Chapter 3: Money and Credit (Economics)

When a borrower takes a loan for an activity whose returns are uncertain, the loan may become a burden. Example: Swapna, a small farmer, borrowed from a moneylender to grow groundnut. Her crop failed because of pests, so she could not repay. She had to sell part of her land to repay the loan, and was left worse off than before. Her loan pushed her into a debt trap.

So in high-risk situations (crop failure due to drought or pests, a business that fails), credit can lead to the loss of assets, a growing debt burden and even distress, especially when the lender is a moneylender charging high interest.

If the activity fails (e.g. Swapna's crop failure), the borrower cannot repay, loses assets like land, and falls into a debt trap.

In a barter system, goods are exchanged directly for goods. Both parties must want what the other has: this is the double coincidence of wants, which is very hard to find.

Example: a potter wants to buy rice. Under barter, he has to find a rice farmer who wants pots at that very time. If the farmer wants cloth instead, the exchange cannot take place.

With money, the potter sells his pots to anyone who wants them and gets money. He then uses the money to buy rice from any farmer. Money acts as an intermediate in the exchange process (a medium of exchange), so a double coincidence of wants is not needed.

Money is a medium of exchange: a potter can sell pots for money to anyone and use the money to buy rice, without having to find a farmer who wants pots.

• People with surplus money deposit it in banks. The deposits are safe, earn interest, and can be withdrawn on demand.
• Banks keep only a small proportion of the deposits as cash (about 5 per cent in India these days) to meet the demand for withdrawals.
• They use the major portion of the deposits to give loans to people and businesses who need money.
• Banks charge a higher interest rate on loans than what they pay on deposits; the difference is their main source of income.

Thus banks mediate between depositors (with surplus funds) and borrowers (who need funds).

Banks accept deposits from people with surplus money, keep a small part as cash, and lend the rest to borrowers at a higher interest rate.

At the top of the note is written "Reserve Bank of India" and "Guaranteed by the Central Government". The note also says, "I promise to pay the bearer the sum of ten rupees", signed by the Governor of the RBI.

Explanation: 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. The law legalises the use of rupees as a medium of payment that cannot be refused in settling transactions in India. The promise and guarantee mean that the note has value because it is backed by the authority of the government: it is accepted as money by everyone.

"Reserve Bank of India – Guaranteed by the Central Government": the RBI issues notes on behalf of the government, and the guarantee makes the rupee a legal medium of payment that cannot be refused.

• Informal lenders (moneylenders, traders, relatives) charge much higher interest rates, have no regulation, and often use unfair means to get their money back.
• Higher cost of borrowing means a larger part of the borrower's income goes in repayment, leaving less for themselves; borrowers may fall into a debt trap.
• Cheap and affordable credit helps people to grow crops, do business, set up small industries and increase their incomes, which is crucial for the country's development.
• At present, the rich households get most of their credit from formal sources, while the poor depend largely on informal sources. Formal credit must reach the poor so that they too benefit.

Hence banks and cooperatives must expand, especially in rural areas, and formal credit must be distributed more equally.

Informal credit is costly and exploitative, while cheap formal credit raises incomes and supports development; since the poor still depend on informal lenders, formal credit must be expanded and spread to them.

A Self-Help Group (SHG) is a group of about 15–20 members, usually women, from one neighbourhood, who pool their savings. Savings per member may be small (from Rs 25 to Rs 100 or more, depending on their ability to save).

• Members can take small loans from the group itself at a reasonable interest rate, lower than the moneylender's.
• After a year or two, if the group is regular in saving, it becomes eligible for a loan from a bank, sanctioned in the name of the group, to create self-employment opportunities for its members (e.g. buying sewing machines, cattle, raw materials).
• Most decisions about savings and loans are taken by the members; the group is responsible for repayment, and members who do not repay are followed up by the others.

Basic idea: to organise the rural poor, especially women, so that they can get cheap credit without collateral, become financially self-reliant, and gain confidence. SHGs also become a platform to discuss social issues such as health, nutrition and domestic violence.

SHGs help the poor, especially women, save together and borrow cheaply without collateral, first from the group and then from banks, so that they become self-reliant.

