ECONOMICS CH -3 Money and credit

1.Which among the given are the reason that money is the most liquid form of assets?
a. It is not widely used by everyone
b. It includes shares and equities
c. It has certain functions
d. It acts as a medium of exchange
2. How does the use of money make it easier to exchange things?
3. Mention some examples of goods/services being exchanged or wages being paid through barter.
4. Why is the modern currency used as a medium of exchange?
5. Salim wants to withdraw Rs 20,000 in cash for making payments. Explain how the cheque payment
would be made.
6. What are the four advantages of ‘Self Help Groups’ for the poor? Explain.
7. Why are demand deposits considered as money?
8. Define the terms of Credit. What the four terms of credits? Give Examples.
9. What do you think would happen if all the depositors went to ask for their money at the same time?
10. Explain the meaning of “collateral.” Why do lenders ask for collateral while lending?
11. Mention the reasons why rural poor people still generally take loans from informal credit sources that
charge a very high rate of interest.
12. What is called the terms of credit? Interest rate, collateral and documentation requirement and mode of
repayment together comprise terms of credit.
13. Given that a large number of people in our country are poor, does it in any way affect their capacity to
borrow?
14. Give two reasons why cheap and affordable credit is important for the country’s development.
15. What are the differences between formal and informal sources of credit?
16. Should there be a supervisor, such as the Reserve Bank of India that looks into the loan activities
ofinformal lenders? Why would its task be quite difficult?
17. Why do you think that the share of formal sector credit is higher for the richer households compared to
the poorer households?
18. How do banks mediate between those who have surplus money and those who need money?
19. Why are the deposits in the bank called the demand deposits? Explain the advantages of deposits with
the banks.
20. Analyse the role of credit for development.
21. 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.
22. Give examples of how money is used as a medium of exchange. Explain. 23. What is the basic idea
behind the SHGs for the poor? Explain in your own words
Very short answer type questions
1. The currency notes on behalf of the Central Government are issued by whom? (2011 D)
2. What is demonetisation?
3. List various ways through which digital transactions are made.
4. What is the main objective to promote digital transactions?
5. What is meant by double coincidence of wants?
6. What is the meaning of barter system?
7. Define money.
8. Why is money called ‘a medium of exchange’?
9. What objects were used as money in India, before the introduction of coins?
10. Which metals were used for making coins in India in later stages?
11. Give the modem forms of money.
12. The modern currency is accepted as a medium of exchange. Why?
13. Why one cannot refuse a payment made in mpees in India?
14. Define a bank.
15. What are demand deposits?
16. What is a cheque?
17. What determines the main source of income for the banks?
 18. Define credit.
19. For what purpose credit is mainly demanded in rural areas?
20. What is a debt-trap?
21. What is collateral?
22. What are the main ‘terms of credit’?
23. Which are the two major sources of formal loan for rural households?
24. Who supervises the functioning of formal sources of loans?
25. Why are banks unwilling to lend loans to small farmers?
26. What kind of credit is commercial for a country’s development?
27. Besides banks, what are the other sources of credit from which the small farmers borrow?
28. What are SHGs?
29. What does the stock of money consist of?
30. Who issues the currency notes in India?
31. For which purpose are a major portion of the deposits with the banks used?
Notes:
MONEY AS A MEDIUM OF EXCHANGE
● Money is referred to as a medium of exchange because it serves as an intermediary in the exchange process.
● A person who has money can readily swap it for whatever commodity or service he or she desires.
Double coincidence of wants: It occurs when both parties agree to sell and buy each other's commodities at the same
time in the trade. Double coincidence of wants is a key element of the barter system.
MODERN FORMS OF MONEY Indians utilised wheat and livestock as currency in the past. Following that came
the use of metallic coinage, such as gold, silver, and copper coins, which lasted well into the twentieth century.
Currency - paper notes and coins – are now modern forms of money. The current kinds of money - currency and
