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Money and Credit

04 Money and Credit

Money as a Medium of Exchange


  • Transactions are made in money because a person holding money can easily exchange it for any commodity or service that he desires.
  • If someone wishes to exchange his possession for a thing he wants, both parties have to agree to sell and buy each other’s commodities and this is known as double coincidence of wants.
  • Barter system involves goods being directly exchanged without the use of money and double coincidence of wants is an essential feature.
  • Money is called a medium of exchange since money acts as an intermediate in the exchange process.

Modern forms of Money


  • Currency including paper notes and coins are the modern forms of money.
  • It is accepted as a medium of exchange because:
    • The currency is authorised by the government of the country.
    • No other individual or organisation is allowed to issue currency as per Indian law.
    • The law also legalises the use of rupee as a medium of payment that cannot be refused in settling transactions in India.



Deposits with Banks

  • The other form in which people hold money is as deposits with banks.
  • Demand deposits also offer a facility which lends it the essential characteristics of money.
  • A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued.

Loan Activities of Banks


  • The major portions of the deposits in banks are used to extend loans.
  • By meeting loan requirements, banks mediate between those who have surplus funds called depositors and those who are in need of these funds called borrowers.
  • Banks charge a higher interest rate on loans than what they offer on deposits and the difference between what is charged from borrowers and what is paid to depositors is their main source of income.

Two Different Credit Situations


  • Some people obtain credit to meet the working capital needs of production to meet the ongoing expenses of production, complete production on time, and thereby increase their earnings.
  • But in rural areas, the main demand for credit is for crop production which involves considerable costs on seeds, fertilisers, pesticides, water, electricity, repair of equipment, etc.

Terms of Credit

  • Terms of credit comprises interest rate, collateral and documentation requirement, and the mode of repayment.
  • The terms of credit vary substantially from one credit arrangement to another depending on the nature of the lender and the borrower.

Loans from Cooperatives

  • The other major sources of cheap credit, besides banks, in rural areas are the cooperative societies (or cooperatives whose members group their resources for cooperation in certain areas.

Formal Sector Credit in India

  • The Reserve Bank of India supervises the functioning of formal sources of loans.
  • Banks are required to periodically submit information to the RBI on how much they are lending, to whom, at what interest rate, etc.


Formal and Informal Credit: Who gets what?

  • The formal sector still meets only about half of the total credit needs of the rural people and the remaining credit needs are met from informal sources.
  • Formal sector loans need to expand but it is also necessary that everyone receives these loans.

Self-Help Groups for the Poor

  • SHGs typically have 15-20 members, usually from the same neighbourhood, who meet and save regularly.
  • People depend on SHGs for timely loans for a variety of purposes and at a reasonable interest rate.
  • SHGs are the building blocks of organisation of the rural poor by helping women become financially self-reliant, providing a platform to discuss and act on a variety of social issues such as health, nutrition, domestic violence, etc. through regular meetings.

Grameen Bank of Bangladesh

  • Grameen Bank of Bangladesh was started in the 1970s as a small project.
  • In October 2014 it had over 8.63 million members in about 81,390 villages spread across Bangladesh.
  • Almost all of the borrowers are women who belong to poorest sections of the society.
  • These borrowers are proof that poor women reliable borrowers and can start and successfully run a variety of small income-generating activities.

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