Chapter 3: Money and Credit - Exam Notes
1. Money as a Medium of Exchange
Core Idea: Money acts as an intermediate step in the
exchange process, eliminating the need for a double
coincidence of wants.
• Barter System: An early method of trade where goods and
services are directly exchanged for other goods without the
use of money.
• Double Coincidence of Wants: A situation in a barter
system where both parties must desire exactly what the
other offers in order to make a trade.
• Medium of Exchange: Money simplifies transactions
because it can be easily exchanged for any commodity or
service; it acts as an intermediate.
• Modern Forms of Money: Includes currency (paper notes
and coins). Unlike earlier forms like cattle or grains, modern
currency has no use of its own but is widely accepted
because it is authorised by the government.
• Currency in India: The Reserve Bank of India (RBI) issues
currency notes on behalf of the Central Government. By law,
the rupee cannot be refused as a medium of payment in
India.
NCERT Example: A shoe manufacturer who wants wheat will
first exchange shoes for money and then use that money to
buy wheat, rather than searching for a farmer who wants
shoes and has wheat.
CBSE Previous Year Questions:
• How does the use of money make it easier to exchange
things?
◦ It eliminates the need for a double coincidence of wants.
◦ It provides a common measure of value for all goods and
services.
◦ It acts as a crucial intermediate step in the exchange
process.
• Why is the Rupee accepted as a medium of exchange in
India?
◦ It is authorised by the Government of India.
◦ The RBI issues notes on behalf of the Central
Government.
◦ The law legalises its use as a payment that cannot be
refused.
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2. Deposits with Banks
Core Idea: People deposit surplus cash in bank accounts for
safety and to earn interest; these are called demand deposits
because they can be withdrawn at any time.
• Demand Deposits: Deposits in bank accounts that can be
withdrawn on demand.
• Safety and Interest: Banks keep money safe and also pay an
amount as interest on these deposits.
• Cheque Facility: A cheque is a paper instructing the bank to
pay a specific amount from the person’s account to the
person named on the paper.
• Loan Mechanism: Banks keep only a small portion (about
15%) of deposits as cash for daily withdrawals and use the
major portion to extend loans.
• Bank Income: Banks charge a higher interest rate on loans
than what they offer on deposits. The difference between
these two rates is their main source of income.
NCERT Example: M. Salim writes a cheque to a leather
supplier; the money is transferred between bank accounts
without any cash payment, completing the transaction safely.
CBSE Previous Year Questions:
• Explain the loan activities of a bank.
◦ Banks accept deposits from people with surplus funds.
◦ They keep a small percentage (15%) as cash reserves for
depositors.
◦ They lend the remaining majority of deposits to
borrowers who need funds.
◦ Banks act as mediators between depositors and
borrowers.
• What is a cheque? How does it help in settling payments?
◦ It is a paper instructing a bank to pay a specific amount to
a named person.
◦ It allows payments to be settled directly from one bank
account to another without the use of cash.
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3. Credit and its Implications
Core Idea: Credit is an agreement where the lender supplies
the borrower with money, goods, or services in return for a
promise of future payment.
• Positive Role: Credit helps meet working capital needs,
complete production on time, and increase earnings.
• Negative Role (Debt Trap): In high-risk situations (e.g., crop
failure), credit can push the borrower into a debt trap,
making recovery very painful and often forcing them to sell
assets.
• Usefulness of Credit: This depends on the risks in the
situation and whether there is some support in case of loss.
NCERT Cases:
• Salim: Took a loan for shoe production, made a profit, and
easily repaid the loan (Positive impact).
• Swapna: A small farmer whose crop failed due to pests; she
was unable to repay and had to sell part of her land (Debt
trap).
CBSE Previous Year Questions:
• "Credit can play a positive or a negative role." Explain.
◦ Positive: It helps borrowers like Salim to increase
production and earnings.
◦ Negative: It can push borrowers like Swapna into a debt
trap due to risks like crop failure.
• What is a 'Debt Trap'?
◦ A situation where a loan is difficult or impossible to repay.
◦ It occurs when the borrower is forced to take more loans
or sell assets to repay old debts.
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4. Terms of Credit
Core Idea: Terms of credit are the specific conditions, such as
interest rate and collateral, under which a loan is provided.
• Key Components: Interest rate, collateral, documentation
requirements, and the mode of repayment.
• Collateral: An asset (like land, building, vehicle, or bank
deposits) that the borrower owns and uses as a security to
the lender until the loan is repaid.
