Money and Credit

1. Why this chapter matters

Look around on any single day and you will spot dozens of transactions running on money — buying milk, paying a bus fare, getting a salary, even a promise to pay later. The chapter has two big halves:

• Money: what it is, why we use it, and the modern forms (currency + bank deposits) linked to the banking system.
• Credit (loans): how borrowing can help or hurt people, the terms of credit, the sources of credit, and why the poor need cheap formal credit.

The thread joining both halves: a healthy banking system that takes deposits and lends them out fairly is essential for a country's development.

2. Money as a medium of exchange

Before money, people bartered — directly swapping one good for another. The trouble is the double coincidence of wants: what one person wants to sell must be exactly what the other wants to buy, at the same time.

Because money can be exchanged for any good or service, everyone prefers to be paid in money. Since money acts as an intermediate in exchange, it is called a medium of exchange.

3. Modern forms of money — currency

Earlier, money had real value of its own: grain and cattle in early ages, then metallic coins of gold, silver and copper. Modern currency — paper notes and coins — is different: it is not made of any precious metal and has no use of its own.

So why is a plain piece of paper accepted as money? Because it is authorised by the government of the country.

4. Modern forms of money — deposits with banks

People do not need all their money in cash at once. A worker paid at month-end deposits the surplus in a bank account. The bank keeps it safe and pays interest on it, and the depositor can withdraw the money on demand whenever needed. Because they can be withdrawn on demand, these are called demand deposits.

The most important feature of demand deposits is that they can be used to make payments without cash, through a cheque. A cheque is a paper instructing the bank to pay a specific amount from the payer's account to the person named on it.

Since demand deposits are widely accepted as a means of payment, together with currency they make up the money in the modern economy. Today payments also flow digitally — by debit/credit cards, internet & mobile banking, and UPI/QR systems — all built on these bank deposits.

5. Loan activities of banks

What do banks do with the deposits they collect? They keep only a small part as cash (about 15 per cent in India) to pay any depositors who come to withdraw on a given day. Since only a few withdraw on any one day, this cushion is enough.

The major portion of deposits is used to give loans, because there is a huge demand for credit for various economic activities. In this way banks mediate between depositors (who have surplus funds) and borrowers (who need funds).

Think it through: if all depositors demanded their money on the same day, the bank could not pay — because most of it has been lent out. This is exactly why the RBI requires banks to hold a minimum cash balance.

6. What is credit? Two different situations

Credit (loan) is an agreement in which the lender supplies the borrower with money, goods or services in return for the promise of future payment. Whether credit helps or harms depends on the situation. NCERT gives two contrasting cases.

The lesson: in one case credit increases earnings; in the other, crop failure pushes the borrower into a debt-trap. Whether credit is useful depends on the risks in the situation and on whether there is some support in case of a loss.

7. Terms of credit

Every loan agreement specifies an interest rate that the borrower must pay along with repayment of the principal (the amount borrowed). Lenders may also demand collateral.

The terms of credit = interest rate + collateral + documentation requirement + mode of repayment. They vary a lot from one lender to another, depending on the nature of the lender and the borrower.

Why this matters for the poor: borrowers prefer easy terms — low interest, easy repayment conditions, and less collateral/documentation. The poor often own little collateral, so banks hesitate to lend to them, and they fall back on costly informal lenders.

8. Variety of credit arrangements — the Sonpur village survey

To see how terms of credit differ in real life, NCERT follows a survey (15 Nov 2019) in Sonpur, a small irrigated village. The same activity — growing potatoes — but very different terms for different people:

• Shyamal (small farmer, 1.5 acres): earlier borrowed from the village moneylender at 5% per month (60% per annum); now borrows from an agricultural trader at 3% per month, but must promise to sell the crop to the trader, who then buys it cheap and profits.
• Arun (medium farmer, 7 acres): gets a bank loan at just 8.5% per annum, repayable over three years. He repays after selling part of the crop, stores the rest in cold storage, and takes a fresh bank loan against the cold-storage receipt — so he earns more.
• Rama (landless labourer): depends on her employer (a landowner) for credit at 5% per month, repaying by working for him. She is almost always in fresh debt before clearing the old, currently owing Rs 5,000. For the landless, the only source of credit is the landlord-employer.
• Cooperatives: besides banks, a major source of cheap rural credit. Members pool resources; the cooperative takes a large bank loan against these deposits as collateral and re-lends to members for implements, cultivation, fishery, housing, etc.

