CH3 Money and Credit

Money is any good that is widely used and accepted in transactions involving the transfer of
goods and services from one person to another

Money is a means by which we can get something in exchange. Initially,

coins came into use. The coins were initially made of precious metals; like
gold and silver. When the precious metals became too precious, ordinary
metals were being used for making coins. Paper money or currency notes
gradually took place of coins; although coins of smaller denominations are
still in use.

The currency notes and coins are issued by the government of an

authorized body. In India, the RBI (Reserve Bank of India) issues currency
notes. On the Indian currency note, you can find a statement which
promises to pay the bearer the amount which is mentioned on the
currency note.

Advantages of Money:

a. Removes the coincidence of wants.

b. Takes less storage space and is easier to carry.
c. Liquidity of currency is easier.
d. Now-a-days; many instruments are available through which it is not
necessary to physically carry the currency.

Other Forms of Money

Deposits with Banks: Most of the people need only some currency for
their daily needs. Rest of the amount is usually kept as deposit in banks.
Money which is kept in a bank is safe and it even earns an interest. One
can withdraw money from his account as and when required. Since
deposit in the bank account can be withdrawn on demand, these deposits
are called demand deposits.

One can use a cheque; instead of cash to settle payments. Moreover, one
can also buy a demand draft from a bank to make payments.
Credit: It is generally defined as a contractual agreement in which a
borrower receives something of value now and agrees to repay the lender
at a later date—generally with interest.
Banks keep a small proportion of their deposits as cash with themselves.
This is usually 15% of their deposits as cash. This amount is kept as
provision to pay the depositors who may come to withdraw the money on
any day. This amount is enough because only a small fraction of people
come to withdraw money on a given day. The rest of the amount is used
by the banks to give money on credit to people who need the credit. A
bank charges interest on the loan which it gives to its creditors. The
interest rate charged by a bank no loans is higher than the interest rate
given by it on deposits. Thus, interest is the main source of income for
banks.

Credit/Debit Cards: Now-a-days, credit/debit cards are in vogue. A debit

card allows you to make payments from the amount which is lying in your
bank account. A credit card, on the other hand, provides money on credit.
Payment through credit/debit card is done electronically and this removes
the need of carrying cash.

Terms of Credit
People often need to borrow money for various purposes. Many
businessmen need to borrow to buy raw materials and machineries. Many
farmers need to borrow to buy seeds, fertilisers, farm equipments, etc.
People usually buy vehicles and houses by borrowing from banks. Thus,
credit plays an important role in the economy.

Every loan agreement specifies terms and conditions; regarding the rate
of interest and term of payment. In most of the cases, the banks fix an EMI
(Equated Monthly Installment) for repayment of loan.

Collateral: An asset which is owned by the borrower and is used as a

guarantee to a lender until the loan is repaid is called the collateral. Land,
house, vehicle, livestocks, deposits with banks, insurance policy, gold, etc.
are examples of assets. If the borrower fails to repay the loan, the lender
reserves the right to sell the collateral to obtain payment.

Terms of Credit: The terms of credit include rate of interest, collateral

and mode of repayment. The terms of credit varies from one loan
agreement to another and also on the nature of the lender and the
borrower.

Sources of Credit
Formal Sector: The formal Sector comprises of banks and cooperative
societies.

Informal Sector: The informal sector consists of money lenders and

friends and relatives, merchants and landlords.

The following diagram shows share of different sources of credit in rural

households in India in 2003.

Fig: Sources of Credit for Rural Households in India in 2003

While the formal sector is bound by the rules and regulations of the RBI
and charge the prevalent rate of interest as per RBI guidelines; the
informal lenders are not bound by such rules. The informal lenders usually
charge a very high rate of interest. A higher cost of borrowing is often
detrimental to the borrower. It usually results in a debt trap for the
borrower. The borrower is seldom able to escape the never ending cycle of
loan repayment.
 Many people are too poor to qualify the requirements of credit-worthiness
of banks and cooperatives. There are many others who may not have
enough documents; like residential certificate or income certificate. Such
people are usually at the mercy of informal lenders.

Self Help Groups

Self Help Groups (SHGs) are recent phenomena. An SHG is comprised of
small number of people; like 15 – 20 members. The members pool their
savings. The collection is then utilised to lend small amounts of money
which may be required by any of the members. The group charges
interest on the loan. The arrangement of loans through Self Help Groups is
also known as microfinance because the small amount of loan is involved.

It was the Grameen Bank of Bangladesh which began experimenting with

microfinance. The founder of Grameen Bank, Mohammad Yunus was
conferred with Nobel Prize in 2006 for his efforts at improving the lot of
the poor.

SHGs have helped immensely in reducing the influence of informal lenders

in rural areas. Many big corporate houses are also promoting SHGs at
many places in India.

