Money and Credit

This is Chapter 3 of the Class 10 book Understanding Economic Development: 15 pages (39–53), with a page of notes for teachers (p. 38). It has seven headed parts — money as a medium of exchange; modern forms of money; loan activities of banks; two different credit situations; terms of credit; formal sector credit in India; self-help groups for the poor — with two graphs, four boxed stories (cheque payments; Salim and Swapna; Megha's house loan; Sonpur's credit arrangements), a box on Grameen Bank, five ‘Let's work these out’ boxes, cartoons and photographs, and 13 exercise questions plus a project. Every loan, interest and repayment figure is recomputed; illustrations we add are marked †.

• Builds on jess202 (Laxmi needed cheap credit to use a well — ‘we will look at some of these needs in Chapter 3’) and leads into jess204 (globalisation and finance) and jess205 (consumer rights — including bank customers).
• Pairs with Introductory Macroeconomics (leec1): leec103 (Money and Banking — functions of money, money supply measures, how banks create credit, the RBI's tools); and Indian Economic Development (keec1): keec105 (Rural Development — rural credit, NABARD, SHGs, Kudumbashree, KCC), keec103 (banking reforms after 1991).
• History: the coins pictured (punch-marked, Gupta, Tughlaq, Akbar's mohar) are discussed in the history books; the colonial moneylender in keec101.
• UPSC, honestly: legal tender (Prelims 2018), what a cash withdrawal does to money supply (2020), sources of farm credit (1999, 2011), priority sector lending (2013) and how SHGs work (2023) all draw on this chapter; GS2/GS3 have repeatedly asked about the SHG–Bank Linkage Programme and microfinance (2015, 2020, 2021), cooperative credit (2014) and financial inclusion (2022, 2026). We link twelve. Money-supply measures and the RBI's policy tools are tested through leec103, not here.

• Money = medium of exchange: it ends barter's need for a double coincidence of wants.
• Modern money = currency (RBI issues notes for the central government; legally can't be refused) + demand deposits (withdrawable on demand; cheques move them).
• Banks keep a small share as cash (book: ‘about 5%’) and lend the rest; the loan–deposit interest gap is their main income.
• Credit helps (Salim) or traps (Swapna). Terms of credit = interest rate + collateral + documents + mode of repayment (Megha: ₹5 lakh, 12%, 10 years).
• Rural India 2019: 66% formal, 34% informal (moneylenders 23%). Sonpur: bank 8.5% a year vs moneylender/landowner 5% a month (60% a year) vs trader 3% a month + crop.
• SHGs: 15–20 members, save ₹25–100, lend internally; after 1–2 years a bank loan to the group, no collateral, group responsibility. Grameen Bank (Yunus, Nobel Peace 2006).

Money is used in buying goods, paying for services and even in promises to pay later. Everyone prefers to be paid in money because money can be exchanged for any good or service. NCERT's shoe manufacturer wants to sell shoes and buy wheat. Under barter — goods exchanged directly — he must find a wheat farmer who also wants shoes: a double coincidence of wants, where what one wishes to sell is exactly what the other wishes to buy. With money he simply sells shoes for money to any buyer and buys wheat with that money. Because money acts as the intermediate in exchange, it is called a medium of exchange.

Early money in India included grain and cattle, then metal coins — gold, silver, copper — a phase that lasted well into the last century. Modern currency — paper notes and coins — is not made of precious metal and has no use of its own. It is accepted because it is authorised by the government: in India the Reserve Bank of India issues currency notes on behalf of the central government; no other individual or organisation may issue currency; and the law makes the rupee a medium of payment that cannot be refused in settling transactions in India.

Deposits with banks. People need only some currency for day-to-day needs; a salaried worker has extra cash at the start of the month and deposits it in a bank account, where it is safe and earns interest. Since these deposits can be withdrawn on demand, they are demand deposits. Their key facility is the cheque: NCERT's shoe manufacturer, M. Salim, pays a leather supplier, Prem Kumar, ₹57,000 by cheque (the cheque pictured is dated 10/6/2016); Prem deposits it, and the money moves from Salim's account to Prem's in a couple of days with no cash. So demand deposits share the essential feature of money — a medium of exchange — and, with currency, constitute money in the modern economy. Without banks there would be no demand deposits and no cheques: modern money is tied to the banking system.

