| Latest Economics NCERT Notes, Solutions and Extra Q & A (Class 9th to 12th) | |||||||||||||||||||
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| 9th | 10th | 11th | 12th | ||||||||||||||||
| Class 10th Chapters | ||
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| 1. Development | 2. Sectors Of The Indian Economy | 3. Money And Credit |
| 4. Globalisation And The Indian Economy | 5. Consumer Right | |
Chapter 3 Money And Credit
This chapter explores two fundamental concepts that drive a modern economy: money and credit. It begins by explaining the essential function of money as a medium of exchange, which eliminates the major inefficiency of the barter system—the need for a 'double coincidence of wants'. Modern forms of money include not only physical currency (notes and coins) but also demand deposits held in banks, which can be used for payments via cheques. The chapter then explains how banks function as intermediaries, using the deposits of savers to provide credit (loans) to borrowers, and earning income from the difference in interest rates.
The second part delves into the dual nature of credit. Credit can play a positive role, enabling production and increasing income. However, it can also push a borrower into a debt-trap, a situation where repaying a loan becomes impossible, leaving the person worse off. The chapter introduces the crucial distinction between the Formal Sector of credit (banks and cooperatives), which is regulated by the RBI and offers reasonable "terms of credit," and the Informal Sector (moneylenders, traders), which is unregulated, charges exploitative interest rates, and often traps the poor. A major barrier for the poor in accessing formal credit is the lack of collateral. As a solution, the chapter highlights the role of Self-Help Groups (SHGs), which empower the poor, especially women, by pooling their savings and enabling them to access formal loans without collateral.
Money as a Medium of Exchange
Money is an integral part of our everyday life, facilitating numerous transactions. In most transactions, goods and services are bought and sold using money. The primary reason transactions are made in money is its function as a universally accepted medium of exchange.
The Barter System and Double Coincidence of Wants
Before the invention of money, goods were exchanged directly for other goods in a system known as the barter system. For this system to work, a crucial condition called double coincidence of wants had to be met. This means that what a person desires to sell is exactly what the other person wishes to buy.
For example, if a shoe manufacturer wants to buy wheat, under the barter system, he must find a farmer who not only wants to sell wheat but also wants to buy shoes in exchange. This process is highly inefficient and time-consuming.
Money as an Intermediate
Money solves the problem of double coincidence of wants by acting as an intermediate in the exchange process. It provides a crucial intermediate step that eliminates the need for a direct match between what two parties want to buy and sell.
The shoe manufacturer can first sell his shoes for money and then use that money to buy wheat from any farmer in the market. He no longer needs to find a farmer who is also in need of shoes.
Since money acts as an intermediary in the exchange process, it is called a medium of exchange. A person holding money can easily exchange it for any commodity or service they desire.
Modern Forms of Money
Throughout history, various objects have been used as money. In early ages, Indians used grains and cattle as money. Later, metallic coins made of gold, silver, and copper were introduced. Today, the forms of money are different.
Currency
Modern forms of money include currency, which consists of paper notes and coins. Unlike early forms of money, modern currency is not made of precious metals and has no intrinsic value or use of its own (e.g., you cannot eat a paper note or use a coin for anything other than a transaction).
So, why is it accepted as a medium of exchange?
- Government Authorization: It is accepted because the currency is authorised by the government of the country.
- Issued by Central Bank: In India, the Reserve Bank of India (RBI) issues currency notes on behalf of the central government. No other individual or organisation is allowed to issue currency.
- Legal Tender: The law legalises the use of the rupee as a medium of payment that cannot be refused in settling transactions in India. This makes it widely accepted.
Deposits with Banks
People also hold money in the form of deposits with banks. Individuals deposit their extra cash in banks by opening a bank account. This serves two purposes: the money is kept safe, and it earns interest.
People can withdraw this money from their accounts whenever they require it. Since these deposits can be withdrawn on demand, they are called demand deposits.
Demand deposits have the essential characteristics of money because they can be used as a medium of exchange through the facility of cheques.
Cheque Payments
A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued. This allows for direct settlement of payments without the use of cash. The money is transferred from one bank account to another in a couple of days.
