositors and borrowers in the following manner-

● A number of depositors deposit a certain sum of money at the bank.

● In India, banks hold about 15% of the money deposited with them as 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 a major portion of the money deposited with them to extend
loans. There is a huge demand for loans for various economic activities.
● Loans are given out to meet the needs of people and organisations. In this
way, banks mediate between those who have surplus funds (the
depositors) and those who are in need of it (the borrowers).
● The borrowers repay the loan with a comparatively higher interest rate
than that offered on deposits.
● When depositors come to withdraw money, they also avail an interest rate
which is lower than the one on loans.
● The difference between what is charged from borrowers and what is paid
to the depositors is their main source of income.

Q7. What is credit? Explain the 2 different credit situations with examples.

​ 7. ​Credit refers to an agreement in which the lender supplies the borrower with
A
money, goods and services in return for the promise of future repayment.

Positive Credit Situation: ​A positive credit situation is when the borrower is able to
repay what was borrowed from the lender and also increase his or her earnings.
For example, Salim, a shoe manufacturer, receives a large order of shoes for the
festive season. In order to meet this demand, he needs more equipment, raw
material and labour. To meet these expenses, he takes credit from a leather
supplier in the form of leather and also borrows some money from his client in
the form of an advance payment. By the end of the month, Salim is able deliver
the order, make a good profit, and repay the borrowed credit. He is able to
increase his earnings.

Thus, credit plays a positive role in these situations.

Negative Credit Situation: ​When borrowing of credit leaves the borrower in a

situation worse off than before, it’s an example of a negative credit situation. For
example, let’s say a small farmer loans money from a moneylender in order to
cultivate groundnut on her plot of land. However, the failing of crops due to a
famine doesn’t allow her to do so. The next year, she takes another loan in order
to grow crops. However, the money from the second year’s harvest isn’t enough
to pay off the debt. Eventually, the farmer has to sell off a major piece of her land
to the moneylender. Credit, in this situation, pushes the borrower into a situation
from which recovery is very painful.

Q8. Explain the terms of credit.

A8. ​Interest rate, collateral, documentation required and the mode of repayment
together comprise the terms of credit.

● Collateral is an asset that the borrower owns (such as land, building,

vehicles, livestock, etc.) and uses this as a guarantee to the lender until the
loan is repaid.
● Interest rate is the amount charged, expressed as a percentage of principal,
i.e., the original amount of money loaned.
● A loan is usually repaid in the form of payments done to the bank
periodically. Mode of repayment is used to refer to the time period
between 2 payments. It can be monthly, quarterly, half-yearly, or yearly.
● Before any bank loans money, it usually asks for some sort of
documentation from the borrower. This includes the borrower’s
employment record and history.
● Terms of credit vary substantially from one credit arrangement to another,
depending on the nature of the lender and the borrower.

Q9. What is the role of the Reserve Bank of India in the Indian banking system?

A9.​ Reserve Bank of India (RBI) supervises the functioning of the formal sources of
loans. For instance, we have seen that banks maintain a minimum cash balance
out of the deposits they receive. The RBI monitors the banks in actually
maintaining the required percentage of cash balance. Similarly, the RBI sees to it
that banks give out loans not to just profit making businesses but also to small
cultivators, small scale industries, small borrowers, etc. Periodically, banks have to
submit information to the RBI on how much they are lending, to whom, at what
interest rate, etc. The RBI is also the only organisation in India which van issue
currency.

Q10. Cheap and affordable credit is crucial for development. Justify.

A10. ​ Cheap and affordable credit is important due to the following reasons-

● Higher cost of borrowing means a greater part of the earnings is used to

repay the loan. Hence, borrowers have less income left for themselves.
● In some cases, high rates of interest mean that amount to be repaid to the
lender is greater than the borrower’s income.
● Also, people who might wish to start an enterprise by borrowing may not
do so because of high cost of borrowing.
● Banks and cooperative societies thus need to lend more. This would lead to
higher incomes and many people could then borrow cheaply for a variety of
purposes. They could grow crops, set up industries, etc. They could trade in
goods or start new businesses.
● Hence, cheap and affordable credit is crucial for the country’s
development.

Q11. How do Self-Help Groups (SHGs) operate?

A11. ​SHGs operate in the following manner-

● A typical SHG has 15-20 members typically belonging to the same
neighborhood, who meet and save regularly. Saving per member varies
from Rs. 25 to Rs. 100 or more, depending on the ability of the people to
save.
● Members can take small loans from the group itself to meet their needs.
The group still charges an interest on these loans, but it is still less than
what the moneylender charges.
 ● After a year or 2, if the group is regular in savings, it becomes eligible for
availing a loan from the bank. A loan is sanctioned in the name of the group
and is meant to increase self-employment opportunities for the members.
● Most of the important decisions regarding the savings and loan activities
are taken by the group members.
● The group decides as regards to the loans to be granted – the purpose, the
amount, interest to be charged, repayment schedule, etc.
● Also, it is the group which is responsible for the repayment of the loan. Any
case of non-repayment by any one member is followed up seriously by
other members of the group.

Q12. What are the advantages of Self Help Groups (SHGs)?

A12. ​SHGs provide its members with the following advantages-

● Small loans are provided to the members for releasing mortgaged land, for
meeting working capital needs (e.g. buying seeds, fertilizers, raw materials
like seeds, etc.), for housing materials for acquiring assets like sewing
machines, handlooms, cattle, etc.
● Self Help Groups (SHGs) help borrowers overcome the problem of lack of
collateral. They can get timely loans for a variety of reasons at a reasonable
interest rate.
● SHGs help women become financially self-reliant. 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.