deposits – are inextricably related to the modern banking system's operation.
Currency: The Reserve Bank of India, on behalf of the Indian government, issues currency notes. No other person or
organisation is permitted to print money. In India, the rupee is generally recognised as a medium of exchange.
Deposit in Banks: People might also keep their money in the form of bank deposits. People put their surplus money
in the bank by opening a bank account in their own name. Banks not only accept deposits, but they also pay interest on
them. Deposits in bank accounts that can be withdrawn on demand are referred to as demand deposits. Cheques are
used instead of cash to make payments.
Cheques: It's a piece of paper that instructs the bank to transfer a specified amount from a person's account to the
person named on the check.
LOAN ACTIVITIES OF BANKS
● Banks only hold a small amount of their deposits in cash on hand. In India, banks now maintain approximately 15%
of their deposits in cash. This is retained as a reserve to pay depositors who may come to the bank on any given day to
withdraw money.
● The majority of deposits are used to extend loans by banks. Loans for numerous economic activities are in high
demand. On loans, banks charge a greater interest rate than they do on deposits.
● Banks' major source of income is the difference between what they charge borrowers and what they pay depositors.
TERMS OF CREDIT Every loan agreement stipulates an interest rate that must be paid to the lender in addition to
the principal repayment. Lenders also want collateral (security) in exchange for loans.
1.Collateral is an asset that a borrower holds, such as land, a building, a vehicle, livestock, or bank savings, that the
borrower uses as a guarantee to a lender until the loan is returned. If the borrower fails to repay the loan, the lender
has the authority to sell the asset or collateral to recover payment.
2. The terms of credit include the interest rate, collateral and documentation requirements, as well as the form of
repayment. It varies depending on the lender's and borrower's personalities.
FORMAL SECTOR CREDIT IN INDIA Credit that is both cheap and accessible is critical for the country's
prosperity. The numerous forms of loans can be divided into the following categories: 1. Formal sector loans: Loans
from the formal sector include those from banks and cooperatives. The Reserve Bank of India (RBI) is in charge of
overseeing the operation of formal loan sources. Banks must report to the RBI how much they are lending, to whom,
and at what interest rate, among other things. 2. Informal sector loans: Loans from the informal sector include those
from moneylenders, traders, employers, family, and friends, among others. There is no regulatory body that oversees
the lending activities of informal lenders. There is no one to stop them from obtaining their money by unethical
means.
Formal and Informal Credit Formal credit: The RBI oversees the operation of formal sources of loans, which
includes banks and cooperatives. To ensure that the bank maintains a minimum cash balance and that loans are given
not just to profit-making businesses and dealers, but also to small growers, small scale industries, small borrowers,
and so on. Banks are required to report their actions to the RBI on a regular basis. Informal credit: Money lenders,
traders, employers, relatives, and friends are just a few examples. There is no one in charge of monitoring their credit
operations. They can charge any interest rate they want. There is no one to stop them from obtaining their money by
unethical means
SELF HELP GROUPS FOR THE POOR Poor households continue to rely on informal sources of financing for the
following reasons:
● In rural India, banks are not widely available.
● Even if banks are present, obtaining a bank loan is substantially more difficult because adequate documentation and
collateral are required. Self-Help Groups were formed to address these issues (SHGs). SHGs are small groups of poor
people who encourage their members to save small amounts of money. A typical SHG includes 15-20 members who
meet and save on a regular basis, usually from the same neighbourhood. Advantages of Self Help Group (SHG):
● It assists borrowers in overcoming the lack of collateral issues.
● SHGs are the foundations of the rural poor's organisation.
● People can receive loans on schedule and at a fair interest rate for a number of objectives.
● It assists women in becoming financially self-sufficient.
● The group's frequent meetings give a forum for discussing and taking action on a variety of social concerns such as
health, nutrition, domestic violence, and so on.

