Chapter 3: Money and Credit

What You Will Learn

• Why money is used as a medium of exchange.
• Problems with the old barter system.
• Modern forms of money — currency and deposits.
• Functions of banks.
• What credit is and terms of credit.
• When credit is useful and when it becomes a debt trap.
• Formal vs Informal sources of credit.
• Role of RBI in the banking system.
• How Self-Help Groups help borrowers.

Money as a Medium of Exchange

• Money is anything that is accepted as a medium of exchange.
• It removes the need to exchange goods directly.
• Example: Instead of giving 10 kg wheat for a shirt, you just pay ₹500.
• Money acts as a medium of exchange, store of value, and unit of account.

Problems with the Barter System

• Barter = exchanging goods directly without money.
• Main problem: double coincidence of wants.
• Both people must want what the other has — this rarely happens.
• Other problems:
  • No common measure of value
  • Difficult to store wealth
  • Some goods can't be divided (like a cow)

Modern Forms of Money

• Modern money has two main forms:
  • Currency — notes and coins
  • Deposits — money in bank accounts
• Both are accepted as money in India.

Currency and Deposits

Currency (Notes and Coins)

• Issued by the Reserve Bank of India (RBI) on behalf of the government.
• RBI issues currency notes — no other person or organisation can do this in India.
• The Rupee is the currency of India.
• In India, law says no one can refuse to accept rupees for payment.

Deposits (Bank Money)

• People keep money in banks as deposits.
• Money can be withdrawn when needed.
• Deposits can be transferred to others using cheques or online transfers.
• Banks also pay interest on deposits — extra money for keeping your money with them.

Banks and Their Functions

• Banks accept deposits from people who have extra money.
• They lend this money to people who need it.
• Banks pay lower interest on deposits and charge higher interest on loans.
• The difference is their profit.
• Banks keep only a small portion (around 15%) of deposits as cash — the rest is lent out.

Credit — What It Is

• Credit (loan) = an agreement where a lender gives money or goods to a borrower.
• The borrower agrees to repay it later, usually with interest.
• Credit can come from banks, moneylenders, friends, relatives, traders, or cooperatives.

Terms of Credit

• Every loan has certain conditions called terms of credit.
• These include:
  • Interest rate — extra money paid on the loan
  • Collateral — something valuable given as security
  • Documentation — paperwork required
  • Mode of repayment — how and when to repay

Credit — Good or Bad?

• Credit can be useful — it helps people invest in business, buy seeds, or get through hard times.
• Credit can be harmful — if borrowers can't repay, they fall into a debt trap.
• Whether credit helps or hurts depends on how it is used and the terms.

Two Examples from the Textbook

Formal vs Informal Credit

• Loans come from two types of sources:
  • Formal — banks, cooperatives
  • Informal — moneylenders, traders, relatives

Formal Sources of Credit in India

• Banks — commercial and cooperative banks
• Cooperative societies — owned by members
• Regional Rural Banks (RRBs) — for rural areas
• Nabard — National Bank for Agriculture and Rural Development
• Self-Help Groups (SHGs) — group lending

Role of RBI (Reserve Bank of India)

• RBI is India's central bank.
• It issues currency on behalf of the government.
• It supervises all banks and formal lenders.
• It ensures banks follow rules and don't cheat customers.
• It also sets interest rates for the whole banking system.
• For informal lenders, RBI has no control — that's why informal loans are often unfair.

Informal Sources of Credit

• Moneylenders — most common
• Traders — sometimes give advance payments
• Landlords — lend to farmers
• Relatives and friends — personal loans

Problems with Informal Credit

• Very high interest rates
• No written records
• Can lead to debt traps
• Borrowers may lose land or assets
• No government protection

Why Formal Credit Matters

• Formal credit is cheaper — lower interest.
• Formal credit is safer — no exploitation.
• Formal credit supports development — helps people invest and grow.
• The government and RBI want more people to use formal credit.

Self-Help Groups (SHGs)

• SHGs are small groups of 15–20 people (usually women) who save money together.
• Each member contributes a small amount regularly (like ₹50–₹100 per month).
• The pooled money is lent to members when they need it — at low interest.
• SHGs are usually formed in rural areas for the poor.
• They help women become financially independent.

How SHGs Help

• Provide small loans without collateral
• Teach savings habit
• Build confidence and decision-making skills
• Give a platform for women to discuss issues
• Sometimes SHGs get group loans from banks

Grameen Bank of Bangladesh

• Started by Muhammad Yunus in the 1970s.
• Gives small loans to poor people, especially women, without requiring collateral.
• Won the Nobel Peace Prize in 2006.
• Proved that the poor are creditworthy if they get the right support.
• Inspired similar models across the world, including SHGs in India.

Important Definitions

Common Mistakes

Quick Revision

Chapter Summary

• Money is a medium of exchange that solves the problem of barter.
• Modern money = currency (notes, coins) + deposits (bank money).
• RBI issues currency and supervises banks.
• Banks accept deposits and give loans, earning from interest differences.
• Credit is a loan with terms — interest, collateral, documentation, repayment.
• Credit can be good (helps growth) or bad (leads to debt traps).
• Formal credit = banks, cooperatives (RBI supervised, low interest).
• Informal credit = moneylenders, traders (not supervised, high interest).
• SHGs help the poor access credit without collateral.
• Grameen Bank (Bangladesh) proved that the poor are creditworthy.

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