Professional Documents
Culture Documents
Barter System: The barter system was used before the advent of money.
People used to exchange one thing for another in this system.
Double Coincidence of wants: The double coincidence of wants is the major
drawback of the barter system. It can be very difficult to find a person who can
fulfill this condition. Suppose you want to barter your MP3 player with a game
console, then you need to find a person who wants to barter his game console
for an MP3 player.
Money
Money is a means by which we can get something in exchange. Initially, coins
came into use. The coins were initially made of precious metals; like gold and
silver. When the precious metals became too precious, ordinary metals were
being used for making coins. Paper money or currency notes gradually took
place of coins; although coins of smaller denominations are still in use.
The currency notes and coins are issued by the government of an authorized
body. In India, the RBI (Reserve Bank of India) issues currency notes. On the
Indian currency note, you can find a statement which promises to pay the
bearer the amount which is mentioned on the currency note.
Advantages of Money:
a.
b.
c.
d.
Terms of Credit
People often need to borrow money for various purposes. Many businessmen
need to borrow to buy raw materials and machineries. Many farmers need to
borrow to buy seeds, fertilisers, farm equipments, etc. People usually buy
vehicles and houses by borrowing from banks. Thus, credit plays an important
role in the economy.
Every loan agreement specifies terms and conditions; regarding the rate of
interest and term of payment. In most of the cases, the banks fix an EMI
(Equated Monthly Installment) for repayment of loan.
Collateral: An asset which is owned by the borrower and is used as a
guarantee to a lender until the loan is repaid is called the collateral. Land,
house, vehicle, livestocks, deposits with banks, insurance policy, gold, etc. are
examples of assets. If the borrower fails to repay the loan, the lender reserves
the right to sell the collateral to obtain payment.
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Terms of Credit: The terms of credit include rate of interest, collateral and
mode of repayment. The terms of credit varies from one loan agreement to
another and also on the nature of the lender and the borrower.
Sources of Credit
Formal Sector: The formal Sector comprises of banks and cooperative
societies.
Informal Sector: The informal sector consists of money lenders and friends
and relatives, merchants and landlords.
The following diagram shows share of different sources of credit in rural
households in India in 2003.
While the formal sector is bound by the rules and regulations of the RBI and
charge the prevalent rate of interest as per RBI guidelines; the informal
lenders are not bound by such rules. The informal lenders usually charge a
very high rate of interest. A higher cost of borrowing is often detrimental to the
borrower. It usually results in a debt trap for the borrower. The borrower is
seldom able to escape the never ending cycle of loan repayment.
Many people are too poor to qualify the requirements of credit-worthiness of
banks and cooperatives. There are many others who may not have enough
documents; like residential certificate or income certificate. Such people are
usually at the mercy of informal lenders.
to. In case of de debtor failing to repay the loan, the lender can recover
some money by selling the collateral.
4. Given that a large number of people in our country are poor, does it in
any way affect their capacity to borrow?
Answer: Credit is always given after properly assessing the repayment
capacity of the borrower. Since poor people do not have repayment
capacity, they are usually unable to get a loan; especially from the
formal sector. They get some loan from the informal sector but in that
case, they often fall in debt trap because of very high rate of interest.
5. Fill in the blanks choosing the correct option from the brackets.
Answer: While taking a loan, borrowers look for easy terms of credit.
This means low (low/high) interest rate, easy (easy/ tough) conditions
for repayment, less (less/more) collateral and documentation
requirements.
6. What are the differences between formal and informal sources of credit?
Answer: The formal sector gives loan only after thorough check of the
borrower. Suitable paperwork is done before giving the loan so that both
the borrower and the creditor can resort to judicial process in case of
any problem. Rate of interest is governed by the government rules when
loan is given by the formal sources. In case of informal sector, rate of
interest is usually very high and the borrower cannot go to the courts in
case of being subjected to arm-twisting tactics by the creditor. Informal
sector usually works on personal influence and relation of the borrower
and creditor.
