Learning Objective
- Money as a Medium of Exchange
- Modern Forms of Money
- Loan Activities of Banks
- Two Different Credit Situations
- Terms of Credit
- Formal Sector Credit in India
- Self Help Groups for the Poor
Money as a Medium of Exchange
Money serves as a medium of exchange, facilitating the easy exchange of goods and services. Holding money enables individuals to readily trade it for any desired commodity or service.
Modern Forms of Money
- In ancient times, Indians used grains and cattle as currency, followed by metallic coins such as gold, silver, and copper, which persisted until recent times.
- Today, modern forms of money primarily consist of currency in the form of paper notes and coins. These modern forms of money, including deposits, are intricately connected with the functioning of the modern banking system.
Currency
In India, the Reserve Bank of India exclusively issues currency notes on behalf of the central government. No other entity is authorized to issue currency. The Indian rupee is universally recognized and accepted as a medium of exchange within the country.
Deposits with Banks
- Another way people hold money is by depositing it in banks. By opening a bank account, individuals can deposit excess cash, with banks providing interest on these deposits.
- Deposits held in bank accounts, known as demand deposits, can be withdrawn on demand.
- Instead of cash, payments from these accounts are made using cheques, which instruct the bank to pay a specified amount from the account to the recipient named on the cheque.
Loan Activities of Banks
- Banks typically reserve a small fraction of their deposits as cash, with Indian banks currently holding about 15% of deposits in cash. This serves as a reserve to meet withdrawal demands from depositors.
- The majority of deposits are used by banks to provide loans, meeting the demand for various economic activities. Banks charge higher interest rates on loans compared to the rates offered on deposits. The difference between these rates constitutes the primary source of income for banks.
Two Different Credit Situations
- Whether credit would be useful or not depends on the risks in the situation and whether there is some support in case of loss.
- When credit pushes the borrower into a situation from which recovery is very painful, it is called debt-trap.
- Ideally, credit helps to increase earnings, and therefore leaves the person better off than before, playying a vital and positive role.
Terms of Credit
- Loan agreements specify an interest rate for repayment of principal, along with collateral demanded by lenders.
- Collateral serves as an asset guaranteeing repayment; if the borrower defaults, the lender can sell the collateral to recoup the loan.
- Terms of credit encompass interest rates, collateral, documentation requirements, and repayment methods, which may vary based on lender and borrower characteristics.
Formal Sector Credit in India
Cheap and accessible credit plays a pivotal role in a country’s development. Loans are broadly categorized into formal and informal sectors:
- Formal sector loans:
Offered by banks and cooperatives, supervised by the Reserve Bank of India. Banks report lending details to the RBI, including amounts, recipients, and interest rates.
- Informal sector loans:
Provided by moneylenders, traders, employers, and acquaintances. Lacking oversight, lenders in this sector may resort to unfair practices for loan recovery.
Formal and Informal Credit:
Who gets what?
Rural communities rely heavily on informal sources for credit, as the formal sector meets only about half of their needs. To reduce dependence on expensive informal credit, banks and cooperatives must increase lending, especially in rural areas. Expanding formal sector loans is essential, ensuring equitable access for all individuals in need.
Self Help Groups for the Poor
Self-Help Groups (SHGs) are small collectives of poor individuals promoting savings among members. Typically comprising 15-20 members from the same neighborhood, they meet regularly to save.
Key benefits of SHGs include:
- Overcoming collateral challenges for borrowers.
- Providing timely loans for various purposes at reasonable interest rates.
- Serving as the foundation for organizing rural communities.
- Empowering women to achieve financial independence.
- Offering a platform for addressing social issues like health, nutrition, and domestic violence during regular meetings.
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