Pattern: the better-off (Arun) get cheap formal credit; the poor (Shyamal, Rama) are stuck with costly informal credit on harsh terms.

9. Formal vs informal sources of credit

All loans fall into two groups:

• Formal sources: banks and cooperatives. Supervised by the RBI.
• Informal sources: moneylenders, traders, employers, relatives and friends. No supervision.

Why high interest is harmful: a higher cost of borrowing means a larger part of the borrower's earnings goes to repay the loan, leaving less to live on. Sometimes the amount to be repaid is greater than total income — leading to a growing debt and a debt-trap (as for Rama). High cost also discourages people from starting enterprises. So cheap and affordable credit is crucial for development.

Two needs for development: (1) banks and cooperatives must increase lending, especially in rural areas, so dependence on informal credit falls; and (2) formal credit must be distributed more equally so that the poor — not just the rich — benefit from cheaper loans.

10. Self-Help Groups (SHGs) for the poor

Why do the poor still depend on informal credit? Banks are not present everywhere in rural India, and even where present, a bank loan needs proper documents and collateral. The poor lack collateral, so they are turned away. Moneylenders, who know borrowers personally, lend without collateral — but charge very high interest, keep no records, and harass borrowers.

Why banks lend to SHGs without collateral: the loan is sanctioned in the name of the group, and the group itself is responsible for repayment. The group decides the loan's purpose, amount, interest and schedule, and any non-repayment by a member is followed up seriously by other members. This peer pressure replaces collateral, so banks are willing to lend to poor women in SHGs.

What SHG loans are used for: releasing mortgaged land, working capital (seeds, fertilisers, bamboo, cloth), housing, and assets like sewing machines, handlooms and cattle — creating self-employment.

Bigger benefits: SHGs help the poor overcome the lack of collateral, get timely loans at reasonable rates, make women financially self-reliant, and become a platform to discuss social issues like health, nutrition and domestic violence.

11. NCERT Exercises — fully answered (Q1-Q13)

Q1. In situations with high risks, credit might create further problems for the borrower. Explain.

When a borrower invests in a high-risk activity (e.g. a single rain-fed crop) and the activity fails, there is no income to repay the loan. The unpaid amount keeps growing with interest. To clear it, the borrower may have to sell assets like land and ends up worse off — a debt-trap, as happened to Swapna. So credit helps only when risk is low or some support exists against loss.

Q2. How does money solve the problem of double coincidence of wants? Explain with an example of your own.

In barter, an exchange needs a double coincidence — both parties must want exactly what the other offers. Money removes this by acting as a medium of exchange. Example: a music teacher who wants to buy a bicycle need not find a cycle seller who wants music lessons. She simply takes money as her fee from students, then pays money to any bicycle seller.

Q3. How do banks mediate between those who have surplus money and those who need money?

Banks accept deposits from people with surplus funds and pay them interest. They keep a small cash reserve (~15%) and lend the rest to borrowers who need funds, charging higher interest. Thus banks channel idle savings to productive uses, earning the difference between interest charged and paid.

Q4. Look at a 10 rupee note. What is written on top? Can you explain this statement?

On top is written "Reserve Bank of India", and it carries the words "I promise to pay the bearer the sum of ten rupees" with the Governor's signature. It means the RBI issues the note on behalf of the central government and guarantees its value; this government authorisation is why the note is accepted as a medium of exchange.

Q5. Why do we need to expand formal sources of credit in India?

• To reduce dependence on informal sources (moneylenders) that charge very high interest.
• To free borrowers from debt-traps caused by high interest.
• To provide cheap, affordable credit that lets people grow crops, set up enterprises and trade — essential for development.
• To ensure the poor also get a fair share of cheap formal loans, not just the rich.

Q6. What is the basic idea behind the SHGs for the poor? Explain in your own words.

The basic idea is to organise the rural poor (mostly women) into small groups who pool their regular savings. Members borrow from this pool, and after regular saving the group becomes eligible for a bank loan in the group's name. The group guarantees repayment, so banks lend even without collateral. SHGs give the poor timely, low-cost credit and help them become self-reliant.