Since demand deposits, facilitated by cheques, are widely accepted as a means of payment, they, along with currency, constitute money in the modern economy. The modern forms of money are thus closely linked to the working of the modern banking system.
Loan Activities of Banks and Terms of Credit
Loan Activities of Banks
Banks perform an interesting and crucial function in the economy. They act as intermediaries between those who have surplus funds (depositors) and those who are in need of funds (borrowers).
The mechanism is as follows:
- Banks accept deposits from the public.
- They keep a small proportion of these deposits as cash with themselves (in India, this is about 15%). This is to pay depositors who might come to withdraw money.
- The major portion of the deposits is used to extend loans for various economic activities.
- Banks charge a higher interest rate on loans than what they offer on deposits. The difference between these two rates is the main source of income for the banks.
Two Different Credit Situations
Credit (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. Credit can play a positive role, but it can also be detrimental, depending on the situation.
| Aspect | Situation 1: Salim (Positive Role) | Situation 2: Swapna (Negative Role - Debt Trap) |
|---|---|---|
| Purpose of Credit | To meet the working capital needs for producing 3,000 pairs of shoes for a festival season order. | To meet the expenses of cultivating groundnut on her land. |
| Risk | The risk of not being able to complete the order on time or the order being cancelled. | The risk of crop failure due to pests or adverse weather, making repayment difficult. |
| Outcome | Salim completed the order, made a good profit, and repaid the loan. Credit helped increase his earnings, leaving him better off. | The crop failed, making repayment impossible. The debt grew, forcing her to sell a part of her land. This is a debt-trap, where credit pushes the borrower into a situation from which recovery is very painful. |
Whether credit would be useful or not depends on the risks involved and whether there is some support in case of loss.
Terms of Credit
Every loan agreement has certain conditions that the borrower and lender agree upon. These are known as the terms of credit. They include:
- Interest Rate: The percentage of the principal amount that the borrower must pay to the lender as a fee for using the money.
- Collateral: An asset that the borrower owns (such as land, building, vehicle, or deposits with banks) and uses as a guarantee to a lender until the loan is repaid. If the borrower fails to repay, the lender has the right to sell the collateral to recover the loan amount.
- Documentation Requirement: Lenders require documents like proof of identity, address, and employment/income records.
- Mode of Repayment: This specifies the duration of the loan and the manner in which it will be repaid (e.g., in monthly instalments).
The terms of credit vary substantially depending on the nature of the lender and the borrower.
Example 1. A House Loan
Megha has taken a loan of $\text{₹} \ 5$ lakhs from the bank to purchase a house. The annual interest rate on the loan is 12 per cent and the loan is to be repaid in 10 years in monthly instalments. Megha had to submit to the bank, documents showing her employment records and salary before the bank agreed to give her the loan. The bank retained as collateral the papers of the new house, which will be returned to Megha only when she repays the entire loan with interest.
Answer:
The details of Megha’s housing loan are as follows:
- Loan Amount: $\text{₹} \ 5,00,000$
- Duration of Loan: 10 years
- Documents Required: Employment records and salary slips.
- Interest Rate: 12% per annum.
- Mode of Repayment: Monthly instalments.
- Collateral: The papers of the new house.
Formal and Informal Sector Credit in India
People obtain loans from various sources, which can be grouped into two categories: formal sector and informal sector.
- Formal Sector: This includes loans from banks and cooperative societies.
- Informal Sector: This includes loans from moneylenders, traders, employers, relatives, and friends.
The Reserve Bank of India (RBI) supervises the functioning of formal sources of loans. It monitors banks to ensure they maintain a minimum cash balance and give loans not just to profit-making businesses but also to small cultivators, small-scale industries, etc. However, there is no organization to supervise the credit activities of lenders in the informal sector.
Comparing Formal and Informal Lenders
The key differences between the two sectors are:
- Interest Rates: Informal lenders charge a much higher interest rate on loans compared to formal lenders. For example, a village moneylender might charge 5% per month (60% per annum), while a bank might charge around 8.5% per annum.
