Money and Credit is Chapter 3 of Class 10 Economics, from the NCERT (National Council of Educational Research and Training) book Understanding Economic Development. It explains why we use money, how banks work, what credit is, the two sides of credit, formal and informal sources of credit, and how self-help groups help the poor. These notes cover the chapter in simple English, with the same examples the textbook uses.
Chapter at a glance
- Money works as a medium of exchange and removes the problem of double coincidence of wants in barter.
- Modern money: currency (notes and coins issued by the Reserve Bank of India) and deposits with banks.
- Credit can help (Salim’s story) or push a person into a debt trap (Swapna’s story). Terms of credit: interest rate, collateral, documentation and mode of repayment.
- Formal sources (banks, cooperatives) are supervised by the RBI; informal sources (moneylenders, traders, relatives) charge very high interest. Poor households depend mostly on informal sources.
Money as a medium of exchange
In a barter system, goods are exchanged directly, without money. This needs a double coincidence of wants: what one person wants to sell must be exactly what the other person wants to buy. A shoe maker who wants wheat must find a wheat farmer who wants shoes. Money solves this. The shoe maker sells shoes for money and buys wheat with the money. Because money acts as an intermediate in the exchange process, it is called a medium of exchange.
Modern forms of money
- Currency: paper notes and coins. Modern currency has no use of its own, unlike grain or cattle used as money in earlier times. It is accepted because the Reserve Bank of India (RBI) issues it on behalf of the central government, and the law makes the rupee legal tender: no one in India can refuse a payment made in rupees.
- Deposits with banks: people deposit their extra cash in banks and earn interest. Deposits that can be withdrawn on demand are called demand deposits. A cheque is a paper instructing the bank to pay a specific amount from a person’s account to the person in whose name the cheque is issued. So demand deposits also work as money.
Loan activities of banks
Banks keep only a small part of the deposits as cash (in India, about 15%) to pay depositors who come to withdraw money on any day. The rest is given as loans to people who need money for farming, business, houses and so on. Banks charge a higher interest on loans than they pay on deposits. The difference is the bank’s main source of income. So banks mediate between depositors, who have surplus money, and borrowers, who need money.
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Two different credit situations
Credit (a loan) is an agreement in which the lender supplies money, goods or services to the borrower in return for a promise of future payment.
- Salim’s story (credit helps): Salim, a shoe manufacturer, gets a big order during the festival season. He takes credit from the leather supplier (to be paid later) and an advance from a trader. He completes the order, makes a profit and repays. Here credit helped him earn more.
- Swapna’s story (credit hurts): Swapna, a small farmer, borrows from a moneylender to grow groundnut. Pests destroy the crop. She cannot repay, borrows again next year, fails again, and has to sell part of her land to clear the debt. Here credit pushed her into a debt trap: a situation where repaying the loan becomes impossible and the borrower ends up worse off than before.
Whether credit is useful depends on the risk in the situation and whether there is support in case of loss. In farming, risk is high because the crop depends on rain and pests.
Terms of credit
Every loan agreement has terms of credit:
- Interest rate: the extra amount the borrower pays along with the principal.
- Collateral: an asset (land, building, vehicle, livestock, bank deposits) that the borrower owns and uses as a guarantee until the loan is repaid. If the borrower fails to repay, the lender can sell the collateral to get the money back.
- Documentation: the papers and proof the lender asks for.
- Mode of repayment: how and when the loan will be repaid, for example monthly instalments or a lump sum.
Terms vary from lender to lender. The textbook example: a house loan from a bank needs documents, has a fixed interest rate and takes the house as collateral; a landlord’s loan to a landless labourer may need no papers, but comes with a very high interest and the condition of working on the landlord’s farm.
Formal and informal sources of credit
| Formal sources | Informal sources | |
|---|---|---|
| Who | Banks and cooperative societies | Moneylenders, traders, employers, relatives and friends |
| Supervision | The RBI supervises: banks must keep a minimum cash balance, give loans to small cultivators and small-scale industries too, and report to the RBI how much they lend and to whom | No supervision. Lenders can charge any interest and use unfair means to get the money back |
| Interest rate | Lower | Much higher |
| Effect | Cheap and affordable credit increases income | A large part of earnings goes in paying interest; borrowers may fall into a debt trap |
In India, 85% of the loans taken by poor households in urban areas come from informal sources, while rich households mostly borrow from formal sources. So the rich get cheap credit and the poor pay heavily. Banks and cooperatives must increase lending, especially in rural areas, so that cheap formal credit reaches the poor and the dependence on informal credit falls.
Self-help groups for the poor
Banks are not present everywhere in rural India, and even where they are, getting a loan is harder than borrowing from a moneylender, because the poor have no collateral. Self-help groups (SHGs) solve this problem:
- A typical SHG has 15 to 20 members, usually women from one neighbourhood, who meet and save regularly (₹25 to ₹100 or more per member).
- Members can take small loans from the group itself at a reasonable interest rate.
- After a year or two of regular saving, the group becomes eligible for a bank loan, given in the group’s name, to create self-employment for members: buying seeds, fertilisers, raw material, a sewing machine, a handcart and so on.
- The group decides the loans, and the group is responsible for repayment. If one member defaults, the other members follow up. So banks can lend without collateral.
- SHGs also help women become self-reliant and give them a platform to discuss social issues like health, nutrition and domestic violence.
The Grameen Bank of Bangladesh, started by Professor Muhammad Yunus in the 1970s, lent small amounts to poor people, mostly women, without collateral, and showed that the poor are creditworthy. Yunus and the bank received the Nobel Peace Prize in 2006.
Key terms
| Term | Meaning |
|---|---|
| Double coincidence of wants | In barter, both parties must want what the other has. Money removes this need. |
| Legal tender | Money that the law requires everyone in the country to accept as payment. |
| Demand deposits | Bank deposits that can be withdrawn whenever the depositor wants. |
| Cheque | A paper instructing the bank to pay a specific amount from a person’s account to the person named on it. |
| Collateral | An asset the borrower pledges as a guarantee until the loan is repaid. |
| Debt trap | A situation in which a borrower cannot repay and has to borrow again or sell assets, ending up worse off. |
| Self-help group | A small group of poor people, usually women, who save regularly and lend to each other and get bank loans as a group. |
Important questions
- In situations with high risks, credit might create further problems for the borrower. Explain. (3 marks)
- How does money solve the problem of double coincidence of wants? Explain with an example. (3 marks)
- Explain the loan activities of banks. Why do banks keep only a small proportion of deposits as cash? (3 marks)
- What are the terms of credit? Explain. (3 marks)
- Why do we need to expand formal sources of credit in India? (5 marks)
- What are the advantages of self-help groups for the poor? (5 marks)
- What is the role of the Reserve Bank of India in the formal credit system? (3 marks)
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FAQs
What is the difference between formal and informal credit?
Formal credit comes from banks and cooperatives, is supervised by the RBI and has lower interest. Informal credit comes from moneylenders, traders, employers and relatives, has no supervision and usually has very high interest.
Why is currency accepted as money in India?
Because the Reserve Bank of India issues it on behalf of the central government, and the law makes the rupee legal tender, which no one can refuse.
What is a debt trap?
A situation in which the borrower cannot repay the loan, borrows again to repay, and ends up selling assets or getting deeper into debt.
More Class 10 Social Science notes
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