Introduction:

• In many of the transactions, goods are being bought and sold with the use of money.
• Credit is a crucial element in economic life.
• We need to find new ways and this is one of the social challenges that developing countries face.

Barter system - The system of exchanging goods is known as 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.
• Two people with different types of needs and goods must be there to satisfy each other's needs.

• It can be very difficult to find a person who can fulfill this condition.
• There are many products which cannot be divided.
• Valuation of goods is very difficult.
• It was time consuming.

Money - An economic unit that functions as a generally recognized medium of exchange for transactional purposes in an economy is called 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.

Money as a medium of exchange:

• A person holding money can easily exchange it for any commodity or service that he or she might want.
• Thus everyone prefers to receive payments in money and then exchange the money for things that they want.
• Take the case of a shoe manufacturer.
• He wants to sell shoes in the market and buy wheat.
• The shoe manufacturer will first exchange shoes that he has produced for money, and then exchange the money for wheat.
• Imagine how much more difficult it would be if the shoe manufacturer had to directly exchange shoes for wheat without the use of money.
• He would have to look for a wheat growing farmer who not only wants to sell wheat but also wants to buy the shoes in exchange.
• That is both parties have to agree to sell and buy each other’s commodities. This is known as double coincidence of wants.

Advantage of Money:

• Removes the coincidence of wants.
• Takes less storage space and is easier to carry.
• Liquidity of currency is easier.

• It is used as a medium of exchange.
• It offers economic freedom to the people.
• It is used for purchasing goods and services.
• It is easy to store money.
• Now-a-days; many instruments are available through which it is not necessary to physically carry the currency.

Measure of value:

• Money serves as a measure of value in terms of unit of account.
• Unit of account means that the value of each good or services is measured in the monetary unit.

Modern forms of money:

Currency - The most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins is called currency.

• Modern forms of money include currency - paper notes and coins.
• Unlike the things that were used as money earlier, modern currency is not made of precious metal such as gold, silver and copper.
• And unlike grain and cattle, they are neither of everyday use.
• The modern currency is without any use of its own.
• Then, why is it accepted as a medium of exchange?
• It is accepted as a medium of exchange because the currency is authorised by the government of the country.
• In India, the Reserve Bank of India issues currency notes on behalf of the central government.
• As per Indian law, no other individual or organisation is allowed to issue currency.
• Moreover, the law legalises the use of rupee as a medium of payment that cannot be refused in settling transactions in India.
• No individual in India can legally refuse a payment made in rupees.
• Hence, the rupee is widely accepted as a medium of exchange.

Money is used as a medium of exchange because:

• It is authorised by the government of the country.
• In case of India the Reserve Bank of India issues currency notes on behalf of the central government.
• In India the law legalises the use of rupee as a medium of payment that cannot be refused in settling transactions in India.
• No individual in India can legally refuse a payment made in rupees.
• Value of each good or service is measured in the monetary unit

Deposits with banks:

• Most of the people need only some currency for their daily needs.
• Rest of the amount is usually kept as deposit in banks.
• Money which is kept in a bank is safe and it even earns an interest.
• One can withdraw money from his account as and when required.

Demand deposits - The deposits in the bank accounts which can be withdrawn on demand are known as demand deposits.

Advantages of depositing money in the bank:

• It is a safer place to keep money in banks as compared to the house or a working place.
• People can earn interest on the deposited money.
• People have the provisions to withdraw the money as and when they require.
• People can also make payments through cheques.

Credit: 

• Banks keep a small proportion of their deposits as cash with themselves.
• This is usually 15% of their deposits as cash.
• This amount is kept as provision to pay the depositors who may come to withdraw the money on any day.
• This amount is enough because only a small fraction of people come to withdraw money on a given day.
• The rest of the amount is used by the banks to give money on credit to people who need the credit.
• A bank charges interest on the loan which it gives to its creditors.
• The interest rate charged by a bank no loans is higher than the interest rate given by it on deposits.
• Thus, interest is the main source of income for banks.

Credit/Debit Cards: 

• Now-a-days, credit/debit cards are in vogue.
• A debit card allows you to make payments from the amount which is lying in your bank account.
• A credit card, on the other hand, provides money on credit.
• Payment through credit/debit card is done electronically and this removes the need of carrying cash.

Cheque - 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 is called cheque.

• One can use a cheque; instead of cash to settle payments.
• Moreover, one can also buy a demand draft from a bank to make payments.