Money and Credit

MONEY AS A MEDIUM OF EXCHANGE
Very Short Answers:-
1. Define Double Coincidence of Wants.
Ans. In the barter system, when the demand of two persons for each other’s commodity is raised at
the same time, it is called double coincidence of wants.
2. How does money act as an intermediate in the exchange process?
Ans. Money eliminates the need for double coincidence of wants e.g., once the shoe manufacturer
exchanges his shoes for money, he can purchase wheat or any other commodity in the market.
3. What is the reason for accepting paper notes as a medium of exchange?
Ans. Paper notes are accepted as a medium of exchange because the currency is authorized by the
government of the country.
4. How does money act as a medium of exchange?
Or
Why is money used for exchange?
Ans. Since money acts as an intermediate in the exchange process, it is called a medium of
exchange.
5. How does the use of money make it easier to exchange things?
Ans. The use of money makes it easier to exchange things because money, by providing the crucial
intermediate step, eliminates the need for double coincidence of wants.
SHORT ANSWERS:-
1. Define money.
Ans. (1) Money refers to a medium of exchange used in economic transactions or in exchange of
goods and services.
(2) Transactions are made in money because it eliminates the inconvenience of barter system of
exchange. In an economy, where money is in use, money by providing the crucial intermediate step,
eliminates the need for double coincidence of wants.
(3) The use of money spans a very large part of our everyday life. There are several transactions
involving money in any single day.
2. How is money used in everyday life? Explain with examples.
Ans. (1) The use of money spans a very large part of our everyday life. There are several
transactions involving money in any single day.
(2) In many of these transactions, goods are bought and sold with the use of money. In some other
transactions, services are exchanged with money. For some, there might not be any actual transfer
of money taking place now but, a promise to pay money later.
(3) For example, we purchase books, pencils, chocolates from money. We give doctor’s fee and
school fee in money. My father receives a monthly salary in money. Hence, money is used in
everyday life.
LONG ANSWERS:-
1. How does money solve the problem of double coincidence of wants? Explain with an
example.
Or
What is meant by the double coincidence of wants? Explain with an example.
Ans. (1) When there was a barter system, exchanging of goods was difficult. The demand of two
persons for each other’s commodity should have raised at the same time, otherwise, the exchange
was not possible. This is called double coincidence of wants.
(2) Money by providing the crucial intermediate step eliminates the need for double coincidence of
wants.
(3) For example, it would not be necessary for the farmer to look for cloth manufacturer who will buy
his grains and at the same time, sell him the cloth. Thus, money has solved this problem because
now people do not have to search for one who will be ready to exchange his goods. This is because
now money acts as a medium of exchange.
2. What was the shortcoming of the barter system that led to the evolution of money as a
medium of exchange?
Or
How can money easily exchange it for goods or services? Give example to explain.
Or
Do you think money makes it easier to exchange things? Explain with the help of an
example.
Ans. (1) A person holding money can easily exchange it for any commodity or service that he or she
might want. Everyone prefers to receive payments in money and then exchange the money for
things that he/she wants.
(2) When there was a barter system, exchanging goods was very difficult. The demand of two
persons for each other’s commodity should have raised at the same time, otherwise, the exchange
was not possible. This is called double coincidence of wants.
(3) Money had solved this problem because now people do not have to search for one who will be
ready to exchange his goods. This is because money acts as a medium of exchange.
3. What is the Barter System? Explain by giving examples.
Ans. (1) Barter system can be defined as a transaction system wherein goods are directly
exchanged without the use of money. In this system, the demand of two persons for each other’s
commodity should have raised at the same time. Otherwise, the exchange was not possible. This is
called double coincidence of wants.
(2) (i) For example, a bookseller sells his books in exchange for wheat. In this case, both parties
i.e., bookseller and wheat farmer have to agree to sell and buy each other’s commodities.
(ii) Double coincidence of wants is an essential feature of this system.
MODERN FORMS OF MONEY
VERY SHORT ANSWERS:-
1. What does currency include?
Ans. Currency includes paper notes and coins.
2. How do the deposits with banks become their source of income?
Ans. Banks make use of the deposits to meet the loan requirements of the people. The difference
between what is charged from borrowers and what is paid to depositors is their main source of
income.
3. How is the facility of demand deposits useful for the depositor?
Ans. People’s money is safe with the banks and it earns an amount of interest.
4. What is the main function of the Reserve Bank of India?
Ans. The Reserve Bank of India issues currency notes on behalf of the central government and
supervises the functioning of formal sources of loans.
MODERN FORMS OF MONEY
1. Define bank.
Ans. A bank is a profit making institution that accepts the deposits, pays an amount as interest on
the deposits and extends loans to the needy.
2. Mention the modern form of money.
Ans. Modern forms of money include currency—paper notes and coins.
3. Which agency issues currency notes on behalf of the Government of India?
Or
Who issues currency notes in India?
Ans. Reserve Bank of India (RBI).
LONG ANSWERS:-
1. What are the modern forms of the money currency in India? Why is it accepted as a
medium of exchange?
Or
Why is modern currency accepted as a medium of exchange without any use of its own?
Findoutthereason.

Ans. (1) The modern forms of money include currency and deposits with banks. It can be classified
into :
(i)Coins, (ii) Paper notes; and
(iii) Credit money or deposits with banks.
(2) Modern currency is accepted as a medium of exchange because the currency is authorized by
the government of the country.
(3) In India, the Reserve Bank of India issues currency notes on behalf of the central government.
Indian law legalizes the use of rupee as a medium of payment that cannot be refused in setting
transactions in India. No individual in India can legally refuse a payment made in rupees.
2. What are the advantages of depositing money in the banks?
Or
“Deposits with the banks are beneficial to the depositors as well as to the nation.” Examine
the statement.
Ans. (1) (i) Deposits with the banks are beneficial for individual because banks accept the deposits
and also pay an amount as interest on the deposits.
(ii) In this way, people’s money is safe with the banks and it earns an amount of interest.
(iii) People also have the provision to withdraw the money as and when they require.
(iv) Demand deposits offer cheque facility to the bank account holder. The facility of cheques against
demand deposits makes it possible to directly settle payments without the use of cash.
(2) Banks use the major portion of the deposits to extend loans for various economic activities. This
creates employment and income to the people of the nation and contributes to the national
development.
3. What is a demand deposit? List two advantages of demand deposits.
Or
What are the advantages of bank deposits?
Ans. (1) A demand deposit is a deposit with the bank that people have the provision to withdraw the
money as and when they require. Since the deposits in the bank accounts can be withdrawn on
demand, these deposits are called demand deposits.
(2) (i) Demand deposits earn an amount as interest.
(ii) They act as a medium of exchange like money. They constitute money in the modern economy.
They are accepted widely as a means of payment by way of a cheque instead of cash.
4. “Forms of currency have undergone several changes since early times.” Elucidate.
Ans. (1) Before the introduction of coins, a variety of objects used.
(2) In the very early ages, Indians used grains and cattle as money. Thereafter came the use of
metallic coins such as gold, silver, copper coins. This was a phase that continued well into the last
century.
(3) Modern forms of money include currency—paper notes and coins. Unlike the things that were
used as money earlier, modern currency is not made of precious metals. The modern currency is
without any use of its own.
5. What is a cheque? What is the advantage of using a cheque for payment?
Ans. (1) A cheque is a paper instructing the bank to pay a specific amount from the person’s
account to the person in whose name the cheque has been issued. For payment through cheque,
the payer who has an account with the bank makes out a cheque for a specific amount.
(2) (i) We issue cheques against demand deposits, which make it possible to directly settle
payments without the use of cash.
(ii) Since demand deposits are accepted widely as a means of payment along with currency, they
constitute money in the modern economy.
LOAN ACTIVITIES OF BANKS
VERY SHORT ANSWERS:-
1. Why do banks maintain cash reserve?
Ans. Banks maintain cash reserves as a provision to pay the depositors who might come to
withdraw money from the bank on any given day.
2. Why do banks keep a small proportion of the deposits as cash with themselves?
Ans. In order to pay the depositors who might come to withdraw money.
3. What is the main source of income of banks?
Or
What is the main source of income for commercial banks?
Ans. Difference between what is charged from the borrowers and what is paid to the depositors.
4. For which purpose do the banks use the major portion of the deposits?
Ans. To extend loans.
5. What percentage of bank deposits is kept as a cash reserve by the banks for the daily
transaction in India?
Ans. About 15%.
6. What does loan agreement specify?
Ans. An interest rate, mode of repayment, collateral and necessary documentation.
LONG ANSWERS:-
1. List any six sources of credit operating generally in Indian villages.
Ans. The following are the sources of credit operating generally in Indian villages :
(1) Moneylenders: They provide 33r1 of total credit needs of rural households.
(2) Co-operative Societies: This source of rural credit provided 25% of total credit needs in 2012.
(3) Commercial Banks: About 25% of the rural needs of credit is fulfilled by commercial banks,
(4) Relatives and Friends: They provide 8% of rural credit needs.
(5) Other Institutional Agencies: They provide 5% of the total credit needs of rural households,
(6) Landlords: They provide about 1% of total credit needs in Indian villages.
TWO DIFFERENT CREDIT SITUATIONS
VERY SHORT ANSWERS:-
1. Why do farmers require credit?
Ans. Farmers require credit to purchase seeds, fertilizers, pesticides and for irrigation purposes.
2. What is agricultural credit?
Ans. Agricultural credit refers to an agreement in which the lender supplies the farmer with money,
goods or services in return for the promise of future payment.
3. What is credit?
Or
What is a loan?
Ans. Credit refers to an agreement in which the lender supplies the borrower with money, goods or
services in return for the promise of future payment.
4. What do you mean by debt-trap?
Ans. A debt-trap is a situation when credit pushes the borrower into a situation from which recovery
is very painful.
LONG ANSWERS:-
1. Credit can push the borrower into a situation from which recovery is very painful. Explain
with the help of an example.
Ans. (1) Farmers usually 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.
(2) For example, as we have studied the case of Swapna in the Textbook, the failure of the crop
made loan repayment impossible.
(3) Swapna had to sell part of the land to repay the loan. Credit, instead of helping Swapna improve
her earnings, left her worse off. This is really an example of what is commonly called debt-trap. In
this way, credit pushes the borrower into a situation from which recovery is very painful.
2. Explain any three possible reasons that people might apply for loans in rural areas. Give
three reasons. (Most Imp)
Ans. (1) People might apply for loans in rural areas to meet the expenses of cultivation. Crop
production involves considerable costs on seeds, fertilizers, pesticides, water, electricity, repair of
equipment, etc. They hope that their harvest would help repay the loans.
(2) In the case of crop failure, they take fresh loans for cultivation and repay previous loans. In this
situation, credit pushes the person into a debt trap.
(3) Many landless agricultural labourers apply for loans to meet the daily expenses. Expenses on
sudden illness or functions in the family are also met through loans.
3. Explain with an example, how credit plays a vital and positive role for development.
Or
Give an example to show how credit can play a positive and vital role in the life of borrower.
Ans. (1) Cheap and affordable credit plays a vital and positive role for the country’s development. It
helps in increasing the economic activities of the borrowers.
(2) A large number of transactions in our day-to-day activities involve credit in some form or the
other.
(3) It may be helpful in growing crops, doing business, setting-up small-scale industries, trade in
goods, etc. If credit is available to the poor people on reasonable terms and conditions, they can
improve their economic condition which in turn, will help them to have a better standard of living.
TERMS OF CREDIT
VERY SHORT ANSWERS:-
1. Mention the terms of credit.
Or
What is required to get a loan from a bank?
Ans. The interest rate, collateral and documentation requirement and the mode of repayment
together comprise what is called the ‘terms of credit’.
2. Define the term ‘collateral’.
Ans. Collateral is an asset that the borrower owns such as land, building, vehicle, livestock’s,
deposits with banks and uses this as a guarantee to a lender until the loan is repaid.
3. What do people from poor households lack in terms of loan applications?
Ans. Collateral and documentation requirement.

SHORT ANSWERS:-
1. Differentiate between the terms of credit offered in formal and informal sectors of credit.
Why are informal sources of credit more convenient and people friendly? Explain.
Ans. (1) Difference between the terms of credit in formal and informal sectors :

Formal Sector
Informal Sector

(i)RBI supervises their function of giving loans.

(ii) Collateral is required to obtain credit. (i)No organization is there to supervise its lending activities.
(ii) This sector gives loans without collateral.

(iii) The rate of interest is comparatively lower than that of

the informal sector loans (iii) Higher interest rates on loan are charged.

(2) Informal sources of credit are more convenient and people friendly because they require no
collateral. The borrowers can approach the money lenders even without repaying their earlier loans.
2. Compare the terms of credit for small blandness agricultural workers and medium farmers
in a village.
Ans.
 Small landless agricultural workers

Medium farmers

(1)The interest rate is up to 60% per annum. (1) The interest rate is 8.5% per annum.

(2) There is no need of any collateral and documentation. (2) There is a need for collateral and documentation for
the bank loan.

(3) He/she repays the money by working for the

landowner. (3) Loans can be repaid anytime in the next three years.

3. Why do lenders ask for collateral while lending ? Give any three reasons.
Ans. (1) Collateral is an asset that the borrower owns and uses this as a guarantee to a lender until
the loan is repaid. Lenders ask for collateral as security against loans.
(2) If the borrower fails to repay the loan, the lender has the right to sell the asset or collateral to
obtain payment.
(3) The bank is a profit-making institution. So, in the case of taking collateral, the repayment of the
loan becomes easy. The bank has no danger of non-performing assets(NPA).
4. Mention any six items that can be kept as a collateral against loans.
Ans. The following items can be kept as a collateral against loans :
(1) Land titles (2) Building
(3) Vehicle (4) Livestock’s
(5) Deposits with banks (6) Share, debenture and L.I.C. Policy.
LONG ANSWERS:-
1. Explain any three terms of credit.
Or
What do ‘terms of credit’ include?
Ans. Terms of credit include the following elements:
(1) Interest rate which the borrower must pay to the lender along with repayment of the principle.
(2) Collaterals such as land titles, deposits with banks, livestock, etc. and documentation required.
(3) Mode of repayment: This means how the borrower would repay the lender his/her loan amount.
For example, on the monthly, quarterly, half-yearly or yearly basis. They may vary depending on the
nature of the lender and the borrower. The terms of credit vary substantially from one credit
arrangement to another.
2. Illustrate with the help of an example how the terms of credit might become difficult for the
small and marginal farmer.
Ans. (1) The terms of credit include interest rate, collateral and documentation requirement and the
mode of repayment. They vary substantially from one credit arrangement to another depending on
the nature of the lender and the borrower.
(2) (i) The terms of credit might become difficult for the small and marginal farmer because they are
not capable of providing collateral such as land titles, deposits with banks, livestock, building,
vehicle. etc.
(ii) They also lack in the mode of payment. In the case of crop failure, it becomes impossible for
fanners to repay the loan in time.
(iii) Small and marginal farmers are also not capable of providing complicated paperwork.
(3) That is why moneylenders are the main source of credit in rural areas. For example. Seasonal
used to take a loan from moneylenders and trailers at an interest rate of 364*-8611 per am.
3. What are the various purposes for which the rural people require credit? What are the
mourns from which they can avail it?
Ans. (i ) People in rural areas generally require credit to meet the expert civilities.
(ii)In the case of crop failure, they take fresh loans for cultivation and to repay previous Want In this
situation, the credit pushes the person into a debt trap.
(iii) Also, they require a loan to meet the daily expenses such as expenses for sudden illness or
functions the family.
(2) The rural people avail haw from these sources banks, co-operative societies, relatives and
friends traders, landlords and others.
FORMAL SECTOR CREDIT IN INDIA
VERY SHORT ANSWERS:-
1. Prove with an argument that there is a great need to expand formal sources of credit in
rural India.
Ans. In order to save poor from the moneylender’s high rate of interest and debt-trap and unfair
means to get their money back.
2. Mention any two main sources of credit operating in Indian villages.
Ans. Money lenders and traders are the main sources of credit operating in Indian villages.
3. Mention any two informal sources of credit.
Ans. Moneylenders and traders.
LONG ANSWERS:-
1. Why is there a great demand for loans or credit,? Explain the reasons.
Ans. There is a great demand dot felon or credit for the following reasons :
(1) Credit plays a vital and e role for the country’s development. It helps in increasing the economic
activities of the borrowers.
(2) It helps to meet the working capital needs of production.
(3) It helps to meet the ongoing expenses of production, complete production on time and thereby
increasing earnings.
(4) It helps in growing crops, doing business, setting up small-scale industries, trade in goods, etc.
(5) A large number of transactions in our day-to-day activities involve credit in some form or the
other.
2. List any six sources of credit operating generally in Indian villages.
Ans. The following are the main sources of credit operating generally in Indian villages:
(1)Moneylenders (33%)
(2) Commercial Banks (25%)
(3) Co-operative Societies (25%)
(4) Relatives and Friends (8%)
(5) Other non-institutional Agencies (2%)
(6) Landlords (1%)
3. How do banks play an important role in the economy of India? Explain.
Or
What is the role of a bank in the economic development of a country? Explain.
Ans. Banks play an important role in the economy of India as is given below :
(1) Banks mediate between those who have surplus money and those who need money. They take
deposits from those who have surplus money and use the major portion of the deposits to extend
loans.
(2) They account for 25% of rural credit in India. In this way, they help in increasing the economic
activities of the borrowers.
(3) In India, banks give loans not just to profit-making businesses and traders but also to small
cultivators, small-scale industries, small borrowers, etc.
(4) Undoubtedly, cheap and affordable credit is crucial for the country’s development. It helps to
grow crops, to meet working capital needs of production and in setting up new industries or trade in
goods.
(5) In this way, they help poor people to increase their standard of living. If credit is available to poor
people at a low rate of interest and on reasonable terms and conditions, they can improve their
economic conditions.
4. What are formal sector loans and informal sector loans? Are there any supervise their
functioning?
Ans. (1) (i) The various types of loans can be conveniently grouped as formal sector loans and
informal sector loans.
(ii) Formal sector loans include loans from banks and co-operatives while informal sector loans
consist of moneylenders, traders, employers, relatives and friends, etc.
(2) Yes, the Reserve Bank of India supervises the functioning of formal sources of loans.
5. What are the commercial banks? Mention any four of their functions.
Ans. (1) A commercial bank or a bank is a profit-making institution that accepts the deposits, pays
an amount as interest on the deposits and extends loans to the needy people.
(2) The following are the functions of a commercial bank :
(i) Commercial banks accept the deposits from those who have surplus money.
(ii) They pay an amount as interest on the deposits.
(iii) Banks in India hold about 15% of their deposits as cash as a provision to pay the depositors who
might come to withdraw money from the bank on any given day and use the major portion of the
deposits to extend loans.
(iv) They mediate between those who have surplus funds and those who are in need of these funds.
They charge a higher interest rate on loans than what they offer on deposits. The difference between
what is charged from borrowers and what is paid to depositors is their main source of income.
6. Why are the poor households still dependent on informal sources of credit?
Ans. Following are the main reasons for formal credit not being available to the rural poor :
(1) There is a need for collateral or complicated paperwork which the rural poor are not capable of
providing.
(2) The moneylenders and rich landowners continue to extend loans to defaulters even if the
previous loan is unpaid.
(3) The banks are mostly unwilling to lend loans to small farmers because the repayment of loans is
dependent on the income from farming. In the case of crop failure, repayment becomes impossible.
So, the recovery from small farmers becomes difficult.
(4) They are hesitant and unsure about the functioning of the banks.
(5) They may not have access to banks in their villages.
7. Why is it necessary for banks and co-operatives to increase their lending in rural areas?
Explain.
Or
Why is there a need to expand the formal sources of credit in India?
Ans. There is a need to expand rural credit for the following reasons :
(1) To save poor from the moneylender’s high rate of interest and debt-trap and unfair means to get
their money back.
(2) Cheap and easily available credit can encourage self-employment like small-scale industries or
business.
(3) It can lead to lower cost of production and higher incomes.
(4) The RBI supervises the functioning of formal sources of loans. It ensures that loans are given
not only to the Profit-making businessmen and traders but also to small cultivators, small-scale
industries, small borrowers, etc.
(5) It will contribute to the country’s development.
8. What is the difference between formal sector loans and informal sector loans? Give two
examples of each.
Or
Mention three points of difference between the formal sector and informal sector loans.
Ans. Following are the differences between formal sector loans and informal loans.

