Chapter – 3

Money And Credit

Q1) How does the use of money make it easier to exchange things?
Ans: (a) Use of money as a medium of exchange has removed the major difficulty of double
coincidence of wants in the barter system.
(b) A person holding money can easily exchange commodity or service that he wants thus
everyone prefers to receive payment in money for things that they exchange.
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Q2) What is meant by double coincidence of wants? Explain with the help of an example.

Ans: It means that both the parties i.e. buyer and the seller have to agree to sell and buy each other’s
commodities. That is what a person desires to sell is exactly what the other wishes to buy.
For example – A shoe manufacturer wants to sell shoes and buy wheat. He will have to look for a
wheat growing farmer who not only wants to sell wheat but also wants to buy the shoes in exchange.
In barter system double coincidence of wants is an essential feature.
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Q3) How does money solve the problem of double coincidence of wants?
Ans: (a) In a barter system, commodities are exchanged with commodities without the use of money.
But in such a system, the two parties are required to be ready to sell and buy each other’s
commodities. This is called Double Coincidence of Wants.

(b) But if the transactions is made in money, then there is no need of double coincidence of wants
because everyone accepts money as a medium of exchange.

(c) With the help of money one can buy a commodity of his choice whenever he so desires.
Therefore money makes the economic activities convenient and simple.
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Q4) Why is money called a Medium of Exchange?
Ans: Money acts as an intermediate in the exchange process that is why it is called a medium of
exchange. Medium of exchange is the primary function of money.
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Q5) Why are demand deposits considered money?

Ans: (a) The facility of cheque against demand deposits make it possible to directly settle payments
without the use of cash.
(b) Since demand deposits are accepted as a means of payment along with currency, they are
considered money in modern economy.
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Q6) Why do money lenders ask for Collateral while lending?
Ans: If the borrower fails to repay the loan, the lender has the right to sell the collateral or asset to
obtain payment.
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Q7) What is meant by Collateral?
Ans: Collateral is an asset that the borrower owns (such as land, building, vehicle, livestock, deposits of
banks) and uses this as a guarantee to a lender until the loan is repaid.
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Q8) What is credit?

Ans: Credit or loan refers to an agreement in which the lender supplies the borrower with money,
goods or services in return for the promise of future payment.
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Q9) What are the differences between formal and informal sources of credit?
Ans:
S.No Formal Source S.No Informal Source
1. These are loans which are taken from the 1. Informal Loans are those which are taken
banks or the cooperatives. from money lenders, traders, employers,
relatives, etc...
2. The rate of interest is usually about 8 to 2. The rate of interest is quite high like 3 to
10% a year. 5% per month which comes out to be 36%
to 60% per annum.
3. Former sector loans do not exploit the 3. In the Informal Sector, the lender
borrower by putting unreasonable sometimes put unreasonable conditions on
conditions on them. the borrower that he has to sell the
produce to him only at a low price.

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Q10) Why should credit at reasonable rates be available for all?
Ans: Credit at reasonable rates should be available to all so that:
(a) The poor households do not have to pay a heavy price for borrowing in the form of high rate of
interest in the informal sector. This can save many people in rural areas for the situation of debt trap.
(b) Credit at lower rate of interest means a small part of earnings of the borrower is used to repay the
loan. It means higher incomes for the borrower. Many people could then borrow cheaply for a variety
of needs.
(c) Cheap and affordable credit is crucial for the country’s development, therefore banks and
cooperative societies need to lend more. People could borrow to grow crops, do business, set up small-
scale industries etc.
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Q11) Why do you think that the share of formal sector credit is higher for the richer households
compared to the poorer households?

Ans: The share of formal sector credit is higher for the richer households because they are considered
to be credit worthy as they are able to give collateral to the banks and the proper documents
required for credit.
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Q12) How do banks mediate between those who have surplus money and those who need money?