Important Questions and Answer

1.Why do banks ask for collateral while giving credit to a borrower? (2014 D, 2011 OD)
Collateral is an asset that the borrower owns (land, building, vehicle, livestock, land documents,
deposits with banks, etc.) which stands as a security against the money borrowed. In case the borrower
fails to repay the loan, the lender has the right to sell the asset or collateral.

2.What is money? Why is modern money currency accepted as a medium of exchange? (2012 D)
Money is a medium of exchange in transactions. A person holding money can easily exchange it for
any commodity or service that he or she might want.
Modem money currency is accepted as a medium of exchange because

 it is certified for a particular denomination (For example, ₹ 10, ₹ 20, ₹ 100, ₹ 1,000).
 it is issued by the Central Bank of the country.
 it is authorized by the government of the country.

3.What are the modern forms of money? Why is the ‘rupee’ widely accepted as a medium of exchange?
Explain two reasons. (2013 D) Or
Why is modern currency accepted as a medium of exchange without any use of its own? Give reasons?
Modem forms of money currency in India include paper notes and coins which are known as Rupees
and Paise.

1. It is accepted as a medium of exchange because the currency is authorized by the Government of

India.
2. In India, the Reserve bank of India issues currency notes on behalf of the Central Government of
India.
3. The law legalizes the use of rupee as a medium of payment that cannot be refused in settling
transaction in India.
4. No Individual in India can legally refuse a payment made in rupees.
Therefore, the rupee is widely accepted as a medium of exchange.

4.“Cheap and affordable credit is essential for poor households both in rural and urban areas.” In the
light of the above statement explain the social and economic values attached to it. (2013 OD) Or
“Cheap and affordable credit is crucial for the country’s development.” Assess the statement. (2016 D)
Or ‘Credit has its own unique role for development’. Justify the statement with arguments. (2016 OD)
Credit means: It refers to an agreement in which the lender supplies the borrower with
money, goods or services in return for the promise of future repayment.
o Cheap and affordable credit is crucial for the country’s growth and economic development.
Credit is in great demand for various kinds of economic activities—big or small investments,
to set up business, buying cars, houses, etc.
 o In rural areas credit helps in the development of agriculture by providing funds to farmers to
buy seeds, fertilizers, expensive pesticides.
o Manufacturers need credit for buying raw material or to meet ongoing expenditure of
production. Credit helps in the purchase of plant, machinery, equipment, etc.
o Some people may need to borrow for illness, marriages etc.
Thus, cheap and affordable credit is crucial for the country’s growth and economic
development.

5.“The credit activities of the informal sector should be discouraged.” Support the statement with arguments.
(2016 D)
The credit activities of the informal sector should be discouraged because:

1. 85% of loans taken by the poor households in the urban areas are from informal sources. There is no
organisation that supervises the credit activities of lenders in the informal sector.
2. Informal lenders charge very high interest on their loAnswer: They try to charge more and more
interest on their loans as there are no boundaries and restrictions.
3. Higher cost of borrowing means a larger part of the earnings of the borrowers is used to repay the
loan.
4. In certain cases, the high interest rate for borrowing can mean that the amount to be repaid is greater
than the income of borrower. This could lead to increasing debt and debt trap, therefore the credit
activities of the informal sector should be discouraged.

6. Why do we need to expand formal sources of credit in India? (NCERT Question)

There is no organisation that supervises the credit activities of lenders in the informal sector. They lend
at whatever interest rate they choose.

1. No one can stop rural money-lenders from using unfair means to get their money back.
2. Informal lenders charge a very high rate of interest on loans and as a result a larger part of the
earnings of the borrowers and farmers are used to pay the loans.
3. The amount to be repaid is often greater than income, and farmers and other borrowers in villages fall
in a debt trap.
Thus, it is necessary that banks and co-operatives increase their lending, particularly in rural areas, so
that dependence on informal sources of credit ends.

