Money and Credit
Fill in the blanks:
- Majority of the credit needs of the _________________households are met from informal sources.
- ___________________costs of borrowing increase the debt-burden.
- __________________ issues currency notes on behalf of the Central Government.
- Banks charge a higher interest rate on loans than what they offer on __________.
- _______________ is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.
Answer the following questions:
Question 1: How does the use of money make it easier to exchange things?
Answer: Unlike the barter system, exchange by using money does not need a double coincidence of wants. Hence, money makes it easier to exchange things. Let us take example of a student who wants to sell his old books and wants to buy a guitar in lieu of that. If he opts for the barter system, he will have to search a person who may be interested in giving off his guitar and in taking old books. But finding such a person can be difficult and time consuming. On the other hand, if the student sells his books and takes money for that, he can easily go to a shop to buy a guitar.
Question 2: Can you think of some examples of goods / services being exchanged or wages being paid through barter?
Answer: Barter system does exist at some degree in our society. Farmers often use this system of exchange to barter different types of farm produce. Even some friends may exchange certain items among each other. Some hawkers sell trinkets and edible stuff in lieu of old bottles and plastic containers.
Question 3: Why do lenders ask for collateral while lending?
Answer: The collateral is a kind of surety, which the lender can hold on to. In case of de debtor failing to repay the loan, the lender can recover some money by selling the collateral.
Question 4: Given that a large number of people in our country are poor, does it in any way affect their capacity to borrow?
Answer: Credit is always given after properly assessing the repayment capacity of the borrower. Since poor people do not have repayment capacity, they are usually unable to get a loan; especially from the formal sector. They get some loan from the informal sector but in that case, they often fall in debt trap because of very high rate of interest.
Question 5: Fill in the blanks choosing the correct option from the brackets.
Answer: While taking a loan, borrowers look for easy terms of credit. This means low (low/high) interest rate, easy (easy/ tough) conditions for repayment, less< (less/more) collateral and documentation requirements.
Question 6: What are the differences between formal and informal sources of credit?
Answer: The formal sector gives loan only after thorough check of the borrower. Suitable paperwork is done before giving the loan so that both the borrower and the creditor can resort to judicial process in case of any problem. Rate of interest is governed by the government rules when loan is given by the formal sources. In case of informal sector, rate of interest is usually very high and the borrower cannot go to the courts in case of being subjected to arm-twisting tactics by the creditor. Informal sector usually works on personal influence and relation of the borrower and creditor.
Question 7: Why should credit at reasonable rates be available for all?
Answer: Credit is an important aspect of economic activity. Right from a small farmer to a big business tycoon; everyone needs to borrow at some time to improve productivity. In case of unreasonable rates, the borrower always runs the risk of falling in the debt trap which is not good for the society and the economy. Hence, reasonable rates are important for all.
Answer the following questions:
Question 8: Should there be a supervisor, such as the Reserve Bank of India that looks into the loan activities of informal lenders? Why would its task be quite difficult
Answer: The informal lenders work according to their own set of rules. They seldom maintain proper records and do not reveal their transaction detail to the government authority. Most of the money involved in this is black money and the lender always wants to earn windfall profits. They will oppose every attempt to bring them into the ambit of governance. Hence, it would be very difficult for supervisor to look into the loan activities of informal sector.
Question 9: Why do you think that the share of formal sector credit is higher for the richer households compared to the poorer households?
Answer: The formal sector credit is available to those who have good repayment capacity. Lending money is the main source of income for banks. They cannot afford to lend to the poor and suffer losses in the bargain. Due to this, the share of formal sector credit is higher for the richer households compared to the poorer households.
Question 10: In situations with high risks, credit might create further problems for the borrower. Explain.
Answer: In situation of high risks, credit often creates further problems for the borrower. To understand this, let us take an example of a marginal farmer who holds a small plot of land. Let us assume that the farmer borrows some money to buy seeds and fertilisers. The harvest which he gets may not be enough to meet his family’s needs. So he never comes in a position to sell the farm produce so that he can repay his loans. If some natural calamity; like flood or drought destroys the crops; it even worsens the situation for him. Finally, there is no other way than to get trapped in the never ending cycle of loans.
