Medium of Exchange:


Barter  System:  Before  the  advent  of  money,  people  used to follow the  bartersystem of exchange. Suppose somebody has surplus vegetables and he needs wheatin  lieu  of  that  then  he  could  find  a  person  who  has  surplus  wheat  and  needsvegetables.


Double Coincidence of wants:


The major feature or rather drawback of the barter system was the coincidence ofwants. It used to be difficult to find a person who can fulfill the coincidence of wants.Moreover,  it  was  impractical  and  difficult  to  carry  heavy  goods  for  barter.  Thisrestricted the economic activity.




In the historical period coins of precious metals started getting used as medium ofexchange and this  was  the birth of  money.  As  precious  metals  were difficult  toprocure so slowly paper money or currency notes began to replace them. Now thegovernment or government authorized body in a country issues currency notes forcirculation.

In India, the Reserve Bank of India issues currency notes. On the currency note youcan observe the statement promising a particular amount to be paid to the bearer ofthe currency note.

Money  removed  the  coincidence  of  wants  factor  and  smoothened  exchangefacilitating economic activity.



Other Forms of Money

Deposits with Banks

The other form in which people hold money is as deposits with banks. At a point oftime, people need only some currency for their day-to-day needs. Banks accept thedeposits and also pay an interest rate on the deposits. In this way people’s money issafe with the banks  and it  earns  an interest.  People also  have the provision towithdraw the money  as  and when they require.  Since  the deposits  in the bankaccounts can be withdrawn on demand, these deposits are called demand deposits.The facility of cheques against demand deposits makes it possible to directly settlepayments without the use of cash. Since demand deposits are accepted widely as ameans  of  payment,  along  with  currency,  they  constitute  money  in  the  modern




Banks keep only a small proportion of their deposits as cash with themselves. Forexample, banks in India these days hold about 15 per cent of their deposits as cash.This is kept as provision to pay the depositors who might come to withdraw moneyfrom the bank on any given day. Since, on any particular day, only some of its many

depositors come to withdraw cash, the bank is able to manage with this cash. Banks

use the major portion of the deposits to extend loans. There is a huge demand forloans for various economic activities.

Banks make use of the deposits to meet the loan requirements of the people. In thisway,  banks mediate between those who have surplus  funds (the depositors) andthose who are in need of these funds (the borrowers). Banks charge a higher interestrate on loans than what they offer on deposits.  The difference between what ischarged  from borrowers  and  what  is  paid  to depositors  is  their  main  source  of


A large number of  transactions in our day-to-day activities involve credit  in someform or the other. Credit (loan) refers to an agreement in which the lender suppliesthe borrower  with money,  goods  or  services  in return for  the promise  of  futurepayment.




Every loan agreement specifies an interest rate which the borrower must pay to thelender  along  with  the  In  rural  areas,  the  main  demand  for  credit  is  for  cropproduction.  Crop  production  involves  considerable  costs  on  seeds,  fertilisers,pesticides, water, electricity, repair of equipment, etc. There is a minimum stretch ofthree to four months between the time when the farmers buy these inputs and whenthey sell the crop. Farmers usually take crop loans at the beginning of the seasonand repay the loan after harvest. Repayment of the loan is crucially dependent onthe income from farming.





Collateral  is  an  asset  that  the  borrower  owns  (such  as  land,  building,  vehicle,livestocks, deposits with banks) and uses this as a guarantee to a lender until  theloan is repaid.If the borrower fails to repay the loan, the lender has the right to sellthe asset or collateral to obtain payment. Property such as land titles, deposits withbanks, livestock are some common examples of collateral used for borrowing.


Terms of Credit

Interest rate, collateral and documentation requirement, and the mode of repaymenttogether  comprise what  is  called the  terms of  credit.  The terms  of  credit  varysubstantially from one credit arrangement to another. They may vary depending onthe nature of the lender and the borrower.


Sources of Credit

Formal Sector


The formal Sector comprises of banks and cooperative societies.

Informal Sector

The informal sector consists of money lenders and friends and relatives, merchantsand landlords.

The following diagram shows share of different sources of credit in rural householdsin India in 2003.

The RBI  sees that the banks give loans not  just  to profit-making businesses andtraders but also to small cultivators, small scale industries, to small borrowers etc.Periodically,  banks have to submit  information to the RBI on how much they arelending, to whom, at what interest rate, etc.

There  is  no  organisation  which  supervises  the  credit  activities  of  lenders  in  theinformal sector. Compared to the formal lenders, most of the informal lenders chargea much higher interest on loans. Thus, the cost to the borrower of informal loans ismuch higher. Higher cost of borrowing means a larger part of the earnings of theborrowers  is  used to repay the loan.  In  certain cases,  the high interest  rate ofborrowing can mean that the amount to be repaid is greater than the income of theborrower. This could lead to increasing debt and debt trap. Also, people who mightwish to start an enterprise by borrowing may not do so because of the high cost ofborrowing.


For these reasons, banks and cooperative societies need to lend more. This wouldlead to higher incomes and many people could then borrow cheaply for a variety ofneeds. They could grow crops, do business, set up small-scale industries etc. Theycould set up new industries or trade in goods.


Self Help Groups


In recent years, people have tried out some newer ways of providing loans to thepoor. The idea is to organise rural poor, in particular women, into small  Self HelpGroups (SHGs) and pool (collect) their savings. A typical SHG has 15-20 members,usually belonging to one neighbourhood, who meet and save regularly. Saving permember varies from Rs 25 to Rs 100 or more, depending on the ability of the peopleto save. Members can take small loans from the group itself to meet their needs. Thegroup charges interest on these loans but this is still less than what the moneylendercharges. After a year or two, if the group is regular in savings, it becomes eligible foravailing loan from the bank.  Loan is sanctioned in the name of  the group and ismeant to create self employment opportunities for the members.

Most of the important decisions regarding the savings and loan activities are takenby the group members. The group decides as regards the loans to be granted — thepurpose,  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

of loan by any one member is followed up seriously by other members in the group.Because of this feature, banks are willing to lend to the poor women when organised

in SHGs, even though they have no collateral as such.

Thus, the SHGs help borrowers overcome the problem of lack of collateral. They can

get  timely  loans  for  a  variety  of  purposes  and  at  a  reasonable  interest  rate.Moreover, SHGs are the building blocks of organisation of the rural poor. Not onlydoes it help women to become financially self-reliant,  the regular meetings of thegroup provide a platform to discuss and act on a variety of  social issues such ashealth, nutrition, domestic violence, etc.