• Lender’s Rights: If the borrower fails to repay, the lender
has the right to sell the collateral to obtain payment.
• Variation: Terms vary substantially depending on the nature
of the lender and the borrower.
NCERT Example: Megha took a house loan of ₹5 lakhs. She
had to provide employment records and salary slips, and the
bank kept the new house papers as collateral.
CBSE Previous Year Questions:
• What are the 'Terms of Credit'?
◦ The set of conditions under which a loan is given.
◦ Includes interest rate, collateral, documentation, and
mode of repayment.
• Define 'Collateral'. Why is it used?
◦ An asset owned by the borrower used as a guarantee for
the lender.
◦ It is used as security; if the borrower defaults, the lender
can sell it to recover funds.
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5. Formal and Informal Credit
Core Idea: Credit sources are grouped into the formal sector
(regulated) and the informal sector (unregulated), with the
poor relying heavily on the latter.
• Formal Sector: Includes banks and cooperatives. They
charge low interest rates and are supervised by the RBI.
• Informal Sector: Includes moneylenders, traders, relatives,
and friends. They charge much higher interest rates, have no
supervisor, and may use unfair means to recover money.
• Role of RBI: Supervises formal sources, ensures banks
maintain cash balance, and sees that loans are given to small
cultivators and borrowers, not just profit-making businesses.
• Credit Gap: Rich households get 83% of their loans from
formal sources, while 85% of poor households depend on
informal sources due to a lack of collateral.
• Importance of Expansion: Cheap and affordable credit is
crucial for national development to avoid debt traps and
promote enterprise.
NCERT Example: In Sonpur, Arun receives a bank loan at 8.5%
per annum, whereas Shyamal borrows from an agricultural
trader at 60% per annum.
CBSE Previous Year Questions:
• Distinguish between formal and informal sources of credit.
◦ Formal: Regulated by RBI, low interest, requires
documentation.
◦ Informal: No supervisor, high interest, often no collateral
needed.
• How does the RBI supervise the functioning of banks?
Why is it necessary?
◦ It monitors cash reserves and periodically checks lending
data (who, how much, what rate).
◦ Necessary to ensure safety of deposits and that credit
reaches small borrowers.
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6. Self-Help Groups (SHGs) for the Poor
Core Idea: SHGs are small groups of rural poor who pool
savings to provide loans to members, helping them overcome
the problem of lack of collateral.
• Structure: Typically 15-20 members from the same
neighborhood who save regularly (₹25–₹100 or more).
• Loan Function: Members take small loans from the group at
low interest; after 1-2 years, the group becomes eligible for a
bank loan sanctioned in the name of the group.
• Decisions: All decisions on loans (purpose, amount,
repayment) are taken collectively by the group members.
• Advantages:
◦ Overcomes lack of collateral.
◦ Provides timely loans at reasonable rates.
◦ Empowers women financially and socially.
◦ Acts as a platform to discuss issues like health, nutrition,
and domestic violence.
NCERT Example: Grameen Bank of Bangladesh has over 9
million members (mostly women) and is a massive success in
reaching the poor at reasonable rates.
CBSE Previous Year Questions:
• Explain the functioning of SHGs.
◦ Members meet and pool regular savings.
◦ Loans are provided for self-employment or small needs.
◦ The group is collectively responsible for repayment.
• Why are SHGs becoming popular among the rural poor?
◦ They provide credit without the need for individual
collateral.
◦ They offer lower interest rates than moneylenders.
◦ They promote financial and social empowerment of
women.
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Exam Focus Points
1. Double Coincidence of Wants: Essential feature of the
barter system that money eliminates.
2. RBI Supervision: Key role in keeping the formal sector
transparent and fair.
3. Bank Income Source: The "spread" or difference between
interest charged to borrowers and paid to depositors.
4. Terms of Credit: A bundle of interest rates, collateral, and
documentation.
5. Debt Trap: A negative cycle of borrowing caused by high
interest or risky situations.
6. Collateral: The "security" asset that often prevents the
poor from accessing formal banks.
7. Empowerment through SHGs: Beyond money, they offer
social platforms for rural women.
Conclusion
Money and credit are central to modern economic life and
are closely linked with the banking system. While credit can
drive development, it can also lead to debt traps if not
provided on reasonable terms. Expanding formal credit to the
rural poor and reducing dependence on expensive informal
sources is essential for a country’s overall growth.