ECONOMICS

CHAPTER:3 MONEY AND CREDIT

1. What is meant by term of credit? What does it include?

Ans: Terms of credit are the requirements need to be satisfied for any credit
arrangements. It includes interest rate, collateral, documentation and mode of
repayment. However, the terms of credit vary depending upon the nature of
lender, borrower and loan.

2. How does money solve the problem of double coincidence of wants?

Ans: Double coincidence of wants is an essential feature, where goods are

directly exchanged without the use of money is also ‘known as Barter system. By
serving as a medium of exchanges money removes the need for double
coincidence of wants and the difficulties associated with the barter system.

3. Why do we need to expand formal sources of credit in India?

Ans: We need to expand formal sources of credit in India:

a) To reduce dependence on informal sources of credit because the latter

charge high interest rates and do not benefit the borrower much.
b) The Reserve Bank of India supervises the functioning of formal sources of
loans. In contrast, there is no organisation which supervises the functioning of
informal source of loans or the credit activities of lenders in the informal
sector.
c) After taking loans form informal lenders sometimes, leads the borrowers to
debt trap because of the high interest rates.
4. What are the reason why the banks might not be willing to lend to certain
borrowers?

Ans: The Banks might not be willing to lend certain borrowers due to the following
reasons:

a) Banks require proper and legal documents and collateral as security against
loans.
b) The borrowers who have not repaid previous loans, the banks might not be
willing to lend them further.
c) Those entrepreneurs, who are going to invest in a business with high risks,
the banks might not be willing to lend money.
d) One of the main objectives of a bank is to earn more profits after meeting a
number of expenses. For this purpose, it has to adopt judicious loan and
investment policies which ensure fair and stable return on the funds.
5. In what ways does the Reserve Bank of India supervise the functions of
Banks? Why is this necessary?

Ans: The Reserve Bank of India supervises the functions of banks in various
ways:

a) RBI holds a part of the cash reserve of the commercial banks. RBI
mainly ensures that the banks maintain a minimum cash balance out of the
deposits they receive.
b) The commercial banks have to submit information to RBI on how much they
are lending, to whom and at what interest rate, etc.
c) RBI observes that the Banks are not only providing loans to profitable
businesses but also to traders and small cultivators, small scale industries,
small borrowers etc.
6. How is money used as a medium of exchange? Explain with examples.

Ans: Money acts as a medium of exchange in the following ways:

a) Overcomes the problem of double coincidence of wants. For example, if a

person needs wheat in exchange of tea, then he/she must search for a person
who is ready to trade wheat for tea. Money made the need for such searches
redundant.
b) Acts as a medium of deferred payment.
c) Has a store value

7. Why is modern currency accepted as a medium of exchange without any use

of its own? Find out the reason.

Ans: Modern currency is accepted as a medium of exchange without any use of

its own because:

a) Modern currency is authorised by the government of a country.

b) In India, the Reserve Bank of India issues all currency notes on behalf of the
central government.
c) No other individual or organisation is allowed to issued currency.
d) The law legalises the use of rupee as a medium of payment that cannot be
refused in settling transactions in India.
e) No individual in India can legally refuse a payment made in rupees.
8. “Poor households still depend on informal sources of credit”. Support the
statement with examples.

Ans: Poor households still depend on informal sources of credit because:

a) Banks are not present everywhere in the rural areas.

b) Even when they are present, getting a loan from the bank is much more
difficult than taking a loan from informal sources.
c) Mega banks or public sector banks require proper documents and collateral
d) Absence of collateral is one of the major reasons which prevents the poor
from getting bank loans.
e) Informal lenders such as moneylenders know the borrowers personally and
they are willing to give a loan without collateral.
9. “The credit activities of the informal sector should be discouraged”. Support
the statement with arguments.

Ans: Credit activities of the informal sector should be discouraged:

a) Most loans from informal lenders carry a very high interest rate and do little to
increase the income of the borrowers.
b) The poor households have to pay a large amount for borrowing.
c) 85% of the loans taken by poor households in the urban areas are from
informal sources.
d) Therefore, cheap and affordable credit is crucial for the country’s
development.
10. How can the formal sector loans be made beneficial for poor farmers and
workers? Suggest any five measures.

Ans: Forma sector loans can be made beneficial for poor farmers and workers in
the following ways:

a) Create awareness to farmers about formal sector loans.

b) Process of providing loans should be made easier. It should be simple, fast
and timely.
c) More number of Nationalized Banks/ Cooperative Banks should be opened in
the rural sector.
d) Banks and cooperatives should increase facility of providing loans so that
dependence on informal sources of credit reduces.
e) The benefits of loans should be extended to poor farmers and small scale
industries.
f) While formal sector loans need to expand, it is also necessary that everyone
receives these loans.
11. Describe the vital and positive role of credit with examples.

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.
Credit plays a vital and positive role as:

a) Credit helps people from all walks of life in setting up their business, increase
their income and support their families.
b) To some people, loan helps a lot in constructing their houses and get relief
from monthly rent.
c) To others, it helps a lot in raising their standard of living.
d) Example of Salim, credit helps him and he is able to increase his earnings.
12. Explain any two features each of formal sector loans and informal sector
loans.

Ans: Formal sector Loans: Include loans from banks and cooperatives. Features
of formal sector loans are:

i) Formal sectors provide cheap and affordable loans and their rate of
interest is monitored by Reserve Bank of India.
ii) Formal sector strictly follows the terms of credit, which include interest
rate, collateral, documentation and the mode of repayment.

Informal sector loans: Include loans from moneylenders, traders, employers,

relatives, friends, etc. Features of informal sector loans are:

i) Their credit activities are not governed by any organisation; therefore, they
charge a higher rate of interest.
ii) Informal sector loan providers know the borrowers personally and hence
they provide loans on easy terms without collateral and documentation.
13. Why does the formal or informal sector asks for a collateral? Why do banks or
lenders demand collateral against loans.

Ans:

i) Every loan agreement specifies an interest rate which the borrower must
pay to the lender along with the repayment of the principal.
ii) In addition, lenders may demand a collateral or an asset that the borrower
owns to use it as a guarantee until he repays the loan.
iii) Interest rate, collateral and documentation requirement and the mode of
repayment are the terms of credit required for formal or informal sectors
for loans.
14. Explain any three loan activities of banks in India.

Ans: Loan activities of Banks in India:

i) Banks use the major portion of the deposits to extend loans.

ii) Banks make use of the deposits to meet the loan requirements of the
people.
iii) Banks mediate between those who have surplus funds (the depositors and
those who are in need of these funds (the borrowers).
iv) Banks charge a higher interest rate on loans than what it offers on
deposits.
15. How is the concept of Self Help Groups important for poor people? Give your
view point.

Ans: SHG- Self Help Group

i) SHGs help in pooling the savings of the members, who are poor
people.
ii) Members can get timely loans for a variety of purposes.
iii) They get loan at a reasonable rate of interest.
iv) It helps borrowers to overcome the problem of lack of collateral and
documentation.
v) It saves them from exploitation of the money lenders.
vi) This interest income becomes an extra source of income of the
members.

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