- Cost of Borrowing: The higher cost of informal loans means a larger part of the borrower's earnings is used to repay the loan, leaving less income for themselves. This can lead to a debt-trap.
- Supervision: The formal sector is supervised by the RBI, while the informal sector is not. Informal lenders can use unfair means to get their money back.
Cheap and affordable credit is crucial for the country’s development. Therefore, it is necessary for banks and cooperatives to lend more, especially in rural areas, to reduce dependence on the expensive and often exploitative informal sector.
Formal and Informal Credit: Who Gets What?
Data shows a significant disparity in access to formal and informal credit based on economic status.
Observations from data on urban and rural households show that:
- Poor Households: A vast majority of their loans (e.g., 85% for urban poor) come from informal sources.
- Rich Households: A vast majority of their loans (e.g., 90% for urban rich) come from formal sources.
This suggests two things: First, the formal sector meets only about half of the total credit needs of rural people. Second, the distribution of formal credit is unequal. Richer households avail cheap credit from formal lenders, while the poor have to depend on expensive informal sources. It is important that formal credit is distributed more equally so that the poor can benefit from cheaper loans.
Self-Help Groups for the Poor
Poor households remain dependent on informal sources of credit for several reasons. Banks are not present everywhere in rural India, and getting a bank loan is difficult due to the requirement of proper documents and, most importantly, collateral. Absence of collateral is a major reason preventing the poor from getting bank loans.
The Emergence and Functioning of SHGs
To address this problem, a new way of providing loans to the poor has emerged: organising rural poor, particularly women, into small Self-Help Groups (SHGs).
The functioning of a typical SHG is as follows:
- Formation and Savings: An SHG usually has 15-20 members from one neighbourhood. They meet and save regularly. The saving amount varies (e.g., $\text{₹} \ 25$ to $\text{₹} \ 100$ or more) depending on the members' ability.
- Internal Lending: Members can take small loans from the group's pooled savings to meet their needs. The group charges interest, but it is less than what moneylenders charge.
- Linkage with Banks: After a year or two of regular savings, the SHG becomes eligible for a loan from a bank. The loan is sanctioned in the name of the group.
- Decision Making: Most important decisions regarding savings and loans (purpose, amount, interest, repayment schedule) are taken by the group members. The group is collectively responsible for the repayment of the loan.
Benefits of SHGs
SHGs play a crucial role in empowering the poor, especially women.
- Overcoming Lack of Collateral: The collective guarantee of the group allows banks to lend to poor women even though they have no individual collateral. This is the most significant benefit.
- Timely and Affordable Loans: Members can get timely loans for a variety of purposes (e.g., working capital, buying assets like sewing machines, releasing mortgaged land) at a reasonable interest rate.
- Financial Self-Reliance: SHGs help women to become financially self-reliant.
- Social Empowerment: The regular group meetings provide a platform for members to discuss and act on various social issues such as health, nutrition, and domestic violence. SHGs are the building blocks of organisation for the rural poor.
Grameen Bank of Bangladesh
The Grameen Bank of Bangladesh is a prime example of the success of micro-credit. Founded by Professor Muhammad Yunus, it has provided credit at reasonable rates to millions of poor people, mostly women. It has demonstrated that poor women are reliable borrowers and can run successful small-scale income-generating activities.
NCERT Questions Solution
Intext Questions (Pages No. 40)
Question 1. How does the use of money make it easier to exchange things?
Answer:
Question 2. Can you think of some examples of goods / services being exchanged or wages being paid through barter?
Answer:
Intext Questions (Pages No. 42)
Question 1. M. Salim wants to withdraw Rs 20,000 in cash for making payments. How would he write a cheque to withdraw money?
Answer:
Question 2. Tick the correct answer.
After the transaction between Salim and Prem,
(i) Salim’s balance in his bank account increases, and Prem’s balance increases.
(ii) Salim’s balance in his bank account decreases and Prem’s balance increases.
(iii) Salim’s balance in his bank account increases and Prem’s balance decreases.
Answer:
Question 3. Why are demand deposits considered as money?