Ans: (a) There are two types of people who go to banks – One who have surplus money to deposit and
the other who want to take loan from the bank. The banks mediate between these 2 types of people.
(b) The bank pays interest to the depositors. Bank charges higher interest rate from the borrowers
than what they pay to the depositors.
(c) Thus the difference of what they charge from the borrowers and what they offer to the
depositors is the main source of income of the bank.
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Q13) Look at a 10 Rupee Note. What is written on top? Can you explain this statement?
Ans: If we look at a 10 Rupee Note, We find the following words written on top:
Reserve Bank Of India
Guaranteed by the Central Govt.
I promise to pay the bearer
The sum of Ten Rupees
Signed
Governor of The Reserve Bank
This means that the Reserve Bank of India has been authorised by the Central Government to issue 10
Rupees Note and the Governor of this bank promises to pay Rs. Ten to the Bearer of this note. Without
this authority given by the Central Government the 10 Rupees note is a mere piece of paper and
nothing else.
It is the authority of the Central Government which makes it a legal Currency.
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Q14) Why do we need to expand the Formal sources of credit in India?
OR
Why should the banks and cooperative societies provide more loans to rural people?
Ans: (a) Cheap and affordable credit by banks and cooperatives is crucial for the country’s
development. When they lend at a low rate of interest many people could borrow cheaply for a
variety of needs. They could grow crops, do business, set up small scale industries or trade in goodsetc.

(b) There should be equitable distribution of loans, banks should not just give loans to profit making
businesses and traders but they should also lend to small cultivators, small borrowers so that the poor
can also take the benefit of cheaper loans.

(c) To protect the rural people from the clutches of the money lenders, landowners, agricultural
traders who charge high rates of interest which makes their life miserable. The poor villagers find
themselves into the state of debt trap. Money lenders use unfair means to get their money back.
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Q15) What is the basic idea behind the SGHs for the poor?
Ans: (a) The idea is to organise rural poor especially women into small Self Help Groups so that they
pool their savings. These groups can have 15-20 members, usually belonging to one neighbourhood
who meet and save regularly.

(b)Thus it helps the borrower to overcome the problem of lack of collateral.

The members can get timely loans for a variety of purposes and at a reasonable interest rate.

(c) The regular meetings of the group provide a platform to discuss and act on a variety of social
issues such as health, nutrition, etc.…
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Q16) What are the reasons, when the banks might not be willing to lend to certain borrowers?
Ans: The banks are sometimes not willing to lend to certain borrowers because of the following
reasons:

(a) Some persons are not able to produce certificate of their income. There are people who are not
able to produce documents of their employment.

(b) Some people have nothing to give to the bank as surety/collateral i.e. land, house, etc.

(c) Sometimes people fail to produce 2 persons who can give their guarantee in case he is unable to
repay the loan.
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Q17) In situations with high risk, the credit might create further problems for the borrower. Explain
Ans: It is clear from the following example that the credit might create further problems for the
borrower in situations with high risk.

(a) If a small farmer like Swapna takes loan from the moneylender to meet the expenses of
cultivation with the hope that her harvest would help her repay the loan.

(b) But if the crop fails due to pests or lack of rain, then it would be impossible for her to pay back
the loan to the money lender. In this case, the loan along with interest would grow into a large
amount.

(c)In the next year, even if the harvest is normal, she would not be in the position to repay all the
loan and as a result would be forced to sell a part of the land to repay the loan.

Thus, in high risk situations, credit creates further problems for the borrower.
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Q18) In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this
necessary?
OR
RBI plays a crucial role in controlling the formal sector. Explain.
Ans: The RBI keeps a check on the different financial activities of the banks in a number of ways:

(a) The banks have to maintain a minimum cash balance out of the deposits they receive from the
public. The RBI monitors the cash balance of different banks.

(b)The RBI sees that the banks give loans not just to profit – making businesses and traders but also
to small cultivators, small scale industries, small borrower, etc.

(c)The RBI sees that the different banks periodically submit information to it on how much they are
lending to the people, to whom they are lending and at what interest rates. Such supervision
by the RBI on the working of the other banks is quite necessary to keep them under control and
to see that there is no mismanagement.
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Q19) Analyse the role of credit for development.
Ans: (a) It helps in increasing economic activities of the borrowers.