Long Answer Questions (LA) 5 Marks

1. What is the basic objective of ‘Self Help Groups’? How do they work? Describe any four advantages
of ‘Self Help Groups’ for the poor. (2015 D, 2011 D)
The basic objective of ‘Self Help Groups’ is to organize rural poor, particularly women
belonging to one neighbourhood into small Self Help Groups (15-20 members). These members save
regularly and the amount varies from ₹25-100 or more depending upon their ability to save.
The four advantages of ‘Self Help Groups’ are as follows:

 The members can take small loans from the group itself to meet their needs. The group charges
interest on these loans which is still less than what moneylenders charge.
 After a year or two, if the group is regular in savings, it becomes eligible for availing loan from the
bank which is sanctioned in the name of the group to create self employment opportunities. All
important decisions regarding loan, purpose, amount of interest, non-payment of loan are taken by
the group members.
For instance, small loans are provided to the members for releasing mortgaged land, meeting
working capital needs, for acquiring assets like sewing machines, handlooms, cattle etc.
 Since non-repayment of loans is dealt with seriously by group members, therefore banks are willing
to lend to the poor women when organized in SHGs, even though they have no collateral as such.
Thus, the SHGs help women to become financially self reliant.
 The regular meetings of the group provide a platform to discuss and act on a variety of social issues
such as health, nutrition, domestic violence etc.
2. ‘Banks and cooperatives help people in obtaining cheap and affordable loans’ Which values according to
you does this support? (2011 OD)
Cheap and affordable loans help people to grow crops, do business, set up small scale industries or
trade in goods. This promotes:

1. Self reliance and financial security and independence of people.

2. Protection of the relatively poor against corrupt moneylenders.
3. Eradication of poverty in general.
4. All this indirectly helps in the country’s development.

3. What is Credit? Why is cheap and affordable credit important for the country’s development? Give four
reasons. (2012 D) Or What is credit? Explain with an example, how credit plays a vital and positive
role for development. (2014 OD)
Credit means loans. It refers to an agreement in which the lender supplies the borrower with
money, goods or services in return for the promise of future repayment.

1. Cheap and affordable credit is crucial for the country’s growth and economic development. Credit is
in great demand for various kinds of economic activities—big or small investments, to set up
business, buying cars, houses, etc.
2. In rural areas credit helps in the development of agriculture by providing funds to farmers to buy
seeds, fertilizers, expensive pesticides.
3. Manufacturers need credit for buying raw material or to meet ongoing expenditure of production.
Credit helps in the purchase of plant, machinery, equipment, etc.
4. Some people may need to borrow for illness, marriages etc.
Thus, cheap and affordable credit is crucial for the country’s growth and economic development.

4.What are the two categories of sources of credit? Mention four features of each. (2013 OD)
The two sources of credit are formal sources and informal sources:
Formal sources of credit:

1. Banks and cooperative societies fall under the formal sector. One can obtain loans from banks or
cooperative societies.
2. The Reserve Bank of India supervises the functioning of formal sources of loAnswer:
3. Bank loans require documentation and collateral (collateral is an asset such as land, building, vehicle,
livestock, deposits with the bank, etc.). This is used as a guarantee to the lender until the loan is paid
back.
4. Formal sources cannot charge any rate of interest from the borrowers according to their whims.
Informal sources of credit:

 In the informal sector money can be borrowed from a person, friend, relative, moneylender,
traders, employers, etc.
 There is no organization that checks or supervises the activities of lenders in the informal sector.
 Loans from informal sources do not require any such collateral.
 They charge a very high rate of interest on loans as they do not require any collateral.

5.Which government body supervises the functioning of formal sources of loans in India? Explain its
functioning. (2012 OD)
The Reserve Bank of India supervises the functioning of formal sources of loans.
Functions of Reserve Bank of India.

1. RBI requires commercial banks to maintain a minimum cash balance out of the deposits they receive.
The RBI monitors that the banks actually maintain the cash balance.
 2. RBI sees that the banks give loans not just to profit-making businesses and traders but also to small
cultivators, small-scale industries, small borrowers, SHGs, etc.
3. RBI issues guidelines for fixing rate of interest on deposits and lending by commercial banks.
4. Periodically, banks have to submit information to the RBI on how much they are lending, to whom, at
what interest rate, etc.

