Economics: Money and Credit

• Money as a Medium of Exchange

  • Barter System
    • Direct exchange of goods
    • Limitation: Double coincidence of wants
  • Medium of Exchange
    • Money acts as an intermediate step
    • Eliminates need for double coincidence
  • Modern Forms of Money
    • Currency: Paper notes and coins
    • Authorized by the Government of India (Reserve Bank of India)
    • Deposits with Banks
      • People deposit extra cash
      • Earn interest
      • Demand Deposits: Withdrawable on demand
      • Cheque Facility: Direct payment without cash

• Loan Activities of Banks

  • Bank Operations
    • Keep a small percentage of deposits as cash (e.g., 15%)
    • Use major portion to extend loans
  • Credit Mechanism
    • Bridge between those who have surplus funds and those in need
  • Credit Intermediation
    • Charge higher interest on loans than what they offer on deposits
    • Difference is the main source of income for banks

• Two Different Credit Situations

  • Positive Credit (Rural/Festival example)
    • Loan helps in production and meeting expenses
    • Income increases; borrower is better off
  • Negative Credit (Debt-Trap)
    • Loan taken for farming/business fails
    • Unable to repay; forced to sell land or take fresh loans
    • Debt-Trap: Caught in a cycle of recovery and mounting debt

• Terms of Credit

  • Components
    • Interest Rate: Cost of borrowing, paid to the lender
    • Collateral: Asset owned (land, building, vehicle, livestock) used as a guarantee
    • Documentation Required: Proof of employment, income, identity
    • Mode of Repayment: Cash, installments, or crop yield
  • Variation
    • Terms differ based on lender (formal vs. informal) and borrower profile

• Formal Sector Credit in India

  • Sources
    • Banks
    • Cooperatives
  • Characteristics
    • Supervised by the Reserve Bank of India (RBI)
    • Lower interest rates
    • Strict collateral and documentation rules
    • Aimed at social welfare and equitable development

• Informal Sector Credit in India

  • Sources
    • Sahukars / Moneylenders
    • Traders, employers, relatives, and friends
  • Characteristics
    • Unregulated (no external supervision)
    • Very high interest rates
    • Leads to the debt-trap
    • Flexible or no collateral requirements

• Self-Help Groups for the Poor (SHGs)

  • Structure
    • Small groups of poor people (usually 15-20 members, mostly women)
    • Regular savings per member (small amounts)
  • Functions
    • Pool savings to provide small loans to members internally
    • Banks start lending to the group once regular savings are shown
  • Benefits
    • Overcomes the problem of lack of collateral
    • Timely loans for various purposes at reasonable interest rates
    • Empowers women financially and socially
    • Collective platform to discuss social issues (health, domestic violence)