(b) If credit is made available to the poor people on reasonable terms and Conditions, they can
improve their economic condition which in turn will help them to have standard of living. This
will help in the overall development.

(c)Credit may increase the activities in the secondary sector i.e. manufacturing sector which plays
an important role in the development of the country.
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Q20) In India, about 80 % of farmers are small farmers, who need credit for cultivation.
(a) Why might banks be unwilling to lend to small farmers?
(b) From whom do these small farmers usually borrow?
(c) Explain with an example how the terms of credit can be unfavourable for the small farmers.
(d) Suggest some ways by which small farmers can get cheap credit.

Ans: (a)The banks are unwilling to lend to small farmers due to following reasons:
(i) The small farmers cannot give any proof of their income.
(ii) They are not able to give anything as guarantee to the bank against loans.
(iii) No one is ready to stand as surety for small farmers.
(b) They often borrow from a money lender or a trader who supplies him seed and other
implements.

(c)If the farmer borrows from either a money lender or a local trader, he will always be at a loss
because he will have to pay a high rate of interest which approximately comes out to be 36% to
60% per annum and sometimes that the crop will be sold to the trader at a price which is lower
than the market price.

(d) Small farmers can get cheap loan from cooperatives which give loans to their members at a
cheap rate.
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Q21) What role do the banks play in the economy of a country?
Ans: (a)They keep the surplus money of the people in safe custody.
(b)They add on to the income of the depositors by giving them interest on the deposits kept by
them.
(c)The banks mediate between those who have surplus money and those who need credit.
d)Banks promote agriculture by providing loans to the farmers who can increase their
production by making better arrangement of irrigation etc.
e) Industries also get a boost as the banks provide cheap loans to the industrialists, thus they are the
backbone of the country’s trade.
(f) Banks employ a large number of people and are a source of livelihood.
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Q22) State which requirements a borrower has to fulfil before taking a loan.
Ans: (a) A certificate of salary or income. Documents of his/her employment record.

(b) The papers of the new asset which the borrower is buying as collateral security or any other
asset which the borrower owns.

(c) The bank can also ask for one or two sureties of such persons who are ready to repay the loan
in case the borrower fails to repay his loan.
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Q23) Mention the factors responsible for dependence on informal sources of credit of the rural people.
Ans: (a) Banks are not present everywhere in the rural areas whereas the informal sources are easily
available in the villages.

(b) Getting a loan from the bank is much more difficult than taking from informal source as the
banks require proper documents and collateral which most of the poor people don’t have.

(c)The Formal sources provide loan only for productive purposes whereas the informal sources
provide credit for productive and non – productive purposes ( for example marriage, treating illness)

Therefore keeping in mind the limitations of both formal and informal sources of credit, people have
evolved new ways and have organised themselves into Self Help Groups.
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Q24) What are the features of Self Help Groups?
OR
What is the idea behind forming Self Help Groups? Explain their functions.
Ans: The idea is to organise rural poor in particular women into Self Help Group and pool or collect
their savings.
Functions Or Features –
(a) Membership: 15 – 20 members belonging to one neighbourhood can form a Self Help Group.
(b) Pooling Small Savings: The savings of the poor people can vary from Rs. 25 to Rs. 100 per member.
(c) Low Rate of Interest: SGH’s charge very low rate of interest from its members.
(d) Small Loans: The members of SGH’s can take small loans from the group itself to meet their needs.
(e) Loans from Banks: The SGH’s become eligible for taking loans from the bank after one or two years.
(f) Self Reliance: These groups are being organised by women and helps to make them financially self-
Reliant.
(g) Platform to Discuss Social Issues:It provides a platform for women to discuss a variety of social
issues like health, domestic violence, etc.
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Q25) What is meant by Debt trap?
Ans: (a)The informal sector charges a very high rate of interest from the borrower which means a large
part of the earnings of the borrowers is used to repay the loan.

(b)As a result the borrower is left with less income for himself and his family.

(c)Sometimes the high interest rate leads to a larger amount to be repaid by the borrower than
his income. This is called Debt Trap.

Q26) Mention the positive and negative impact of credit.