Advantages:

• It is the safest mode of transaction.
• It is easy to carry a cheque as compared to money.
• Thus we see that demand deposits share the essential features of money.
• The facility of cheques against demand deposits makes it possible to directly settle payments without the use of cash.
• Since demand deposits are accepted widely as a means of payment, along with currency, they constitute money in the modem economy.
• You must remember the role that the banks play here.
• But for the banks, there would be no demand deposits and no payments by cheques against these deposits.
• The modern forms of money-currency and deposits are closely linked to the working of the modern banking system.

Loan activities of banks:

• Banks keep only a small proportion of their deposits as cash with themselves.

(About 15% for their deposits)

• Banks use the major portion of the deposits to extend loans.
• Banks make use of deposits to meet the loan requirements of the people.
• In this way, Banks mediate between those who have surplus funds (The depositors) and those who are in needs of funds (the borrowers).
• Bank charge a higher rate of interest on loans than what they offer on deposits.
• The difference between what is charged from borrowers and what is paid to depositors is their main source of income.

Do you know?

• The Reserve Bank of India (RBI) started producing notes in 1938. At present, the Reserve Bank of India controls the issuance and management of currency in India.
• The Indian rupee symbol was adopted in 2010, that was created by D. Udaya Kumar. To create the symbol the Latin letter "R" and Devanagari letter Ra "" is used and given two parallel lines representing the Indian National Flag.
• The present series of bank notes is known as the Mahatma Gandhi series. It was introduced in 1996 on the 10-rupee note. Now, all the notes have an image of Mahatma Gandhi.
• Demonetization is the process of removing certain form of currency from circulation.
• The borrowers from the Grameen Bank have proved that not only are poor women reliable borrowers, but that they can start and run a variety of small income-generating activities successfully.

Two different credit situations:

• A large number of transactions in our day-to-day activities involve credit in some form or the other Credit (loan) refers to an agreement in which the lender supplies the borrower with money, goods or services in return for the promise of future payment.

Let us see how credit works through the following two examples:

Festival seasons

• It is festival season two months from now and the shoe manufacturer, Salim, has received an order from a large trader in town for 3,000 pairs of shoes to be delivered in a month time.
• To complete production on time, Salim has to hire a few more workers for stitching and pasting work.
• He has to purchase the raw materials.
• To meet these expenses, Salim obtains loans from two sources.
• First, he asks the leather supplier to supply leather now and promises to pay him later.
• Second, he obtains loan in cash from the large trader as advance payment for 1000 pairs of shoes with a promise to deliver the whole order by the end of the month.
• At the end of the month, Salim is able to deliver the order, make a good profit, and repay the money that he had borrowed.
• In this case, Salim obtains credit to meet the working capital needs of production.
• The credit helps him to meet the ongoing expenses of production, complete production on time, and thereby increase his earnings.
• Credit therefore plays a vital and positive role in this situation.

Swapna's problem

• Swapna, a small farmer, grows groundnut on her three acres of land.
• She takes a loan from the moneylender to meet the expenses of cultivation.
• Hoping that her harvest would help repay the loan.
• Midway through the season the crop is hit by pests and the crop fails.
• Though Swapna sprays her crops with expensive pesticides, it makes little difference.
• She is unable to repay the moneylender and the debt grows over the year into a large amount.
• Next year, Swapna takes a fresh loan for cultivation.
• It is a normal crop this year.
• But the earnings are not enough to cover the old loan.
• She is caught in debt. In Swapna's case, the failure of the crop made loan repayment impossible.
• She had to sell part of the land to repay the loan.
• Credit, instead of helping Swapna improve her earnings, left her worse off.
• This is an example of what is commonly called debt-trap.
• Credit in this case pushes the borrower into a situation from which recovery is very painful.
• She has to sell a part of the land to pay off the debt.

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.

Terms of Credit: 

The terms of credit include rate of interest, collateral, documentation requirement 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.

Interest Rate - The amount a lender charges for the use of assets expressed as a percentage of the principal is called interest rate.

Every loan agreement specifies an interest rate which the borrower must pay to the bank along with the repayment of the principal amount.

Collateral - An asset that the borrower owns (such as lands, building, vehicles, livestocks, deposits with bank) and uses this as a guarantee to a lender until the loan is repaid is called 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 has the right to sell the collateral to obtain payment.

Advantage of Credit:

• It helps the people to purchase houses.
• It helps the businessmen to expand their business.
• The difference between the lending rate and borrowing rate is the source of income for the banks. In rural areas, the main demand for credit is for crop production.
• Farmers usually take crop loans at the beginning of the season and repay the loan after harvest. Repayment of the loans is crucially dependent on the income from farming.