Answer:
Intext Questions (Pages No. 44)
Question 1. Fill the following table.
| Salim | Swapna | |
|---|---|---|
| Why did they need credit? | ||
| What was the risk? | ||
| What was the outcome? |
Answer:
Question 2. Supposing Salim continues to get orders from traders. What would be his position after 6 years?
Answer:
Question 3. What are the reasons that make Swapna’s situation so risky? Discuss factors – pesticides; role of moneylenders; climate.
Answer:
Intext Questions (Pages No. 45)
Question 1. Why do lenders ask for collateral while lending?
Answer:
Question 2. Given that a large number of people in our country are poor, does it in any way affect their capacity to borrow?
Answer:
Question 3. Fill in the blanks choosing the correct option from the brackets.
While taking a loan, borrowers look for easy terms of credit. This means __________ (low/high) interest rate, ______________(easy/tough) conditions for repayment, ___________(less/more) collateral and documentation requirements.
Answer:
Intext Questions (Pages No. 47)
Question 1. List the various sources of credit in Sonpur.
Answer:
Question 2. Underline the various uses of credit in Sonpur in the above passages.
Answer:
Question 3. Compare the terms of credit for the small farmer, the medium farmer and the landless agricultural worker in Sonpur.
Answer:
Question 4. Why will Arun have a higher income from cultivation compared to Shyamal?
Answer:
Question 5. Can everyone in Sonpur get credit at a cheap rate? Who are the people who can?
Answer:
Question 6. Tick the correct answer.
(i) Over the years, Rama’s debt
· will rise.
· will remain constant.
· will decline.
(ii) Arun is one of the few people in Sonpur to take a bank loan because
· other people in the village prefer to borrow from the moneylenders.
· banks demand collateral which everyone cannot provide.
· interest rate on bank loans is same as the interest rate charged by the traders.
Answer:
Question 7. Talk to some people to find out the credit arrangements that exist in your area. Record your conversation. Note the differences in the terms of credit across people.
Answer:
Intext Questions (Pages No. 50)
Question 1. What are the differences between formal and informal sources of credit?
Answer:
Question 2. Why should credit at reasonable rates be available for all?
Answer:
Question 3. Should there be a supervisor, such as the Reserve Bank of India, that looks into the loan activities of informal lenders? Why would its task be quite difficult?
Answer:
Question 4. Why do you think that the share of formal sector credit is higher for the richer households compared to the poorer households?
Answer:
Exercises
Question 1. In situations with high risks, credit might create further problems for the borrower. Explain.
Answer:
Question 2. How does money solve the problem of double coincidence of wants? Explain with an example of your own.
Answer:
Question 3. How do banks mediate between those who have surplus money and those who need money?
Answer:
Question 4. Look at a 10 rupee note. What is written on top? Can you explain this statement?
Answer:
Question 5. Why do we need to expand formal sources of credit in India?
Answer:
Question 6. What is the basic idea behind the SHGs for the poor? Explain in your own words.
Answer:
Question 7. What are the reasons why the banks might not be willing to lend to certain borrowers?
Answer:
Question 8. In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this necessary?
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Question 9. Analyse the role of credit for development.
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Question 10. 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.
Answer:
Question 11. 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?
(b) What are the other sources from which the small farmers can borrow?
(c) Explain with an example how the terms of credit can be unfavourable for the small farmer.
(d) Suggest some ways by which small farmers can get cheap credit.
Answer:
Question 12. Fill in the blanks:
(i) Majority of the credit needs of the _________________households are met from informal sources.
(ii) ___________________costs of borrowing increase the debt-burden.
(iii) __________________ issues currency notes on behalf of the Central Government.
(iv) Banks charge a higher interest rate on loans than what they offer on __________.
(v) _______________ is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.
Answer:
Question 13. Choose the most appropriate answer.
(i) In a SHG most of the decisions regarding savings and loan activities are taken by
(a) Bank.
(b) Members.
(c) Non-government organisation.
(ii) Formal sources of credit does not include
(a) Banks.
(b) Cooperatives.
(c) Employers.
Answer: