MONEY AND CREDITS
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 Since the deposits in the bankaccounts can be withdrawn on demand, these deposits are called demand deposits.The facility of cheques against demand deposits makes it possible to directly settlepayments without the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.
TERMS OF CREDIT
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
The formal Sector comprises of banks and cooperative societies.
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.