Money and Credit

Every card in this deck

QDouble coincidence of wants

AA situation in which what one person wishes to sell is exactly what the other wishes to buy, and vice versa. It is an essential feature of a barter system, where goods are exchanged directly without money.

QHow does money solve the problem of double coincidence of wants?

AMoney acts as an intermediate step in exchange. A shoe maker no longer needs a wheat farmer who also wants shoes; he sells shoes to anyone for money and uses the money to buy wheat or anything else. That is why money is called a medium of exchange.

QWhy is modern paper currency accepted as a medium of exchange even though it has no use of its own?

ABecause the government authorises it. In India only the Reserve Bank of India may issue currency notes, which it does for the central government, and the law makes the rupee a means of payment that nobody in India can legally refuse.

QDemand deposits

ADeposits in bank accounts that can be withdrawn on demand. Because they can be used to settle payments directly by cheque, without cash, and are widely accepted, they share the essential features of money and, along with currency, count as money in a modern economy.

QCheque

AA written order from an account holder telling their bank to pay a stated sum from their account to the person named on it. The payee deposits it, the money moves between accounts, and the payment is settled without cash.

QHow do banks mediate between depositors and borrowers, and how do they earn income?

ABanks keep only a small share of deposits as cash (about 5 per cent in India) for daily withdrawals and use most of the rest to give loans. They charge borrowers a higher interest rate than they pay depositors; the difference is their main source of income.

QCredit (loan)

AAn arrangement in which a lender provides a borrower with money, goods or services now, in exchange for the borrower's promise to pay later.

QHow can credit play a positive role for a producer? Use Salim the shoe maker as an example.

ASalim took leather on credit from his supplier and an advance from a trader to meet working capital needs for a large order. Credit let him pay ongoing costs, finish production on time, deliver, repay and earn a good profit, increasing his earnings.

QDebt trap

AA situation in which credit pushes the borrower into a position from which recovery is very painful. For example, Swapna's crop failed, she could not repay the moneylender, her debt grew, and she had to sell part of her land.

QWhy is credit risky in rural crop production?

AFarmers borrow at the start of the season for seeds, fertilisers, pesticides, water and repairs, and repay after harvest, so repayment depends entirely on farm income. If the crop fails, they cannot repay. Whether credit helps depends on the risks involved and whether there is support in case of loss.

QCollateral

AAn asset owned by the borrower, such as land, a building, a vehicle, livestock or bank deposits, that is pledged to the lender as security. If the loan is not repaid, the lender has the right to sell the asset to recover the money.

QTerms of credit

AThe interest rate, collateral, documentation requirements and mode of repayment of a loan, taken together. They vary widely with the nature of the lender and the borrower.

QHow do the terms of credit from informal lenders hurt borrowers like Shyamal and Rama in Sonpur?

AShyamal borrows from a trader at 3 per cent a month and must sell his crop to him cheaply after harvest. Rama, a landless labourer, pays her landowner 5 per cent a month and repays by working for him, so she takes fresh loans before clearing old ones and stays in debt.

QHow do cooperative societies such as Krishak Cooperative provide cheap credit to their members?

AMembers pool resources by depositing with the cooperative. Using these deposits as collateral, it obtains a large bank loan and lends the funds to members for implements, cultivation, trade, fishery and housing. Once repaid, another round of lending begins. Cooperatives are a formal source of credit.

QFormal vs informal sources of credit

AFormal sources are banks and cooperatives, supervised by the RBI. Informal sources are moneylenders, traders, employers, relatives and friends, whom no organisation supervises, so they can charge any interest rate and use unfair means to recover loans.

QHow does the Reserve Bank of India supervise the functioning of banks?

AIt checks that banks actually keep the minimum cash balance out of their deposits. It ensures they lend not only to profit-making businesses and traders but also to small cultivators, small-scale industries and small borrowers. Banks must periodically report to it how much they lend, to whom and at what interest rate.

QWhy is the high cost of informal credit harmful for borrowers and the economy?

AA larger part of borrowers' earnings goes to repaying the loan, leaving them less income. The amount due can exceed their income, leading to growing debt and a debt trap. High borrowing costs also stop people from starting enterprises.

QWhy is cheap and affordable credit crucial for a country's development?

AIf banks and cooperatives lend more, many people can borrow cheaply to grow crops, run businesses, set up small-scale industries or trade. This raises incomes and reduces dependence on costly informal loans, which do little to raise borrowers' income.

QWhy is formal credit unequally distributed between rich and poor households?

ARich households get most of their loans cheaply from formal lenders (83 per cent in urban areas), while poor urban households get 54 per cent from informal sources at high cost. Formal credit must expand and be shared more equally so the poor benefit from cheaper loans.

QWhy do poor rural households still depend on informal lenders rather than banks?

ABanks are not present everywhere, and bank loans need proper documents and collateral, which the poor often lack. Moneylenders know borrowers personally and lend without collateral, even before earlier loans are repaid, though they charge very high interest, keep no records and harass borrowers.

QSelf Help Group (SHG)

AA group of 15-20 rural poor, usually women from one neighbourhood, who meet and save regularly. Members take small loans from the pooled savings at lower interest than moneylenders charge. After a year or two of regular saving the group becomes eligible for a bank loan in its name.

QWhy are banks willing to lend to poor women organised in SHGs, even without collateral?

AThe group itself decides on loans, including purpose, amount, interest and repayment schedule, and is responsible for repayment. Any member's non-repayment is followed up seriously by the others. This collective responsibility replaces collateral.

QHow do Self Help Groups benefit their members beyond providing loans?

AThey give timely loans at reasonable interest for many purposes, from releasing mortgaged land to buying sewing machines or cattle. They make women financially self-reliant, build organisation among the rural poor, and their meetings are a platform to discuss health, nutrition and domestic violence.

QWhat did the Grameen Bank of Bangladesh demonstrate about lending to the poor?

AStarted by Muhammad Yunus in the 1970s, it had over 9 million members in about 81,600 villages by 2018, almost all poor women. They proved that poor women are reliable borrowers and can successfully run small income-generating activities when credit comes on reasonable terms.