Ans: (a) Credit helps to increase earnings of the borrower and therefore the person is in a
better off situation than before.
Eg. As in case of Salim, who obtains loan /credit to meet the working capital needs of his production of
shoes. The credit helps him to meet his ongoing expenses of production, complete production on time,
and thereby increase his earning. Credit therefore plays a vital and positive role in this situation.

(b) On the other side, due to crop failure, credit pushes the person into debt trap. Sometimes the
borrower has to sell a portion of his land to pay off the loan and thus the condition of the
borrower becomes worse than before.
Eg. As in case of Swapna, who took credit from a moneylender to meet the expenses of cultivation but
due to failure of the crop, loan repayment became impossible. She had to sell a piece of her land to
pay off the dedt. Credit in this case pushes the borrower into a situation from which recovery is
painful.
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Q27) Define the term ‘Money’.
Ans: Money may be defined as anything which is generally accepted by the people in exchange of
goods and services or in repayment of debts. It acts as an intermediate in exchange process. It is a
medium of exchange.
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Q28) What does ‘Terms of credit’ include?
Ans: While giving loan, the lender specifies certain terms and conditions relating to the loan to be
followed by the borrower are known as Terms of credit.
It includes:
(a) Interest rate
(b)Collateral and documentation required.
(c)Mode of payment, etc.
These terms vary depending on the nature of borrower and lender.
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Q29) Explain ‘Barter Exchange System’ with the help of an example.
Ans: It implies direct exchange of goods against goods without use of money is called Barter Exchange
System. It is also called Commodity for Commodity Exchange Economy.
Eg. When a weaver gives cloth to the farmer in return for getting wheat from the farmer, it is called
Barter Exchange.
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Q30) List some items which are kept as collateral security against loans. What happens if a borrower
fails to repay the loans?
Ans: Collateral refers to use of assets by the borrower as a guarantee to a lender until the loan is
repaid. Items which can be kept as collateral are land tiles, deposits with the banks, livestock, etc.
The lender has the right to sell the collateral items to obtain payment if the borrower fails to
repay the loan.

Q31) The modern currency is without any use of its own as a commodity? Why it is accepted as
money?
Ans: Modern currency is without any use of its own as it is not made of precious metal such as gold,
silver, etc. But still it is accepted by all as a medium of exchange because:
(a) It is authorised by the Government of the country
(b) In India, the law legalises the use of Rupee as a medium of payment which cannot be refused in
settling transactions in India. No individual can refuse a payment in Rupee.
(c) In India, The value of each good or service is measured in Rupee.
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Q32) What are the functions of money?
Ans: (a) Medium of Exchange.
(b) Measure of Value.
(c) Store of Value
(d) Standard of Demand payments
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Q33) ‘Cheap and affordable credit is crucial for the country’s development’. Explain.
Ans:Cheap and affordable credit is crucial because:
(a) To Increase The Income: Cheap credit means high income for the farmers and the traders as they
will have to pay less interest on credit.

(b) To Avoid Debt Trap: Low interest rates can save the people from debt trap and would make them
economically stronger.

(c) Low cost of Production: Cheap credit would lower the cost of production which would help in
increasing the profits of the people.

(d) Growth of the Country: People would be encouraged to expand their business or can grow more
crops which would increase production in turn growth of the country.
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Q34) What are Demand Deposits? What are their advantages?
Ans: The deposits in the bank accounts which can be withdrawn on demand are known as Demand
Deposits.
Advantages:
(a) People earn interest on demand deposits.
(b) The depositors can make payment through a cheque.
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Look for the answers of the following questions : ( 1 markers )

Q1. What is the source of income of the banks?

Q2. How is money transferred from one bank account to another bank account? Explain with the help
of an example.

Q3. What are the benefits of SHGs for the poor people?

Q4. Recognise the situation when both parties in a barter system have to agree to sell and buy each
other’s commodities what is it called?

Q5. Why are banks willing to lend the SHGs even though they have no collateral?

Q6. ‘SHGs are building blocks of organisation of the rural poor’, Explain.

Q7. Why are poor households still dependent on informal sources of credit?

Q8.What is collateral?