Formal Sector Loans Informal Sector Loans

(1) Higher interest rates on loan are charged.

(1)Comparatively rate of interest charged is lower than

that of the informal sector loans.

(2) No organization is there to supervise its lending
activities.
(2) RBI supervises their function of giving loans.

(3) They are ready to give loans without collateral.

(3) Collateral is required to obtain credit.

(4) Poor households largely depend on informal

(4) Rich urban households depend largely on formal sources.
sources of credit.

(5) Examples : Traders, employers, money-lenders,

(5) Examples: Banks and Co-operatives. relatives, friends, etc.

9. What are formal sources of credit? Why do we need to expand formal sources of credit in
India?
Or
Why do we need to expand formal source or credit in India? Explain any four reasons.
Or
Describe two reasons why banks and cooperative societies must increase their lending in
rural areas. Give three suggestions for how it can be achieved.
Ans. (1) The formal source of credit includes a loan from banks and co-operatives.
(2) We need to expand formal sources of credit in India for the following reasons :
(i) Formal sources of credit are less risky and they charge a low rate of interest.
(ii) The Reserve Bank of India supervises the functioning of formal sources of loans. It monitors the
banks in actually maintaining a cash balance.
(iii) RBI ensures that loans are given not only to the profit-making businessmen and traders but also
to small cultivators, small-scale industries, small borrowers, etc.
(iv) Compared to the formal lenders, most of the informal lenders charge higher interest rates. Thus,
the cost to the borrower becomes much higher that leads to less income. Also, the borrowers may
become victim to debt-trap. So, formal sector loans help reduce dependence on informal sources of
credit.
(v) Due to the high interest rates of the informal source of credit, people who might wish to start an
enterprise by borrowing, may not do so because of the high cost of borrowing.
(vi) Cheap and affordable credit by the formal sector is crucial for the country’s development.
(3) (i) The bank should open its branches in villages.
(ii) The RBI should give guidelines to the bank to make loan procedure simpler.
(iii) Public awareness of the banks and cooperatives should be increased.
10. Explain the term ‘debt-trap’. Why is it more rampant in rural areas ? Give two reasons.
Ans. (1) When the credit pushes the borrower into a situation from which the recovery is very
painful, it is called debt-trap. For example, in the case of crop failure small or marginal farmers have
to sell a portion of his/her land to repay the loan.
(2) The debt-trap is rampant in rural areas because of the following reasons :
(i) Farmers take loans for crop production, equipment, fertilizers, etc. If crop failure happens due to
any reason, they become unable to pay back the loan.
(ii) There is usually an absence of any kind of support to the farmers in case of crop failure. So, they
are clearly much worse off than before.
11. “RBI plays a crucial role in controlling formal sector loan.” Explain.
Or
In what ways does the Reserve Bank of India supervise the functioning of banks?
Ans. (1) The Reserve Bank of India supervises the functioning of formal sources of credit in India. It
is the central bank of India.
(2) It supervises the functioning of banks in the following ways :
(i) The RBI monitors that the banks actually maintain a minimum cash balance out of the deposits
they receive. Banks in India these days, hold about 15 per cent of their deposits as cash.
(ii) RBI ensures that the banks give loans not just to profit-making business and traders but also to
small cultivators, small-scale industries, small borrowers, etc.
(iii) Periodically, banks have to submit information to the RBI on how much they are lending, to
whom, at what interest rates, etc.
12.The following table shows the sources of credit for a rural household in India in 2012 :
 Source Share

Money-lenders 33%

Co-operative societies 25%

Commercial Banks 25%

17%

Others (traders, relatives etc.)

