Money and credit question and answers

What are the various sources of credit in rural areas? Which one of them is the most
dominant source of credit and why? (2013 D)
Answer:
Moneylenders are the most dominant amongst sources of credit for rural
households. They constitute an informal source of credit. They charge a very high
rate of interest on loans as they do not require any collateral. They are the most
convenient source of credit in the rural areas.
Other sources of rural credit:

1. Cooperative Societies are another major source of rural credit. They are a
source of formal sector credit. Members of a Cooperative pool their resources
for helping one another, e.g., Farmers’ Cooperatives, Weavers’ Cooperatives,
etc. They offer cheap credit in rural areas for their members. Once these loans
are repaid, another round of loans is offered.
2. Agricultural traders, relatives and friends are other informal sources of rural
credit. Some farmers borrow from agricultural traders who supply the farm
inputs (such as seeds, fertilizers, pesticides, etc.) on credit at the beginning of
the cropping season and repay the loans after the harvest.
3. Commercial banks also give loans to rural households. However, not many
rural households borrow from banks as they require proper documentation and
collateral.

How do banks play an important role in the economy of India? Explain. (2015 OD)
Answer:

1. Banks help people to save their money and keep their money in safe custody.
To ensure safety of their money, people deposit their money with banks. Banks
accept deposits and pay interest on deposits. People have the provision to
withdraw their money as and when they require.
2. Banks also grant loans to people for a variety of purposes. In times of need
individuals, business houses and industries can borrow money from the banks.
3. Credit provided by banks is crucial for the country’s growth and economic
development. Credit is needed for all kinds of economic activities, to set up
business, buy cars, houses, etc.
4. Banks also help people in obtaining cheap and affordable loans. This can help
people to grow crops, do business, set up small-scale industries or trade in
goods and also help indirectly in the country’s development. They should do
so, so that relatively poor people do not have to depend on informal sources of
credit (money-lenders).

.
How can the formal sector loans be made beneficial for poor farmers and workers?
Suggest any five measures. (2016 OD)
Answer:
Formal sector loans can be made beneficial for poor farmers and workers in the
following ways:
 1. Create greater awareness among farmers about formal sector loans.
2. Process of providing loans should be made easier. It should be simple, fast
and timely.
3. More number of Nationalized Banks/cooperative banks should be opened in
rural sectors. Banks and cooperatives should increase facility of providing
loans so that dependence on informal sources of credit reduces.
4. The benefits of loans should be extended to poor farmers and small scale
industries.
5. While formal sector loans need to expand, it is also necessary that everyone
receives these loans. It is important that formal credit is distributed more
equally so that the poor can benefit from cheaper loans.

Q1. Why is money used as a medium of exchange? or why is transactions made in money?

Ans

1. A person holding money can easily exchange it for any commodity or service that he or she
might want. Thus everyone prefers to receive payments in money and then exchange the
money for things that they want.
2. In contrast, in an economy where money is in use, money by providing the crucial
intermediate step eliminates the need for double coincidence of wants.
3. It is no longer necessary for the shoe manufacturer to look for a farmer who will buy his
shoes and at the same time sell him wheat. All he has to do is find a buyer for his shoes.
Once he has exchanged his shoes for money, he can purchase wheat or any other
commodity in the market.
4. Since money acts as an intermediate in the exchange process, it is called a medium of
exchange.

Q2. What is double coincidence of wants? In which situation does it arise?

Ans

if a shoe manufacturer had to directly exchange shoes for wheat without the use of money. He
would have to look for a wheat growing farmer who not only wants to sell wheat but also wants
to buy the shoes in exchange.

That is, both parties have to agree to sell and buy each others commodities. This is known as
double coincidence of wants.

What a person desires to sell is exactly what the other wishes to buy.

In a barter system where goods are directly exchanged without the use of money,
double coincidence of wants is an essential feature.
Limitations of barter system:
 1) Lack of double coincidence of wants
2) There are many products which cannot be divided.

What are the modern forms of money? How are they different from the forms used
before?

Ans:

1. BEFORE MODERN

Before the introduction of coins, a variety of objects was used as money.

