1. Money as a Medium of Exchange
In a barter system, goods are exchanged directly for other goods. This creates the problem of double coincidence of wants—both people must want what the other person has.
Money solves this problem by acting as an intermediate in exchange.
Example:
A shoe producer can sell shoes for money and then use that money to buy wheat. He does not need to find a wheat farmer who also wants shoes.
Key point: Money makes buying and selling easier because it is widely accepted as a medium of exchange.
2. Modern Forms of Money
Currency
Modern currency consists mainly of paper notes and coins. Unlike earlier forms of money such as cattle, grain and precious-metal coins, modern currency generally has little or no value for direct use.
It is accepted because it is authorised by the government.
In India:
- The Reserve Bank of India (RBI) issues currency notes on behalf of the Central Government.
- The rupee is legally accepted for payments in India.
Bank Deposits
People do not keep all their money as cash. They deposit surplus money in bank accounts.
These deposits:
- are kept safely in banks,
- earn interest,
- can be withdrawn when required.
Deposits that can be withdrawn on demand are called demand deposits.
3. Cheques and Demand Deposits
A cheque is a written instruction to a bank to pay a specified amount from one person’s account to another person.
Cheque payments allow money to move between bank accounts without using cash.
Therefore, demand deposits have important characteristics of money because they can be used for payments.
Remember
Modern money = Currency + Demand Deposits.
4. How Banks Use Deposits
Banks do not keep all deposited money as cash.
They:
- Keep a small portion as cash to meet withdrawals.
- Use a major portion of deposits to provide loans.
- Connect people who have surplus funds with people who need funds.
Thus, banks act as mediators between depositors and borrowers.
Banks generally charge borrowers a higher interest rate than the rate paid to depositors. The difference contributes to the bank’s income.
Flow:
Depositors → Banks → Borrowers
Borrowers repay loans + interest → Banks → Depositors receive deposits + interest
5. Credit
Credit (loan) is an arrangement in which a lender provides money, goods or services to a borrower with an agreement that payment will be made in the future.
Credit can have two very different effects:
Positive effect
If borrowed money is used productively and the expected income is earned, credit can increase earnings.
Example: Salim borrowed resources to complete a shoe order. Completing the order enabled him to earn a profit and repay the loan.
Negative effect
If the activity financed by credit fails, repayment can become difficult.
Example: Swapna’s crop failed. Her inability to repay caused her debt to grow, eventually forcing her to sell part of her land.
This situation is called a debt trap.
Main idea
Credit is useful when the borrower has a reasonable chance of earning enough to repay it. Risk and availability of support in case of loss are important.
6. Terms of Credit
Every loan agreement has certain conditions. Important terms of credit include:
- Interest rate — the additional amount paid to the lender.
- Collateral — an asset given as security for the loan.
- Documentation — documents required by the lender.
- Mode of repayment — how and when the borrower repays the loan.
Collateral may include land, buildings, vehicles, livestock or bank deposits. If the borrower fails to repay, the lender may have rights over the collateral according to the loan agreement.
Easy terms of credit
Borrowers generally prefer:
- Low interest
- Easy repayment conditions
- Less collateral
- Less documentation
7. Sources of Credit
Credit sources are broadly divided into:
Formal Sector
- Banks
- Cooperative societies
Informal Sector
- Moneylenders
- Traders
- Employers
- Relatives and friends
The RBI supervises formal sources, while there is no equivalent organisation supervising informal lenders in the same way.
8. Formal vs Informal Credit
| Formal Credit | Informal Credit |
|---|---|
| Banks and cooperatives | Moneylenders, traders, employers, etc. |
| Supervised by RBI | No comparable formal supervision |
| Usually more regulated | Lenders may set their own conditions |
| Generally lower borrowing costs | Often higher interest |
| Requires documentation and, often, collateral | May be easier to obtain |
Informal loans can become expensive because of high interest rates. A high repayment burden may reduce the borrower’s income and can contribute to a debt trap.
9. Why Cheap and Formal Credit Matters
Affordable credit is important for economic development because people can use loans to:
- grow crops,
- start businesses,
- establish small industries,
- trade,
- meet productive needs.
The chapter stresses that formal credit should expand and reach poorer households more effectively.
Poor households often depend more on informal lenders because they may lack:
- collateral,
- required documents,
- easy access to banks.
Thus, improving access to affordable formal credit is important for reducing dependence on costly informal borrowing.
10. Self-Help Groups (SHGs)
Self-Help Groups organise poor people, particularly women, into small groups that regularly save money.
A typical SHG:
- has around 15–20 members,
- encourages regular savings,
- allows members to take small loans,
- charges interest that is generally lower than that of moneylenders,
- may become eligible for bank loans after maintaining regular savings.
The group itself decides important matters such as:
- who receives loans,
- loan amount,
- interest,
- repayment schedule.
Importance of SHGs
SHGs help members:
- overcome the problem of lack of collateral,
- obtain timely credit,
- access loans at reasonable rates,
- become more financially self-reliant.
They also provide a platform for discussing wider social issues.
11. Key Terms — One-Line Revision
Barter: Direct exchange of goods or services without using money.
Double coincidence of wants: A situation where each party wants exactly what the other has.
Medium of exchange: The role of money in facilitating buying and selling.
Demand deposit: A bank deposit that can be withdrawn on demand.
Credit: An arrangement involving present borrowing with an agreement for future payment.
Collateral: An asset pledged as security for a loan.
Debt trap: A situation in which debt becomes difficult to repay and may continue increasing.
Formal credit: Credit obtained from regulated institutions such as banks and cooperatives.
Informal credit: Credit obtained from sources such as moneylenders, traders, employers, relatives and friends.
SHG: A small group, usually of poor members, that pools savings and provides credit to members.
12. Chapter in One Flow
Money removes the difficulty of barter
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Currency + demand deposits form modern money
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Banks accept deposits and provide loans
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Credit supports economic activities
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Credit may increase income or create a debt trap
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Loan conditions depend on interest, collateral, documents and repayment
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Credit comes from formal and informal sources
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Affordable formal credit should reach poorer households
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SHGs help poor people, especially women, obtain credit and overcome collateral barriers.