Q7. What are the reasons why the banks might not be willing to lend to certain borrowers?

Banks may refuse when borrowers lack collateral and proper documents, when there is a high risk the loan will not be repaid (e.g. uncertain income, crop failure), or when there is no proof of regular income / repaying capacity. This is why many poor people cannot get bank loans.

Q8. In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this necessary?

The RBI monitors the minimum cash balance banks keep, ensures banks lend to small cultivators, small industries and small borrowers (not only big businesses), and makes banks periodically report how much they lend, to whom and at what interest rate. This is necessary to keep banks safe, protect depositors' money, and ensure credit reaches all sections fairly.

Q9. Analyse the role of credit for development.

Cheap credit lets people grow crops, set up small-scale industries, and run businesses, raising their incomes and the country's output. Higher incomes let more people borrow and invest further. But credit also has a dual nature — at high cost or high risk it can create debt-traps. Hence cheap and affordable credit, equally distributed, is crucial for development.

Q10. Manav needs a loan to set up a small business. On what basis will Manav decide whether to borrow from the bank or the moneylender? Discuss.

Manav will compare the terms of credit: (a) interest rate — banks charge much less; (b) collateral and documents — banks demand them, the moneylender may not; (c) availability and convenience — moneylenders are nearby and quick; (d) repayment conditions. If he has collateral and documents, the cheaper bank loan is better; if not, he may be forced to the moneylender despite the high cost.

Q11. In India, about 80 per cent of farmers are small farmers, who need credit for cultivation.

• (a) Why might banks be unwilling to lend to small farmers? Small farmers often lack collateral and documents, and crop income is uncertain (risk of failure), so banks fear non-repayment.
• (b) What are the other sources from which small farmers can borrow? Informal sources — moneylenders, traders, landlords, relatives and friends — and cooperatives or SHGs.
• (c) Explain with an example how the terms of credit can be unfavourable for the small farmer. A trader lends to Shyamal only on the condition that he sell his crop to the trader at a low price; or a moneylender charges 5% per month (60% a year). Such harsh terms leave the farmer little or push him into debt.
• (d) Suggest some ways by which small farmers can get cheap credit. Expand bank and cooperative lending in rural areas, form SHGs for collateral-free group loans, and have the RBI ensure banks lend to small borrowers at reasonable rates.

Q12. Fill in the blanks:

• (i) Majority of the credit needs of the poor households are met from informal sources.
• (ii) Higher costs of borrowing increase the debt-burden.
• (iii) Reserve Bank of India issues currency notes on behalf of the Central Government.
• (iv) Banks charge a higher interest rate on loans than what they offer on deposits.
• (v) Collateral is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.

Q13. Choose the most appropriate answer.

• (i) In an SHG most of the decisions regarding savings and loan activities are taken by — (b) Members.
• (ii) Formal sources of credit does not include — (c) Employers.

12. Common confusions cleared

• Currency vs deposits: both are money. Currency = notes & coins; demand deposits = money in your bank account, spendable by cheque/UPI.
• "Demand deposit" ≠ a special scheme — it just means the deposit can be withdrawn on demand (any time).
• Collateral vs interest: interest is the extra paid for using the loan; collateral is the asset pledged as security. Different things.
• Formal source ≠ government source. Formal = banks + cooperatives supervised by the RBI; cooperatives need not be government-owned.
• Cooperatives are FORMAL; moneylenders, traders and employers are INFORMAL.
• Credit is not always bad — it helped Salim. It harms only with high risk or harsh terms (Swapna).
• The RBI does not supervise informal lenders — that is exactly why their interest is unchecked.

13. Quick revision checklist

• Money = medium of exchange; removes the double coincidence of wants.
• Modern money = currency (RBI-issued) + demand deposits (cheque/UPI).
• Banks keep ~15% cash, lend the rest; income = loan interest − deposit interest.
• Credit = loan against a promise of future payment; helps (Salim) or traps (Swapna).
• Terms of credit = interest + collateral + documentation + mode of repayment.
• Formal = banks & cooperatives (RBI-supervised); informal = moneylenders, traders, employers (costly, unsupervised).
• SHGs: 15-20 members, pooled savings, group-guaranteed bank loans without collateral; Grameen Bank (Yunus, Nobel 2006).
• Goal: expand cheap formal credit and share it equally for development.