For example, since the very early ages, Indians used grains and cattle as money. Thereafter
came the use of metallic coins — gold, silver, copper coins — a phase which continued well
into the last century.

2. MODERN FORMS

Modern forms of money include 1)currency — paper notes and coins, 2)deposits with banks:
demand deposits and cheques.

3. HOW ARE THEY DIFFERENT

Unlike the things that were used as money earlier, modern currency is not made of precious metal
such as gold, silver and copper. And unlike grain and cattle, they are neither of everyday use. The
modern currency is without any use of its own.

Q4. Why Is currency used as a medium of exchange?

It is accepted as a medium of exchange because the currency is authorised by the government of the
country.

In India, the Reserve Bank of India issues currency notes on behalf of the central government. As
per Indian law, no other individual or organisation is allowed to issue currency.

Moreover, the law legalises the use of rupee as a medium of payment that cannot be refused in
settling transactions in India.

No individual in India can legally refuse a payment made in rupees. Hence, the rupee is widely
accepted as a medium of exchange.

Q5. What are bank deposits? Why are they called demand deposits?

The other form in which people hold money is as deposits with banks.
At a point of time, people need only some currency for their day-to-day needs. For instance,
workers who receive their salaries at the end of each month have extra cash at the beginning of the
month.

People with money/ extra cash deposit it with the banks by opening a bank account in their name.
Banks accept the deposits and also pay an amount as interest on the deposits.

In this way people’s money is safe with the banks and it earns an amount as interest. People also
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

Q6. What is a cheque?

payments can be made by cheques instead of cash. For payment through cheque, the payer who has
an account with the bank, makes out a cheque for a specific amount.

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.

Advantages: 1) It is the safest mode of transaction

2. it is easy to carry a cheque as compare to money

Q7. How do demand deposits share the essential features of money? / How are currency and
deposits closely linked?

The facility of cheques against demand deposits makes it possible to directly settle payments
without the use of cash.

Since demand deposits are accepted widely as a means of payment, along with currency, they
constitute money in the modern economy.

Q8. What is the main source of income for the banks? What do they do with these deposits that they
accept? / How does banking system work?

Banks keep only a small proportion of their deposits as cash with themselves.

For example, banks in India these days hold about 15 per cent of their deposits as cash.

This is kept as provision to pay the depositors who might come to withdraw money from the bank on
any given day.

Banks use the major portion of the deposits to extend loans. There is a huge demand for loans for
various economic activities.
 Banks make use of the deposits to meet the loan requirements of the people. In this way, banks
mediate between those who have surplus funds (the depositors) and those who are in need of these
funds (the borrowers).

Banks 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.

Q.Why is there a need to supervise formal sources of loans?

Ans: 1) whether banks maintain the cash balance

2) whether the banks give loans to not only profit-making bussinesses but also to small producers ,
cultivaters, small-scale industries,etc.

3) how much banks are lending, to whom and at what interest rate.

Q9. Define credit. How can it be negative as well as positive in some ways. Explain with help of
examples.

Ans: Credit (loan) refers to an agreement in which the lender supplies the borrower with money,
goods or services in return for the promise of future payment.

Credit can play a both positive and negative role.

a.
 POSITIVE- It helps to meet on going expenses of production and working capital needs. It
helps to complete production on time and increase income of producer. It helps to generate
trust.

For example, a manufacturer taking credit during festive season in anticipation of increased demand
for his product during the festival, to expand his production, to meet his production costs  and later
that situation has worked in his favour, as it enabled him to increase his output and sales too. In such
a situation ,credit plays a positive role. As in case of Salim the shoe manufacturer, the example
mentioned in the textbook.

 b. NEGATIVE: Credit pushes the borrower into a situation from which recovery is very
painful. It pushes the person into a debt trap. Credits reduces the reputation of the
borrower. 

However, in another situation for instance, a small farmer who has taken credit for cultivation might face a

problem. As crop production involves high costs on inputs life HYV of seeds, fertilizers, pesticides etc. Farmers

generally take loans at the beginning of the season and repay after harvest. But the failure of the crop makes
loan repayment impossible, which at times compel them to sell part of their land which worsens their situation.