7. Why should credit at reasonable rates be available for all?
Answer: Credit is an important aspect of economic activity. Right from a
small farmer to a big business tycoon; everyone needs to borrow at
some time to improve productivity. In case of unreasonable rates, the
borrower always runs the risk of falling in the debt trap which is not good
for the society and the economy. Hence, reasonable rates are important
for all.
8. Should there be a supervisor, such as the Reserve Bank of India that
looks into the loan activities of informal lenders? Why would its task be
quite difficult?
Answer: The informal lenders work according to their own set of rules.
They seldom maintain proper records and do not reveal their transaction
detail to the government authority. Most of the money involved in this is
black money and the lender always wants to earn windfall profits. They
will oppose every attempt to bring them into the ambit of governance.
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Hence, it would be very difficult for supervisor to look into the loan
activities of informal sector.
9. Why do you think that the share of formal sector credit is higher for the
richer households compared to the poorer households?
Answer: The formal sector credit is available to those who have good
repayment capacity. Lending money is the main source of income for
banks. They cannot afford to lend to the poor and suffer losses in the
bargain. Due to this, the share of formal sector credit is higher for the
richer households compared to the poorer households.
10.
In situations with high risks, credit might create further problems
for the borrower. Explain.
Answer: In situation of high risks, credit often creates further problems
for the borrower. To understand this, let us take an example of a
marginal farmer who holds a small plot of land. Let us assume that the
farmer borrows some money to buy seeds and fertilisers. The harvest
which he gets may not be enough to meet his familys needs. So he
never comes in a position to sell the farm produce so that he can repay
his loans. If some natural calamity; like flood or drought destroys the
crops; it even worsens the situation for him. Finally, there is no other
way than to get trapped in the never ending cycle of loans.
There are many people who do not have access to the formal credit
sources. Such people often fall in the hands of moneylenders who
resort to all sorts of methods to suppress the poor. To help such people
out of the economic mess, it is necessary to reach the formal sources of
credit to them. It will also help in improving the socioeconomic
conditions in villages and remote areas.
4. What is the basic idea behind the SHGs for the poor? Explain in your
own words.
Answer: Self Help Groups are made to help those poor who do not
have access to the formal sources of credit. There are various reasons
for their inability to secure a loan from banks or cooperatives. These
people are so poor that they fail the creditworthiness. Moreover, the
amount borrowed by them is too small to even recover the cost of
administration of loan. Illiteracy and lack of awareness further
compounds the problems for them. The SHGs help them in providing
micro finance so that they can sustain their livelihood. Moreover, SHGs
also facilitate the development of a repayment culture among such
people.
5. What are the reasons why the banks might not be willing to lend to
certain borrowers?
Answer: A bank usually lends to a person who has repayment capacity.
Banks avoid lending for a risky venture. These are the reasons, banks
might not be willing to lend to certain borrowers.
6. In what ways does the Reserve Bank of India supervise the functioning
of banks? Why is this necessary?
Answer: RBI is the central bank of India. It formulates policies for the
banking sector in India. Proper rules and regulations are necessary for
the banking system because the banks affect the overall economy in a
great way. By regulating the functioning of banks, RBI not only keeps a
check on the banking and finance but also on the overall economy so
that economic crisis does not erupt.
7. Analyse the role of credit for development.
Answer: Credit plays a crucial role in development. For most of the
businesses, credit becomes necessary for expansion at some time or
the other. Without credit, a small company cannot be changed into a big
corporate house. Farmers cannot go for large scale farming in the
absence of credit. Majority of people shall never be in a position to buy
a house or a car in the absence of loan. Demand of car and houses
helps in developing the economy in a significant way.
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13.
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16.
(i) Coins such as gold, silver, copper coins. (ii) Paper notes, (iii)
Fiat money, (iii) Credit money or deposits with Banks, and (iv)
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93.
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