• The borrower has no collateral (land, building, vehicle, livestock, bank deposits) to pledge as a guarantee.
• The borrower has no regular income or record of steady employment, so repayment is uncertain.
• The borrower lacks proper documents (proof of identity, address, income) needed by banks.
• The borrower has not repaid earlier loans (a poor credit record).
• The purpose of the loan is too risky, or the amount is too small to be worth the bank's costs.

Lack of collateral, no regular income, missing documents, a poor repayment record, or a risky purpose.

How:

• The RBI monitors that banks actually maintain the minimum cash balance out of the deposits they receive.
• It sees that banks give loans not just to profit-making businesses and traders but also to small cultivators, small-scale industries and small borrowers.
• Banks have to submit periodic information to the RBI on how much they are lending, to whom, and at what interest rate.

Why: it is necessary to keep people's deposits safe, to make sure that banks do not take excessive risks, to ensure that credit reaches all sections of society, including the poor and priority sectors, and to keep the banking system stable and trustworthy.

The RBI checks that banks keep the minimum cash balance, lend to small farmers and industries as well as big businesses, and report their lending; this protects depositors and ensures fair, stable banking.

• Credit helps people to start or expand economic activities: farmers buy seeds, fertilisers and pumps; small producers buy raw materials; businesses set up factories. This increases production and incomes.
• Example: Salim, a shoe manufacturer, takes credit from a trader to complete a large order, earns a good profit and his business grows.
• Credit also creates employment and helps people meet emergencies.
• Cheap and affordable credit is crucial: when the terms are reasonable, credit plays a vital and positive role in development. But high-interest informal credit (like Swapna's) can lead to a debt trap.

So for credit to help development, it must be affordable and available to all, especially the poor; formal sources should expand and lending should be fair.

Credit lets people invest in farms and businesses, raising production, incomes and employment; but it promotes development only when it is affordable and reaches everyone, otherwise it can cause a debt trap.

Manav should compare the terms of credit:

If Manav has collateral and the necessary documents, he should borrow from the bank, as it is cheaper and safer. Only if he cannot meet the bank's requirements might he consider other sources, preferably an SHG or cooperative rather than a moneylender.

He should compare interest, collateral, documents, repayment terms and safety; a bank loan is cheaper and safer if he can meet its requirements.

1. Small farmers often lack collateral (little or no land of their own), have no regular income or proper documents, and farming is risky (crop failure), so banks fear they may not be repaid.
2. Informal sources: moneylenders, traders, large farmers, landlords, relatives and friends; also cooperatives and self-help groups.
3. Example: a small farmer borrows from a trader at a high rate of interest, on the condition that the crop is sold to the trader at a low price soon after harvest. If the crop fails, as happened to Swapna, the debt keeps growing and the farmer has to sell land to clear it. So high interest, forced sale of produce and loss of collateral make the terms unfavourable.
4. Ways to get cheap credit: expanding bank branches and cooperatives in rural areas, Kisan Credit Cards, forming self-help groups, government schemes of loans at low interest and crop insurance, and lending without collateral through SHGs and microfinance.

(a) They lack collateral and regular income, and farming is risky. (b) Moneylenders, traders, landlords, relatives, cooperatives and SHGs. (c) E.g. high interest and forced low-price sale of crops to the lender, leading to loss of land. (d) Rural banks and cooperatives, Kisan Credit Cards, SHGs and government loan schemes.

(i) poor (ii) High (iii) The Reserve Bank of India (iv) deposits (v) Collateral

(i) (b) Members (ii) (c) Employers

Might get a bank loan: the government employee, the small trader, the graduate student (education loan) and possibly the autorickshaw driver (vehicle loan, with the vehicle as collateral).

Might not get a bank loan: the construction worker, migrant labourer, household maid and the worker whose factory has closed.

Criterion: whether the person has a regular income and collateral or documents that a bank requires, i.e. their ability to assure the bank of repayment.

Loans are needed for emergencies, work tools, stock, vehicles, education and housing; those with regular income and collateral (government employee, small trader, student with an education loan, auto driver) may get bank loans, while casual and unemployed workers may not.