Here, credit has a negative impact.

Analyse the role of credit for development.

a. Credit plays an important role in country’s development. In rural areas, the main
demand for credit is for crop production.

b. Credit enables farmers to purchase modern inputs like fertilizers, seeds, pesticides,
machines etc. all this results in good crop production.

c. Credit helps traders and business men to expand their business and increase earnings.

d. In the developing economy like India, bank credit is an important input variable in the
production functions of agricultural, industrial commercial and allied productive activities.

e. The development plans of the country and a number of schemes to reduce

unemployment and poverty are implemented through banks and thus through credit.

f. will help in the end of vicious cycle of debt trap.

debt trap: a situation in which it becomes impossible for the borrower to repay the loan
and borrower adds on a new debt to pay the existing debt. It moves in a viscious cycle.

Q10. Why is credit payment such a major problem in rural areas/India?

ANS: In rural areas, the main demand for credit is for crop production.

Crop production involves considerable costs on seeds, fertilisers, pesticides, water, electricity, repair
of equipment, etc.

Farmers usually take crop loans at the beginning of the season and repay the loan after harvest.

If however the harvest/ business fails the payment of credit becomes a very difficult task adding to
already existing viscious cycle of poverty and debt.

This is an example of what is commonly called debt-trap. Credit in this case pushes the borrower
into a situation from which recovery is very painful.

As in order to repay the loan taken borrowers may take another loan at a higher rate of interest.

Q11. Define collateral.

Ans: Collateral is an asset that the borrower owns (such as land, building, vehicle, livestocks,
deposits with banks) and uses this as a guarantee to a lender until the loan is repaid.

If the borrower fails to repay the loan, the lender has the right to sell the asset or collateral to
obtain payment.
Property such as land titles, deposits with banks, livestock are some common examples of collateral
used for borrowing.

Q12. Define terms of credit.

Ans: Interest rate, collateral and documentation requirement, and the mode of repayment together
comprise what is called the terms of credit.

i. Interest rate: Formal sector demands less rate of interest compared to informal
sector. At present, they demand 6 to 14 % interest rate.
ii. Collateral and documentation requirement: It refers to the security against the
loan demanded and kept by the lender until the loan is paid back. It can be gold
or documents of properties or other certificates attached with the application.
iii.
The mode of repayment: The borrower should pay back the interest and the
principal amount weekly or monthly by cash or cheques as decided at the time
of making agreements.

The terms of credit vary substantially from one credit arrangement to another. They may vary
depending on the nature of the lender and the borrower.

Q13. What are cooperatives? How do they function?

Ans: WHAT ARE COOPERATIVES?

When a group of people form a society to support each other in times of needs is called
cooperatives. Each member deposits fixed amount at regular intervals.

HOW DO THEY FUCTION?

Besides banks, the other major source of cheap credit in rural areas are the cooperative societies
(or cooperatives).

Members of a cooperative pool their resources for cooperation in certain areas such as farmers
cooperatives, weavers cooperatives, industrial workers cooperatives, etc.

With these deposits as collateral, the Cooperative has obtained a large loan from the bank. These
funds are used to provide loans to members.

Once these loans are repaid, another round of lending can take place.

 NOTE: Sources of Credit –1. Formal Sources includes Banks and Cooperatives

2. Informal Sources includes money lenders, traders, landlords, friends,

relatives etc.
Q14. Differentiate between formal and informal sector.

FORMAL INFORMAL
These include loans from banks and It includes moneylenders, traders, employers,
cooperatives relatives and friends, etc.
 The Reserve Bank of India supervises the  There is no organisation which supervises the
functioning of formal sources of loans. credit activities of lenders in the informal
sector.
Compared to the informal lenders, there is Compared to the formal lenders, most of the
lower interest rates on loans. informal lenders charge a much higher interest
on loans.
The formal sector has to periodically submit As there is no supervising power, they don’t have
information to RBI. to give any such information on lending,or what
More documentation is required. interest rate.
No documentation is required.