Banks keep only a small proportion of deposits as cash — NCERT: ‘banks in India these days hold about 5 per cent of their deposits as cash’ — to pay depositors who come to withdraw on any day; since only some come on a given day, this is enough. The major portion is used to extend loans. Banks thus mediate between those with surplus funds (depositors) and those who need funds (borrowers). They charge a higher interest rate on loans than they pay on deposits; the difference is their main source of income.

Credit (loan) is an agreement in which the lender supplies money, goods or services in return for a promise of future payment. (1) Festival season: Salim gets an order for 3,000 pairs of shoes to be delivered within a month. To hire extra stitching and pasting workers and buy materials, he borrows from two sources: the leather supplier gives leather now for payment later, and the large trader pays an advance for 1,000 pairs (a third of the order). He delivers on time, makes a good profit and repays. Credit met his working capital needs — a vital, positive role.

(2) Swapna's problem: a small farmer with three acres of groundnut borrows from a moneylender for cultivation. Pests destroy the crop despite expensive pesticides; she can't repay; the debt grows over the year. Next year she borrows again; the crop is normal but earnings can't cover the old loan; she sells part of her land. This is a debt trap: credit pushes the borrower into a situation from which recovery is very painful. In rural areas the main demand for credit is for crop production — seeds, fertilisers, pesticides, water, electricity, repairs — with three to four months between buying inputs and selling the crop; repayment depends on farm income. Whether credit helps depends on the risks and on whether there is support in case of loss.

Every loan agreement specifies an interest rate to be paid along with the principal. Lenders may also demand collateral: an asset the borrower owns — land, building, vehicle, livestock, bank deposits — used as a guarantee until the loan is repaid; if the borrower fails to repay, the lender may sell it. Megha's house loan: ₹5 lakh from a bank at 12% a year, repaid over 10 years in monthly instalments; she had to submit employment records and salary documents; the bank keeps the papers of the new house as collateral until she repays the whole loan with interest. Interest rate, collateral and documentation, and mode of repayment together make up the terms of credit, which vary with the lender and the borrower.

How the EMI is found (Beyond NCERT): with monthly rate r = 12% ÷ 12 = 1% and n = 120 months, EMI = P × r × (1 + r)ⁿ ÷ [(1 + r)ⁿ − 1] = 5,00,000 × 0.01 × 3.3004 ÷ 2.3004 ≈ ₹7,174. In the first month, interest is 1% of ₹5,00,000 = ₹5,000 — about 70% of the instalment — so after five years ₹3,22,487 is still owed. Charging 12% on the full ₹5 lakh for all 10 years (‘flat’ interest) would cost ₹6,00,000 in interest instead of ₹3,60,826.

Sonpur (students' notes dated 15 November 2019; a small irrigated village growing potatoes): Shyamal, a small farmer with 1.5 acres, used to borrow from the village moneylender at 5% a month (60% a year); now he borrows inputs on credit from an agricultural trader at 3% a month, but must also sell his crop to the trader, who buys low at harvest and sells later when prices rise. Arun, with 7 acres, is one of the few with a bank loan — 8.5% a year, repayable any time within three years; he will store part of his potatoes in cold storage and borrow again against the cold-storage receipt. Rama, a landless labourer with months of no work, borrows for daily needs, illness and family functions from her landowner-employer at 5% a month, repays by working for him, usually borrows again before repaying, and owes ₹5,000; she stays with him despite ill-treatment because he is her only source of loans. Nearby, the Krishak Cooperative has 2,300 farmer members; it takes members' deposits, uses them as collateral for a large bank loan, and lends to members for implements, cultivation and trade, fishery, housing and other needs.

Formal and informal sectors. Loans from banks and cooperatives are formal; loans from moneylenders, traders, employers, relatives and friends are informal. The RBI supervises formal lenders: it checks that banks maintain the minimum cash balance, sees that they lend not only to profit-making businesses and traders but also to small cultivators, small-scale industries and small borrowers, and requires periodic reports on how much they lend, to whom and at what rate. No one supervises informal lenders: they charge whatever they choose and may use unfair means to recover. Higher borrowing costs eat into borrowers' earnings (Shyamal), can exceed income and cause rising debt (Rama), and deter people from starting enterprises. So banks and cooperatives must lend more — cheap and affordable credit is crucial for development.

Who gets what. Graph 2 divides urban households into four groups: the share of loans from informal sources is 54% for poor households, 38% for households with a few assets, 27% for the well-off and only 17% for the rich (83% formal). A similar pattern holds in rural areas: the rich get cheap formal credit, the poor pay heavily. NCERT draws two conclusions: formal credit must expand, and it must be distributed more equally so the poor benefit from cheaper loans.

