MONEY AND CREDIT

Exercises:
1. In situations with high risks, credit might create further
problems for the borrower. Explain?
Ans:
 High-risk situations occur in rural areas because there the main
demand for credit is for crop production which involves considerable
costs on seeds, fertilisers, electricity, repair of equipment.
 There is a minimum stretch of three of four months between the time
when farmers buy these inputs and when they sell the crop.
 Farmers generally take crop loans at the beginning of the season and
repay the loan after harvest.
 Repayment of the loan is crucially dependent on the income from
farming.
 If a crop fails due to shortage of rain or for any other reason, a small
farmer must sell a part of the land to repay the loan.

2. How does money solve the problem of double coincidence of

wants? Explain with example of your own.
Ans:
 In a barter system where goods are directly exchanged without the
use of money, double coincidence of wants is an essential feature.
 By serving as a medium of exchanges, money removes the need for
double coincidence of wants and the difficulties associated with the
barter system.
 For example, it is no longer necessary for the farmer to look for a
book publisher who will buy his cereals at the same time sell him
books.
3. How do banks mediate between those who have surplus money
and those who need money?
Ans:
 People hold money as deposits with banks which pay an interest rate
on them.
 People do not withdraw their cash daily.
 The banks, therefore, hold only 15 percent of their deposits as cash
with themselves to pay the depositors who might come to withdraw
money from the bank on any given day.
 Since, on any day, only some of its many depositors come to
withdraw cash, the bank can manage with this cash.
 They use a major portion of the deposits to extend loans to those
who need money.
 The banks make use of deposits to meet the loan requirements of the
people.

4. Look at a 10 rupee note. What is written on top? Can you explain

this statement?
“Reserve Bank of India” and “Guaranteed by the Government”
are written on top.
Ans:
 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 cannot be refused in a setting transaction in India.
5. Why do we need to expand formal sources of credit in India?
Ans:
 Moneylenders and agricultural traders charge 5% per month, much
higher than the 10-15% annual rate of banks, yet this higher interest
does little to boost borrowers' income.
 The farmers who take loans from a trader are forced to sell their
crops to him at a low price. As a result of it, the farmers suffer while
the traders make a profit by selling grains at a higher price.
 Higher interest means the borrower must pay a major portion of his
earnings to repay the interest and principal of the loan. This
sometimes leads to debt trap for the borrowers.
 Banks and cooperatives charge lower interest rates and do not
exploit borrowers. Therefore, expanding formal credit sources in India
is essential, ensuring that everyone has access to these loans.
 This would also lead to higher incomes and many people could then
borrow cheaply for a variety of needs. The formal credit should be
distributed equally to benefit the poor from the cheaper loan.

6. What is the basic idea behind the SHGs for the poor? Explain in
your own words.
Ans:
 The basic behind the SHGs is to provide a financial resource for the
poor through organizing the rural poor especially women, into small
Self-Help Groups.
 They also provide timely loans at a responsible interest rate without
collateral.
 Thus, the main objectives of the SHGs are:
(i) To organize rural poor especially women into small Self-Help
Groups.
(ii) To collect savings of their members.
(iii) To provide loans without collateral.
(iv) To provide timely loans for a variety of purposes.
(v) To provide loans at a responsible rate of interest and easy
terms.
7. What are the reasons why the banks might not be willing to lend
to certain borrowers?
Ans:
 Banks require proper documents and collateral as security against
loans. Some persons fail to meet these requirements.
 The borrowers who have not repaid previous loans, the banks might
not be willing to lend them further.
 The banks might not be willing to lend those entrepreneurs who are
going to invest in the business with high risks.
 A key objective of a bank is to earn profits after covering expenses by
adopting sound loan and investment policies that ensure fair and
stable returns.

8. In what ways does the Reserve Bank of India supervise the

functioning of banks? Why is this necessary?
Ans:
 The Reserve Bank of India monitors the amount of money that banks
loan out, and the amount of cash balance maintained by them.
 It also ensures that banks give out loans not just to profiteering
businesses but also to small cultivators, small scale industries, and
small borrowers.
 Periodically, banks are supposed to submit information to the RBI on
the amounts lent, to whom, and at what rates of interest.
 This monitoring is necessary to ensure that equality is preserved in
the financial sector, and that small industry is also given an outlet to
grow.
 This also ensures that banks don’t lend more than they should,
preventing crises like the 1930s Great Depression, which severely
impacted the global economy.
9. Analyze the role of credit for development.
Ans:
 It helps in increasing economic activities of the borrowers.
 If credit is made available to the poor people on reasonable terms
and conditions, they can improve their economic condition. This will
help in the overall development.
 Credit may increase the activities in the secondary sector e.,
manufacturing sector. Thus, with credit people could grow crops, do
business, set up small-scale industries.
 They could set up new industries or trade in goods.
 Therefore, credit is crucial for the country’s development.

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.
Ans: Manav will decide whether to borrow from the bank or the
moneylender based on the following terms of credit:
 rate of interest
 requirements availability of collateral and documentation required by
the banker.
 mode of repayment.

Depending on these factors and of course, easier terms of repayment,

Manav must decide whether he must borrow from the bank or the
moneylender.

11. In India, about 80 percent of farmers are small farmers, who

need cultivation.
(a) Why might banks be unwilling to lend to small farmers?
Ans:
 The banks might be unwilling to lend to small farmers because the
farmers usually take crop loan at the beginning of the season and
repay the loan after harvest.
 Repayment of loan is dependent on the income from farming. And
in case of crop failure, repayment becomes impossible.
 In such cases, the recovery of loan from the small farmers
becomes very difficult.
  The small farmers must sell part of the land to repay the loan that
is why banks do not want to give loans to small farmers.

(b) What are the other sources from which the small farmers
can borrow?
Ans: Small farmers usually borrow from moneylenders or agricultural
traders.

(c) Explain with an example of how the terms of credit can be

unfavorable for the small farmer.
Ans:
 In case of failure of crops, it becomes impossible for small farmers
to repay the loan by selling their crops.
 Thus, to repay, the small farmers sell a part of the land.
 This leads to worsening of their condition.
 Sometimes, small farmers give collateral or security against loans.
 The collateral generally consists of land, building, vehicles,
livestock.
 In case of nonpayment of loan, the lender may sell the collateral to
recover loan. Under above conditions, the terms of credit become
unfavorable for the small farmers.

(d) Suggest some ways by which small farmers can get cheap
credit.
Ans:
 Besides banks, the other major source of cheap credit in rural
areas are the cooperative societies or cooperatives.
 Members of a cooperative society, pool their resources for
cooperation in certain areas.
 The cooperative accepts deposits from its members.
 With these deposits as collateral, the cooperative obtains loan from
the bank.
 These funds are used to provide loans to members.
12.
(i) Majority of the credit needs of the __________households are
met from informal sources.
(ii) __________costs of borrowing increase the debt-burden.
(iii) __________issues currency notes on behalf of the Central
Government.
(iv) Banks charge a higher interest rate on loans than what they
offer on __________.
(v) _________is an asset that the borrower owns and uses as a
guarantee until the loan is repaid to the lender.

Ans:

(i) Poor
(ii) High
(iii) Reserve Bank of India
(iv) Deposits
(v) Collateral

13.
(i) (b) Members
(c) Employers