6.What are the various sources of credit in rural areas? Which one of them is the most dominant source of
credit and why? (2013 D)
Moneylenders are the most dominant amongst sources of credit for rural households. They constitute an
informal source of credit. They charge a very high rate of interest on loans as they do not require any
collateral. They are the most convenient source of credit in the rural areas.
Other sources of rural credit:

1. Cooperative Societies are another major source of rural credit. They are a source of formal sector
credit. Members of a Cooperative pool their resources for helping one another, e.g., Farmers’
Cooperatives, Weavers’ Cooperatives, etc. They offer cheap credit in rural areas for their members.
Once these loans are repaid, another round of loans is offered.
2. Agricultural traders, relatives and friends are other informal sources of rural credit. Some farmers
borrow from agricultural traders who supply the farm inputs (such as seeds, fertilizers, pesticides, etc.)
on credit at the beginning of the cropping season and repay the loans after the harvest.
3. Commercial banks also give loans to rural households. However, not many rural households borrow
from banks as they require proper documentation and collateral.

7. “Deposits with the banks are beneficial to the depositors as well as to the nation”. Examine the statement.
(2016 OD, 2015 D)
Benefit of deposits to the depositors:

1. Bank accepts the deposits and pays interest to the depositor.

2. Banks help people save their money and keep their money in safe custody of the bank.
3. People can withdraw the money as and when they require.
4. Banks also grant loans to people for a variety of purposes. In times of need, individuals, business
houses and industries can borrow money from the banks.

Benefit of deposits to the Nation:

1. Banks use the major proportion of the deposit to extend loans.
2. There is a huge demand for loans for various economic activities. In times of need, business houses
and industries can borrow money from the banks.
3. Banks mediate between those who have surplus funds and those who are in need of these funds. Thus,
it helps in the economic development of the Nation.

8.How do banks play an important role in the economy of India? Explain. (2015 OD)
Banks help people to save their money and keep their money in safe custody. To ensure safety of their
money, people deposit their money with banks. Banks accept deposits and pay interest on deposits. People
have the provision to withdraw their money as and when they require.

1. Banks also grant loans to people for a variety of purposes. In times of need individuals, business
houses and industries can borrow money from the banks.
2. Credit provided by banks is crucial for the country’s growth and economic development. Credit is
needed for all kinds of economic activities, to set up business, buy cars, houses, etc.
3. Banks also help people in obtaining cheap and affordable loans. This can help people to grow crops,
do business, set up small-scale industries or trade in goods and also help indirectly in the country’s
development. They should do so, so that relatively poor people do not have to depend on informal
sources of credit (money-lenders).
9.Describe the vital and positive role of credit with examples. (2016 D)
In the festive season, a shoe manufacturer, Ram receives an order from a large trader in town for
3,000 pairs of shoes to be delivered in a month’s time. To complete production on time Ram has to hire
workers for stitching and pasting work. He has to purchase the raw materials. To meet these expenses Ram
obtains loans from two sources.
 First, he asks the leather supplier to supply leather now and promises to pay him later.
 Second, he obtains loan in cash from the large traders as advance payment for 1000 pairs of shoes
with a promise to deliver the whole order by the end of the month.
 At the end of the month, Salim is able to deliver the order, make a good profit and repay the money
he had borrowed.
 Salim obtains credit to meet the working capital needs of production. The credit helps him to meet
the ongoing expenses of production, complete production on time and thus increase his earnings.
Credit therefore plays a vital and positive role in this situation.
10.How can the formal sector loans be made beneficial for poor farmers and workers? Suggest any five
measures. (2016 OD)
Formal sector loans can be made beneficial for poor farmers and workers in the following ways:

1. Create greater awareness among farmers about formal sector loans.

2. Process of providing loans should be made easier. It should be simple, fast and timely.
3. More number of Nationalized Banks/cooperative banks should be opened in rural sectors. Banks and
cooperatives should increase facility of providing loans so that dependence on informal sources of
credit reduces.
4. The benefits of loans should be extended to poor farmers and small scale industries.
5. While formal sector loans need to expand, it is also necessary that everyone receives these loans. It is
important that formal credit is distributed more equally so that the poor can benefit from cheaper
loans.