Poor households depend on informal credit because banks are absent or demand collateral and documents, while moneylenders lend without collateral but charge very high rates, keep no records and harass borrowers. A newer way: organise the rural poor, especially women, into Self Help Groups. A typical SHG has 15–20 members from one neighbourhood who meet and save regularly — ₹25 to ₹100 or more each, by ability. Members take small loans from the group at interest below the moneylender's. After a year or two of regular saving, the group becomes eligible for a bank loan, sanctioned in the group's name to create self-employment — releasing mortgaged land, working capital (seeds, fertilisers, bamboo, cloth), housing materials, assets such as sewing machines, handlooms, cattle. The group decides the purpose, amount, interest and repayment schedule and is responsible for repayment; any default is followed up by other members. Because of this, banks lend to poor women in SHGs without collateral. SHGs are building blocks of organisation of the rural poor: they make women financially self-reliant and give a platform to act on health, nutrition and domestic violence.

Scale, for a feel (our arithmetic †): a 20-member group each saving ₹100 a month pools ₹24,000 in a year; a 15-member group saving ₹25 a month pools ₹4,500 — small sums, but a record of discipline that a bank can lend against.

Grameen Bank of Bangladesh is one of the biggest success stories in reaching the poor at reasonable rates. It started in the 1970s as a small project; in 2018 it had over 9 million members in about 81,600 villages (about 110 members per village, our arithmetic). Almost all borrowers are women from the poorest sections, who have shown they are reliable borrowers and can run small income-generating activities. Its founder, Professor Muhammad Yunus, received the 2006 Nobel Peace Prize; NCERT quotes him: if credit is made available to poor people on appropriate and reasonable terms, ‘these millions of small people with their millions of small pursuits can add up to create the biggest development wonder’.

Five ‘Let's work these out’ boxes and two yellow notes. Outlines below; numbers recomputed.

Thirteen questions and a project. Try first, then open.

Numbers

One-liners

• Money ends barter's need for a double coincidence of wants.
• Money is a medium of exchange — an intermediate step.
• Currency is accepted because the law authorises it, not because it is valuable in itself.
• Modern money = currency + demand deposits.
• Banks lend most of what they take in; the interest gap is their income.
• Credit helps or traps depending on risk and support.
• Terms of credit: interest, collateral, documents, repayment.
• The poor borrow informally because they lack collateral.
• SHGs replace collateral with group responsibility.
• Cheap, widely shared formal credit is crucial for development.

Traps to avoid

• Graph 1 is 66% formal, not ‘about half’ as the text says.
• 5% a month is 60% a year only as simple interest; compounded it is 79.6%.
• The RBI issues notes; coins and ₹1 notes are issued by the Government of India.
• A cash withdrawal leaves the money supply unchanged.
• A cheque is an instruction; the demand deposit is the money.
• The SHG–Bank Linkage Programme was begun by NABARD (1992), not SBI.
• ‘About 5% as cash’ is undated and is not the same as the CRR held with the RBI.
• Graph 2 has no year or source.
• Collateral belongs to the borrower; the lender can sell it only on default.
• Employers are informal lenders.

Prelims — what UPSC asks

• Money: legal tender = money a creditor must accept (2018); a cash withdrawal leaves money supply unchanged (2020). Money-supply measures (M1, M3) and RBI tools are leec103's ground.
• Credit: farmers' main sources — cooperatives, commercial banks, RRBs, moneylenders (1999); commercial banks lead in farm credit (2011); priority sector = agriculture, small enterprises, weaker sections (2013); SHGs: group responsibility, NABARD's 1992 programme (2023).
• Also expect: demonetisation dates, UPI and NPCI, DICGC cover, KCC, PMJDY, MUDRA, Grameen and Yunus.

Mains — where it appears and how to answer

• GS2: the SHG–Bank Linkage Programme (2015), microfinance and SHGs for asset creation and women's empowerment (2020), and for breaking poverty–malnutrition cycles (2021). GS3: cooperative credit (2014, the All India Rural Credit Survey's words); financial inclusion and inclusive growth (2022, 2026). Use Sonpur's rates, Graph 1's 66/34 split and Graph 2's poor–rich gap, each with its year.
• Set positions side by side — moneylenders as exploiters vs as information-rich lenders; microfinance as transformative, modest or harmful — and give schemes as dated facts. No present-day political commentary.

Tap an option. NCERT's own exercise questions come first; the rest test the figures and common confusions.

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