Question 11: How do banks mediate between those who have surplus money and those who need money?
Answer: Banks take deposits from different people. People, who have surplus money, maintain a healthy deposit in banks. There are many who may be looking for loan. Such people go to the bank if they want to borrow from the formal sector. The bank provides them loan from the deposit which is lying with the bank. Thus, banks serve as a conduit between those who have surplus money and those who need money.
Question 12: Look at a 10 rupee note. What is written on top? Can you explain this statement?
Answer: The following statement is written on the note, “I promise to pay the bearer the sum of ten rupees”. This is followed by the signature of the RBI Governor. This statement shows that the central bank of India has fixed a certain value on the currency note and the value applies to everybody and at everyplace in the country.
Question 13: Why do we need to expand formal sources of credit in India?
Answer: Around 48% credit in India comes through the informal sector. There are many people who do not have access to the formal credit sources. Such people often fall in the hands of moneylenders who resort to all sorts of methods to suppress the poor. To help such people out of the economic mess, it is necessary to reach the formal sources of credit to them. It will also help in improving the socioeconomic conditions in villages and remote areas.
Question 14: What is the basic idea behind the SHGs for the poor? Explain in your own words.
Answer: Self Help Groups are made to help those poor who do not have access to the formal sources of credit. There are various reasons for their inability to secure a loan from banks or cooperatives. These people are so poor that they fail the creditworthiness. Moreover, the amount borrowed by them is too small to even recover the cost of administration of loan. Illiteracy and lack of awareness further compounds the problems for them. The SHGs help them in providing micro finance so that they can sustain their livelihood. Moreover, SHGs also facilitate the development of a repayment culture among such people.
Question 15: What are the reasons why the banks might not be willing to lend to certain borrowers?
Answer: A bank usually lends to a person who has repayment capacity. Banks avoid lending for a risky venture. These are the reasons, banks might not be willing to lend to certain borrowers.
Question 16: In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this necessary?
Answer: RBI is the central bank of India. It formulates policies for the banking sector in India. Proper rules and regulations are necessary for the banking system because the banks affect the overall economy in a great way. By regulating the functioning of banks, RBI not only keeps a check on the banking and finance but also on the overall economy so that economic crisis does not erupt.
Question 17: Analyse the role of credit for development.
Answer: Credit plays a crucial role in development. For most of the businesses, credit becomes necessary for expansion at some time or the other. Without credit, a small company cannot be changed into a big corporate house. Farmers cannot go for large scale farming in the absence of credit. Majority of people shall never be in a position to buy a house or a car in the absence of loan. Demand of car and houses helps in developing the economy in a significant way.
Question 18: 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: Manay needs to compare the rates of interest by various lenders. He also needs to compare the demand for collateral and repayment terms and conditions. The creditor who is asking for a low interest rate, less collateral and easier terms of repayment would be the preferable creditor.
Question 19: Why might banks be unwilling to lend to small farmers?
Answer: Small farmers do not have enough assets; either in cash or kind; which can be given as collateral. There is no guarantee of regular income for the small farmer. Hence his repayment capacity would always be questioned by the bank.
Question 20: What are the other sources from which the small farmers can borrow?
Answer: A small farmer can borrow from friends and relatives, zamindar and the local moneylender. He can also go the SHGs.
Question 21: Explain with an example how the terms of credit can be unfavourable for the small farmer.
Answer: If the creditor wants that the farmer can utilize his farm produce only after repaying the loan amount, it can be a problem for the farmer. If the creditor wants a very high interest rate or wants the interest to be paid on a monthly basis, then it can be a problem for the farmer.
Question 22: Suggest some ways by which small farmers can get cheap credit.
Answer: Microfinance; on the lines of Grameen Bank of Bangladesh; can be a good way to help small farmers. Many Self Help Groups are being formed in various parts of the country to help out small farmers.