Q15. Discuss role of RBI in formal sector.

Ans: The Reserve Bank of India supervises the functioning of formal sources of loans.

The RBI monitors the banks in actually maintaining cash balance.

The RBI sees that the banks give loans not just to profit-making businesses and traders but also to
small cultivators, small scale industries, to small borrowers etc.

Periodically, banks have to submit information to the RBI on how much they are lending, to whom,
at what interest rate, etc.

Q16. Discuss the disadvantages of informal sector/ Why should informal sources be discouraged?

Ans: There is no organisation which supervises the credit activities of lenders in the informal sector.

They can lend at whatever interest rate they choose. There is no one to stop them from using unfair
means to get their money back.

Compared to the formal lenders, most of the informal lenders charge a much higher interest on
loans. Thus, the cost to the borrower of informal loans is much higher. They keep no record of the
transactions and harass the borrowers.

Higher cost of borrowing means a larger part of the earnings of the borrowers is used to repay the
loan.

Hence, borrowers have less income left for themselves .

In certain cases, the high interest rate for borrowing can mean that the amount to be repaid is
greater than the income of the borrower. This could lead to increasing debt and debt trap.

Also, people who might wish to start an enterprise by borrowing may not do so because of the high
cost of borrowing.

Q17. Why is cheap and affordable credit crucial for the country’s development?

Ans:

• banks and cooperative societies need to lend more. It is necessary that banks and
cooperatives increase their lending particularly in the rural areas, so that the dependence on
informal sources of credit reduces.

This would lead to higher incomes and many people could then borrow cheaply for a variety of
needs.

They could grow crops, do business, set up small-scale industries etc.

They could set up new industries or trade in goods.

In rural areas credit helps in development of agriculture by providing funds to the farmers to buy
seeds, fertilisers, etc.

Some people may need to borrow for illness, marriages, etc.

Manufacturers need credit to buy new equipment, machinery, raw material, meet ongoing
expenditure, etc.

Affordable credit would also end the cycle of debt trap.

It enables more investment which will lead to acceleration of economic activities.

Credit plays an important role in country’s development. In rural areas, the main demand
for credit is for crop production.

b. Credit enables farmers to purchase modern inputs like fertilizers, seeds, pesticides,
machines etc. all this results in good crop production.

c. Credit helps traders and business men to expand their business and increase earnings.

d. In the developing economy like India, bank credit is an important input variable in the
production functions of agricultural, industrial commercial and allied productive activities.

e. The development plans of the country and a number of schemes to reduce

unemployment and poverty are implemented through banks and thus through credit.

f. will help in the end of vicious cycle of debt trap.

Therefore, Cheap and affordable credit is crucial for the country’s development.

Q18. Describe informal and formal credit distribution in rural and urban areas.

Ans: 85 per cent of the loans taken by poor households in the urban areas are from informal sources.
There is no organisation that supervises credit activities.

Only 10 per cent of their loans are from informal sources, while 90 per cent are from formal sources.
A similar pattern is also found in rural areas. The rich households are availing cheap credit from
formal lenders whereas the poor households have to pay a large amount for borrowing.

First, the formal sector still meets only about half of the total credit needs of the rural people. The
remaining credit needs are met from informal sources.

Q19. Why is it necessary that the banks and co-operatives increase their lending particularly in rural
areas?

Ans: 1) This will help people to grow crops, do businesses, set up small scale industries or trade in
goods which will eventually lead to country’s economic development.

2) promotes self- reliance and financial security

3) helps in eradication of poverty and less dependance on informal resources.

4) the formal sector still meets only about half of the total credit needs of the rural people. The
remaining credit needs are met from informal sources. Most loans from informal lenders carry a very
high interest rate and do little to increase the income of the borrowers. This will protect the
relatively poor from corrupt money lenders.

Q20. Why is it a necessity that everyone has access to these formal loans?

Ans: while formal sector loans need to expand, it is also necessary that everyone receives these
loans. At present, it is the richer households who receive formal credit whereas the poor have to
depend on the informal sources. It is important that the formal credit is distributed more equally so
that the poor can benefit from the cheaper loans.