11. How does the use of money make it easier to exchange things?
Money is frequently characterised in terms of its three purposes or services. Money functions as a
means of exchange, a store of value, and a monetary unit.
● Money's primary role is to facilitate transactions as a medium of exchange. All transactions would have
to be handled via barter, which is the direct exchange of one commodity or service for another in the
absence of money.
● Money must retain its worth over time in order to function as a medium of trade; it must be a store of
value. Money would not solve the doublecoincidence of desires problem if it could not be stored for a
period of time and still be valued in exchange. As a result, it would not be adopted as a medium of
exchange.
● Money also serves as a unit of account, allowing for the measurement of the worth of goods and
services traded.
12. Can you think of some examples of goods/services being exchanged or wages being paid through
barter?
1. In rural regions, food grains are frequently swapped for other crops. Even in certain government
programmes, workers are paid in kind rather than cash, for example, 5 kg of wheat every day of work.
2. When money devalues rapidly i.e., hyperinflation, such as during the Venezuelan crisis during the
Bolivarian Revolution, barter systems are occasionally used.
3. In exchange for their military duty, Roman soldiers were paid salt.
13. Why are demand deposits considered as money?
● Demand deposits are a type of deposit that acts as a means of exchange, similar to money.
● The individual who needs to be paid receives a check. The cheque orders the bank to deduct the needed
sum from the individual issuing the payment's deposit. In this case, a transaction has occurred without the
use of currency, with the same result. As a result, demand deposits are seen as money.
14. Why do lenders ask for collateral while lending? Ans: Collateral is a borrower's asset, such as land or
a building, that is used as a guarantee to the lender until the loan is returnedLenders require collateral for
several reasons:
1. It serves as a guarantee for the loan.
2. If the borrower fails to repay the loan, the lender has the right to seize the collateral as compensation.
Collateral assures the lender that the loan will be repaid because the borrower will lose the collateral if the
loan is not fully repaid.
15. Why should credits at reasonable rates be available for all?
● To achieve equality of opportunity, everyone should have access to credit at a reasonable rate
● Everyone who wants to help the economy by providing services should be given the opportunity to
obtain the financial resources they need to establish their firms or purchase assets.
● To keep the country's inflation rate under control, everyone needs access to regulated credit. Money's
time value must be managed.
● This must also be offered to reduce instances of unsecured credit with excessive interest rates that harm
borrowers’ livelihoods. If the borrower's entire earnings are used to repay high-interest informal credit,
the borrower will be forced to close their business, which is not a good situation.
16. In a situation with high risks, credit might create further problems for the borrower. Explain.
1. A high-risk situation indicates that the borrower will have difficulty repaying the loan.
2. The loan is repaid with the profits generated by the borrower's business.
3. The loan is repaid with the profits generated by the borrower's business. The revenue generated in high-
risk professions like agriculture is based on crop performance. In the event that crops fail due to
insufficient rainfall, the agriculturist will be unable to profit from their crop yield. They will be unable to
repay the loan on time, and the interest will continue to accrue. They will have to double the crop yield in
the next phase to be able to repay a significant portion of the loan without losing money. These kinds of
circumstances put the borrower in a difficult situation
17.In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this
necessary? Ans: The Reserve Bank of India is a central bank that regulates bank lending and other
financial activities. The Reserve Bank of India keeps a close eye on banks in the following ways:
1. The Reserve Bank of India (RBI) oversees formal bank loans and sets interest rates for these loans
based on the economy's overall performance and people's purchasing power.
2. The RBI ensures that banks lend to profit-making businesses as well as smaller-scale borrowers for a
variety of economic activities.
3. The Reserve Bank of India ensures that banks keep a cash reserve available for depositors who wish to
withdraw funds.