MONEY AND CREDIT
Chapter- 3
1. In situations with high risks, credit might create further problems for the borrower.
Explain.
Answer:
1. Rural areas are at high risk as the main demand for credit is for crop production which includes significant expenditure on seeds, fertilizers, pesticides, water, electricity and equipment repairs.
2. There is a minimum spread of three months of four months between the time farmers purchase these inputs and the time they sell the crop.
3. Farmers usually borrow crops at the beginning of the season and repay the loans after the harvest.
4. Debt repayment is crucially dependent on income from agriculture.
5. If the crop fails due to lack of rainfall or for some other reason, a small farmer must sell a portion of the land to pay off the loan.
6. Crop failures create more problems for borrowers. Credit does not improve his income but leaves him worse off than before. In high-risk situations, credit pushes the borrower into a debt trap, a situation from which recovery is very painful.
2. How does money solve the problem of double coincidence of wants? Explain with
an example of your own.
Answer: In an exchange system where goods are exchanged directly without the use of money, the dual coincidence of demands is an essential feature. By acting as a medium of exchange, money removes the dual coincidences of what is sought and the difficulties associated with the system of exchange. For example, the farmer does not need to find a book publisher who will sell books to him who will buy his food crops at the same time. He just has to find a buyer for his food grain. If he has exchanged food grains for money, he can purchase any goods or services he needs. This is because money acts as a medium of exchange.
3. How do banks mediate between those who have surplus money and those who
need money?
Answer:
1. People keep money as deposits with banks who pay interest rates on them.
2. People cannot withdraw their cash daily.
3. Therefore, banks keep only 15 per cent of their deposits in cash to pay depositors who come to withdraw money from the bank on any given day.
4. Since, on any given day, only some of its many depositors come to withdraw cash, the bank is able to manage with this cash.
5. They use a major portion of the deposits to provide loans to people in need of funds.
6. Banks use deposits to meet people’s credit needs.
7. Hence, thus, banks intermediate between people who have excess money and those who need money. Banks charge higher interest rates on loans than they offer on deposits. The difference between the two is the major source of income for the banks.
4. Look at a 10 rupee note. What is written on top? Can you explain this statement?
Answer:
In India, the Reserve Bank of India issues currency notes on behalf of the central government. The statement means that the currency is authorized or guaranteed by the Central Government. That is, Indian law legalizes the use of the rupee as a medium of payment that can not be refused in a setting transaction in India.
5. Why do we need to expand formal sources of credit in India?
Answer:
We need to expand formal sources of credit in India due to the following reasons :
• Mahajans or agricultural merchants charge much higher interest on loans. They usually charge 5 per cent per month while banks charge around 10 to 15 per cent per annum. Higher interest rates do little to boost borrowers’ earnings.
• Farmers who take loans from a trader are forced to sell their crops at lower prices. As a result, farmers suffer while traders profit by selling crops at higher prices.
• High interest rates mean that the borrower must pay back a major portion of his or her income to pay the interest and principal on the loan. This sometimes results in a debt trap for borrowers.
• On the other hand, banks and cooperatives charge low interest and do not exploit borrowers. Under these circumstances, there is a need to expand formal sources of credit in India. Everyone is also required to receive this loan.
• This will result in more income and many people can then borrow cheaply for various needs. Formal credit should be distributed equally to benefit the poor from cheap credit.
• It may be added that cheap and accessible credit is important for the development of the country.
6. What is the basic idea behind the SHGs for the poor? Explain in your own words.
Answer:
The main objective of SHGs is to provide a financial resource to the poor through organizing the rural poor, especially women, into small self-help groups. They provide timely loans at responsible interest rates without collateral. Therefore, the main objectives of SHG are:
• Organize the rural poor, especially women, into small self-help groups.
• to collect the savings of their members.
• Granting of loans without collateral.
• Timely disbursement of loans for various purposes.
• Provide loans at a responsible interest rate and simple terms.
• Provide a platform to discuss and work on various social issues such as education, health, nutrition, and domestic violence.
7. What are the reasons why the banks might not be willing to lend to certain borrowers?
Answer:
Banks may be unwilling to lend to some borrowers for the following reasons:
• Banks need proper documentation and collateral as security against the loan. Some individuals fail to meet these requirements.