Q21. Poor households are still dependant on informal resources. Comment why.

Ans: Banks are not present everywhere in rural India. Even when they are present, getting a loan
from a bank is much more difficult than taking a loan from informal sources.

bank loans require proper documents and collateral.

Absence of collateral is one of the major reasons which prevents the poor from getting bank loans.

Informal lenders such as moneylenders, on the other hand, know the borrowers personally and
hence are often willing to give a loan without collateral.

The borrowers can, if necessary, approach the moneylenders even without repaying their earlier
loans.
However, the moneylenders charge very high rates of interest, keep no records of the transactions
and harass the poor borrowers.

Q22. What are SHG’S? Explain its salient features.

SHG: is a holistic program. They are small groups of poor people who organize
themselves and voluntarily save money collectively to aid each other in time
of need.
Ans: The idea is to organise rural poor, in particular women, into small Self Help Groups (SHGs) and
pool (collect) their savings.

A typical SHG has 15-20 members, usually belonging to one neighbourhood, who meet and save
regularly.

Saving per member varies from Rs 25 to Rs 100 or more, depending on the ability of the people to
save.

Members can take small loans from the group itself to meet their needs. The group charges interest
on these loans but this is still less than what the moneylender charges. After a year or two, if the
group is regular in savings, it becomes eligible for availing loan from the bank.

Loan is sanctioned in the name of the group and is meant to create self-employment opportunities
for the members. For instance, small loans are provided to the members for releasing mortgaged
land, for meeting working capital needs (e.g. buying seeds, fertilisers, raw materials), for housing
materials, for acquiring assets like sewing machine, handlooms, cattle, etc.

Most of the important decisions regarding the savings and loan activities are taken by the group
members.

The group decides as regards the loans to be granted — the purpose, amount, interest to be
charged, repayment schedule etc.

Also, it is the group which is responsible for the repayment of the loan. Any case of nonrepayment
of loan by any one member is followed up seriously by other members in the group.

Because of this feature, banks are willing to lend to the poor women when organised in SHGs, even
though they have no collateral as such.

Why are banks willing to give loans to SHG but not to poor farmers?
Ans: it is the group which is responsible for the repayment of the loan. Any case of
nonrepayment of loan by any one member is followed up seriously by other members in
the group.
Because of this feature, banks are willing to lend to the poor women when organised in
SHGs, even though they have no collateral as such.
Why are banks unwilling to lend loans to small farmers?

Banks provide loans after collateral and documentation securities, which generally the small farmers
failed to comply with. Therefore, banks are unwilling to lend loans to small farmers. They also have
absence of collateral security. The borrowers who have not paid their previous loans, so the banks
may be unwilling to provide a further loan to them. The banks might not be willing to lend to those
entrepreneurs who are going to invest in high risk businesses.

Q23. Why are SHGS called the building blocks of the poor?

Ans: SHG is a holistic program. They are small groups of poor people who
organize themselves and voluntarily save money collectively to aid each
other in time of need.
SHGs help borrowers overcome the problem of lack of collateral. They can get timely loans for a
variety of purposes and at a reasonable interest rate.

It has called for active participation of women. Not only does it help women to become financially
self-reliant, 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.

Q24. Note on Grameen Bank of Bangladesh.

• Ans: Grameen Bank of Bangladesh is one of the biggest success stories in reaching the poor
to meet their credit needs at reasonable rates.

Started in the 1970s as a small project, Grameen Bank in 2018 had over 9 million members
in about 81,600 villages spread across Bangladesh.

Almost all of the borrowers are women and belong to poorest sections of the society.

These borrowers have proved that not only are poor women reliable borrowers, but that
they can start and run a variety of small income-generating activities successfully.

’If credit can be made available to the poor people on terms and conditions that are
appropriate and reasonable these millions of small people with their millions of small
pursuits can add up to create the biggest development wonder.” Professor Muhammad
Yunus, the founder of Grameen Bank, and recipient of 2006 Nobel Prize for Peace .

NCERT QUESTIONS ( see full marks)