On the basis of the table answer the following questions:

(1) What is the share of the formal sector in the total credit?
(2) Suggest two measures for improving the share of the formal sector in total credit.
(3) Why is moneylender still the largest single source of credit?
Ans. (1) The share of formal sector in total credit is 25% + 25% = 50%.
(2) (i) More credit facilities should be made available in rural areas by opening more bank branches
there.
(ii) The procedure of giving loans should be made easier and simpler.
(3)(i) This is because the formal sources of credit are not available everywhere.
(ii) The procedure of giving credit by the formal sector is so often very cumbersome.
SELF-HELP GROUPS FOR THE POOR
VERY SHORT ANSWERS:-
1. Which is the newer way of providing loans to the rural poor, particularly women?
Ans. Self Help Groups.
2. Why are banks and co-operative Societies more popular lending agencies?
Ans. They provide loans at a cheap rate of interest.
LONG ANSWERS:-
1. How do SHG’s act to provide a platform for women to address their various social issues?
Ans. SHGs act to provide a platform for women to address their various social issues in the
following ways:
(1) A Self-Help Group is an organization of rural poor, particularly women who pool their savings.
(2) The SHG encourages its members for savings and enables them to take small loans from the
group itself to meet their needs. In this way, it addresses their economic issue that is the base of
many social issues.
(3) SHGs are the building blocks of the organization of the rural poor. Not only does it help women to
become financially self-reliant, but the regular meetings of the group also provide a platform to
discuss and act on a variety of social issues such as health, nutrition, domestic violence, etc.
(4) The SHG provides self-employment opportunities to its members by providing them loans for
meeting working capital needs, for housing materials, for acquiring assets like a sewing machine,
handlooms, cattle, etc.
(5) The group charges interest on these loans but this is still less than what the money-lenders
charge.
2. Self-Help Groups enjoy a lot of freedom in their functioning. Explain.
Ans. (1) In Self-Help Groups, there is no provision of a certain number of members or a certain
amount to deposit. Members are free to their number and amount to deposit in the group.
(2) Most of the important decision regarding the savings and loan activities are taken by the group
members.
(3) The group decides as regards the loans to be granted—the purpose, amount, interest to be
charged, repayment schedule, etc.
(4) Also, it is the group which is responsible for the repayment of the loan. In any case of non-
repayment of the loan by anyone, the member is followed up seriously by other members in the
group.
(5) The SHGs help borrowers overcome the problem of lack of collateral and documentation
requirement. Besides, the regular meetings of the group provide a platform to discuss and act on a
variety of social issues such as health, nutrition, domestic violence, etc.
3. Self-Help Groups can help in solving the problem of credit in rural areas. Explain.
Or
In what ways do Self-Help Groups help the rural sector of the economy?
Ans. (1) The absence of collateral is one of the major reasons which prevent the poor from getting
bank loans. Whereas, there is no need for collateral or difficult paperwork to take loans from SHGs.
(2) SHGs have a lower interest rate than that of moneylenders or traders. They can get timely loans
for a variety of purposes.
(3) It creates employment opportunities for the members who are rural poor, particularly women.
(4) It encourages regular savings of the rural poor.
(5) SHGs help rural women not only to become financially self-reliant but also, the regular meetings
of the group provide a platform to discuss and act on a variety of social issues such as health,
nutrition, domestic violence, etc.
4. Describe the organization, working and importance of Self-Help Groups.
Or
What are the Self-Help Groups? How do they work? Explain.
 Or
What is meant by Self Help Group? Explain its working.
Ans. (1) SHGs are the groups created by the needy persons themselves, especially women to fulfil
their credit and loan needs. A typical SHG has 15-20 members, who meet and save regularly.
(2) Saving of per member varies from 25 to Z 100 or more depending on the ability of the people to
save.
(3) Members can take small loans from the group itself to meet their needs.
(4) The group charges interest on these loans but this is still less than what the money-lenders
charge.
(5) If the group is regular in savings, it becomes eligible for availing loan from the bank. The loan is
sanctioned in the name of the group and is meant to create self-employment opportunities for the
members.
5. Why are informal sources of credit preferred in rural areas? Give five reasons.
Ans. Informal sources of credit are preferred in rural areas for the following reasons:
(1) There is no need for collateral such as land; building, vehicles, deposits with banks. The rural
poor people are unable to provide collateral.
(2) Also, there is no need for complicated paperwork which the rural poor are not capable of
providing.
(3) These moneylenders, traders and rich landlords continue to extend loans to defaulters even if the
previous loan is unpaid.
(4) They are hesitant and unsure about the functioning of the banks.
(5) They may not have access to banks in their villages.
(6) The procedure for giving credit is often very simple.
6.Why are credit arrangements not fair for all sections of society? Give three reasons.
Suggest two remedies for the problem.
Or
Why is the share of formal sector credit higher for the richer households compared to the
poorer households ? Give any three reasons responsible for this.
Ans. (1) Undoubtedly, credit arrangements are not very fair for all sections of society The share of
formal sector credit is higher for. the richer households as compared to the poorer households. This
has the following reasons :
(i) Poverty affects poor households’ capacity to borrow. Formal sector credit requires proper
documents and collateral as security against loans. Collateral is an asset. So, poor people lack in