Disadvantage of Credit:

• Banks charge a very high rate of interest which mean a large part of earning of the borrowers is used to repay the loan.
• If the borrowers fail to repay the loan, the bank has the right to sell the assets of the borrowers.
• If loan is used for unproductive activities the borrower can be pushed into a debt trap.
• Banks don't provide credits to the poor people as they don't have any approved security.

Loan from cooperatives:

• Besides banks, the other major source of cheap credit in rural areas is the cooperative societies (or cooperatives).
• Members of a cooperative pool their resources for cooperation in certain areas.
• There are several types of cooperatives possible such as farmer’s cooperatives, weaver’s cooperatives, industrial workers cooperatives, etc.
• Krishak Cooperative functions in a village not very far away from Sonpur.
• It has 2300 farmers as members.
• It accepts deposits from its members.
• With these deposits as collateral, the Cooperative has obtained a large loan from the bank, these funds are used to provide loans to members.
• Once these loans are repaid, another round of lending can take place.
• Krishak Cooperative provides loans for the purchase of agricultural implements, loans for cultivation and agricultural trade, fishery loans, loans for construction of houses and for a variety of other expenses.

Formal sector in 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.

Fig: Sources of Credit for 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.

Formal lender resources:

These include those resources which are controlled by the government. Banks and Cooperatives fall in the formal category.

In formal lender resources: These include money lenders, traders, relatives and friends.

Difference between formal and informal credit
Formal	Informal
These resources work under the supervision of the R.B.I. The rate of interest is very low. Commercial banks, Cooperative banks, Societies are the main sources of Formal Credit.	These do not work under any government organisation. The rate of interest is very high. Relatives, moneylenders and landlords are the main sources of Informal Credit

Unequal distribution of formal sector loans:

• Even after more than 50 years of independence most of rural and poor people still depends on non formal resources for their loan requirement 85 % of the loan taken by poor households in the urban areas are from informal sources.
• The poor households have to pay a heavy price for borrowing

RBI Lender of the last resort:

• The Reserve Bank of India supervises the functioning of formal sources ans.
• For instance, we have seen that the banks maintain a minimum cash balance out of the deposits they receive.
• The RBI monitors the banks actually maintaining cash balance.
• Similarly, the RBI sees that the banks give loans not just too profit-making businesses and traders but also to small cultivators, small scale industries, to small borrowers etc.
• Periodically, banks have to submit information to the RBI on how much they are lending, whom, at what interest rate, etc.

The role of formal sector in the country's development:

• Banks and cooperative societies need to lend more.
• This would lead to higher incomes and many people could then borrow cheaply a variety of needs.
• They could grow crops, do business, set up small scale industries etc.
• They could set up new industries or trade goods.
• Cheap and affordable credit is crucial for the count development.
• Most loans from informal lenders carry a very high interest rate a do little to increase the income of the borrowers.
• Thus, it is necessary that banks and cooperatives increase their lending particularly in the rural areas, so that the dependence on informal sources of credit reduces.
• While formal sector loans need to expand, it is also necessary that everyone receives these loans.
• At present, it is the richer households who receive formal credit whereas the poor have to depend on the informal sources.
• It is important that the formal credit is distributed more equally so that the poor can benefit from the cheaper loans.

Self Help Groups (SHG) for the poor:

• It helps in pooling the savings of the members, who are poor.
• Members can get timely loans for a variety of purposes and at a reasonable rate of interest.

Major features of SHGS:

• A typical SHGS can have 15-20 members usually belonging to the same village.
• The main motive of SHGS is to pool the savings of the poor people.
• Saving per member can vary from Rs. 25 to Rs. 100 or more depending on the ability of the people and the strength of the group.
• It provides loans to their members at reasonable rates.
• After a year or two, if the group is regular in savings, it becomes eligible for bank loans.
• Loan is sanctioned in the name of the group with the main motive to create self employment opportunities for the members.Most of the SHGS work in a democratic way.

Importance of SHGS:

• The SHGS help borrowers overcome the problem of lack of collateral.
• They can get timely loans for a variety of purposes and at a reasonable interest rate.
• Moreover, SHGS are the building blocks of organisation of the rural poor.
• Not only does it help women to become financially self reliant, the regular meetings of the group provide a platform to discuss and act on a variety of social issues such as health, nutrition, domestic violence, etc.

Grameen Bank of Bangladesh:

• Grameen Bank of Bangladesh is one of the biggest success stories in reaching the poor to meet their credit needs at reasonable rates.
• Started in the 1970s as a small project Grameen Bank in 2011 has over 8.35 million borrowers in about 80,000 villages spread across Bangladesh.
• Almost all of the borrowers are women and belong to poorest sections of the society.