• Banks may not be willing to lend more to borrowers who have not repaid their previous loans.
• Banks may not be willing to lend to entrepreneurs who are going to invest in businesses with high risk.
• One of the main objectives of a bank is to earn higher profits after meeting several expenses. For this purpose, it must adopt an equitable lending and investment policy that ensures a fair and steady return on funds.
8. In what ways does the Reserve Bank of India supervise the functioning of banks?
Why is this necessary?
Answer:
The Reserve Bank of India monitors the amount of money banks lend, and also the amount of cash they maintain. It also ensures that banks provide loans not only to profitable businesses, but also to small farmers, small enterprises, and micro-borrowers. From time to time, banks are required to submit information to the RBI on the amount lent, to whom, and at what interest rate.
This monitoring is necessary to ensure that equity is preserved in the financial sector, and small enterprises are also given a marketplace to develop. This is also done to ensure that banks do not lend more money than they need, as this could lead to a situation similar to the Great Depression of the 1930s in the United States, which also severely affected the world economy.
9. Analyse the role of credit for development.
Answer:
The role of credit for development is crucial as follows:
• It helps in increasing the economic activity of the borrowers.
• If credit is made available to the poor on reasonable terms and conditions, they can improve their economic situation. This will help in all developments.
• Credit can increase activity in the secondary sector, i.e. the manufacturing sector. Therefore, with loans, people can grow crops, do business, set up small-scale industries. They can set up new industries or trade goods. Therefore, debt is very important for the development of the country.
10. Manav needs a loan to set up a small business. On what basis will Manav decide
whether to borrow from the bank or the moneylender? Discuss.
Answer:
Man will decide whether to take a loan from a bank or moneylender based on the following loan terms:
• Interest rates
• collateral and documentation requirements required by bankers.
• Method of payment.
Depending on these factors and, of course, on the simple terms of repayment, one will have to decide whether to borrow from the bank or from the lender.
11. In India, about 80 per cent of farmers are small farmers, who need credit for cultivation.
(a) Why might banks be unwilling to lend to small farmers?
Answer: banks may be reluctant to lend to smallholder farmers since farmers typically borrow crops early in the season and repay the loans after harvest. Debt repayment is dependent on income from agriculture. and in case of crop failure, payment becomes impossible. In such cases, it becomes very difficult to recover loans from smallholder farmers. Small farmers have to sell parts of the land to repay loans which is why banks do not want to lend to small farmers.
(b) What are the other sources from which the small farmers can borrow?
Answer: Small farmers usually borrow from moneylenders or agricultural traders.
(c) Explain with an example how the terms of credit can be unfavourable for the
small farmer.
Answer: When crops fail, it becomes impossible for smallholder farmers to sell their crops and repay the loans. To pay in this way, small farmers sell a piece of land. This deteriorates their condition. Sometimes, smallholder farmers provide collateral or security against the loan. Collateral usually includes land, buildings, vehicles, and livestock. In case of default, the lender may sell the loan to collateral to recover the loan. In the above circumstances, the loan terms become unfavorable for smallholder farmers.
(d) Suggest some ways by which small farmers can get cheap credit.
Answer: Apart from banks, another major source of cheap loans in rural areas is cooperative societies or cooperatives. Members of a cooperative society pool their resources for cooperation in some areas. The cooperative accepts deposits from its members. When these deposits are collateralized, the cooperative receives a loan from the bank. These funds are used to provide loans to members.
12. Fill in the blanks:
(i) Majority of the credit needs of the _________________households are met
from informal sources.
Answer: poor
(ii) ___________________costs of borrowing increase the debt-burden.
Answer: High
(iii) __________________ issues currency notes on behalf of the Central
Government.
Answer: Reserve Bank of India.
(iv) Banks charge a higher interest rate on loans than what they offer on
__________.
Answer: deposits.
(v) _______________ is an asset that the borrower owns and uses as a guarantee
until the loan is repaid to the lender.
Answer: Collateral.
13. Choose the most appropriate answer.
(i) In a SHG most of the decisions regarding savings and loan activities are taken by
(a) Bank.
(b) Members.
(c) Non-government organisation.
(ii) Formal sources of credit does not include
(a) Banks.
(b) Cooperatives.
(c) Employers.
Answer:
(i) (b)
(ii) (c)