providing such things which affect their capacity to borrow.
(ii) The poor people do not repay e„
(iii) The people in villages may not have access to banks in their village. Also, they are R. loan on
time because of the various day-to-day needs. =hesitant and unsure about the functioning of the
banks.
(2) (i) More credit facilities should be made available in rural areas by opening more banks there.
(ii) The procedure of giving loans should be made easier and simpler.
VALUE BASED QUESTIONS
1.”Credit must be made available to the poor people on appropriate and reasonable term to
respect certain essential values.” Explain.
Ans. (1) (i) Undoubtedly, poverty affects poor households’ capacity to borrow. Formal sector credit
requires proper documents and collateral as security against loans. Collateral is an asset. So, poor
people lack in providing such things which affect their capacity to borrow.
(ii) Besides, they do not repay loans on time because of the various day-to-day needs.
(iii) That is why the formal sector is unwilling to lend to poor households.
(2) However, credit must be available to the poor people on appropriate and reasonable terms to
respect certain essential values.
(i) Credit at low rate of interest i.e., cheap and affordable credit would increase the incomes of the
poor. This would make them economically self-dependent.
(ii) Economic self-dependency would increase the social status of the poor.
(iii) Also, this could free them from the clutches of moneylenders, traders and rich landlords that
would certainly instil the feeling of self-respect in them.
(iv) Increased earnings would boost up their entrepreneurship. They could now grow crops, do
business, set up small-scale industries, etc.
(v) This may be a source of inspiration for the poor. Inspiration refers to an unconscious burst of
creativity in an artistic Endeavour.
2. Explain the social and economic values for which it is necessary to expand formal sources
of credit in India.
Ans. (1) Economic values :
(i)The formal sources of credit include a loan from commercial banks and co-operatives. They
provide loans at a cheaper and more affordable rate of interest than that of informal sources of
credit. This would increase the incomes of the borrower. They would have to give a little portion of
their earnings as interest. And the rest is left with themselves. This would make them
economically self-dependent.
(ii) Formal sources of credit do not have unethical terms and conditions like informal sources of
credit. This would result in a higher earning.
(iii) The Reserve Bank of India ensures that formal sources of credit provide loans to the poor small
cultivators, small borrowers, etc. so that they could increase their earnings and standard of living.
(2) Social values :
(i) Economic self-dependency boosts up the social status of the poor. With their increased incomes,
they could grow crops, do business, set-up small-scale industries, etc. This could free them from the
clutches of moneylenders, traders or landlords and increase their status in the society.
(ii) The RBI ensures loans to the poor, small cultivators and small borrowers through formal sources
of credit. In this way, they bring social equality.
3.”To achieve the overall development of the country, cheap and affordable credit is
necessary for all.” Explain the social and economic values attached to it.
Ans. (1) (i) It is absolutely true that to achieve the overall development of the country, cheap and
affordable credit is necessary for all. This is because about one-fourth of our population is still poor
that have little access to formal sources of credit due to the absence of collateral. They have to
depend upon the informal sources of credit at a high rate of interest.
(ii) The elderly people and women are the poorest of the poor in our society. So, for the woman
empowerment, cheap and affordable credit is essential.
(iii) There is a regional disparity in our country. There is a large difference between the Per Capita
Income of Delhi and Bihar. So, the cheap and affordable rate of interest is essential for increasing
industry and income of the people, especially in less-developed regions.
(2) (i) Economic values: Cheap and affordable credit would increase incomes of the poor. They
would have to give a little portion of their earnings as interest amount. And the rest is left with
themselves. This would make them economically self-dependent.
(ii) Social values: Economic self-dependency would boost up social status of the people. With their
increased earnings, they could grow crops, do business, set-up small-scale industries, etc. This
could free them from the clutches of moneylenders, traders or landlords and increase the social
status of the poor in the society.
4. “Self-Help Groups play an important role in solving the problems of rural poor.” In this
context explain the social and economic values attached to it.
Ans. (1) It promotes women empowerment. SHGs are the groups created by needy persons
themselves, especially women to fulfil their credit and loan needs. A typical SHG has 15-20
members, who meet and save regularly. So, through SHGs, women become economically
independent. They are engaged in economic activities. Their voices are heard in the family and
society.
(2) The SHG encourages teamwork because it is an organization of about 15-20 members who
meet and save at a regular interval.
(3) The Self-Help Group leads to self-sufficiency to its members. Members can take small loans
from the group itself to meet their needs. If the group is regular in savings, it can avail loans from the
bank that is meant to create self-employment opportunities for the members.
(4) They are helpful in the eradication of poverty. This is because, the SHG provides cheap loans
to its members to start self-employment activities such as establishing business units, shops, small
trading etc. In this way, they increase their incomes which leads to the eradication of poverty.
(5) The SHG is a source of inspiration to its members. Inspiration refers to an unconscious burst of
creativity in an artistic endeavour. It is a directing agent for a man to seek some purpose in life. Also,
it controls over obstacles.