EOCNOMICS- MONEY AND CREDIT Banks circulate the money deposited by customers in the banks by lending it out to businesses at a rate of interest as a credit, which then acts as the income of the bank.... It is payable by the debtor after a certain fixed period of time, often with a certain amount of interest. Credit money is any future monetary claim against an individual that can be used to buy goods and services. There are many forms of credit money, such as IOUs, bonds and money market accounts. Virtually any form of financial instrument that cannot or is not meant to be repaid immediately is credit money. The key difference between cash and credit is that one is your money (cash) and one is the bank's (or someone else's) money (credit).... Yes, you need to pay back the money you borrowed, but there is also usually an additional amount you have to pay back this is called interest. Credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future, generally with interest. Credit also refers to an accounting entry that either decreases assets or increases liabilities and equity on the company's balance sheet. credit terms definition. The terms which indicate when payment is due for sales made on account (or credit). For example, the credit terms might be 2/10, net 30. This means the amount is due in 30 days; however, if the amount is paid in 10 days a discount of 2% will be permitted. There are three types of money recognized by economists - commodity money, representative money, and also fiat money. The Four Different Types of Money. Money can be described as a generally accepted medium of exchange for goods and services. Virtually anything can be considered money, as long as it performs the three major functions of money (i.e. medium of exchange, store of value, unit of account). The only difference between cash and credit transactions is the timing of the payment. A cash transaction is a transaction where payment is settled immediately. On the other hand, payment for a credit transaction is settled at a later date. Bank credit is an agreement between banks and borrowers where banks trust a borrower to repay funds plus interest for either a loan, credit card or line of credit at a later date. It is money banks lend or have already lent to customers. Bank credit is the total borrowing capacity banks provide to borrowers. Banks- Banks offer a very wide range of consumer credit services including loans with or without collateral, loans and other financing for major purchases such as automobiles, home improvement loans and financing, and home mortgages.
Money is often defined in terms of the three functions or services that it provides. Money serves as a medium of exchange, as a store of value, and as a unit of account. Medium of exchange. Money's most important function is as a medium of exchange to facilitate transactions. What is Money? We all know money as the paper notes that we use to buy goods and services. But money is much more than that. It is a form of currency that is used in our day to day monetary transactions. Money need not necessarily be in terms of paper notes. There are several forms of money available today. Such as plastic money which is in forms of Debit and Credit Cards. Digital Money which is in form of the amount you may carry in your e-wallet. With the augment of technology, the nature of money has also drastically changed. Initially we used coins and paper notes to purchase goods and services. Although this form of currency is still available and sufficiently circulated in the market. The market has seen a steady rise in other forms of payments. Function of Money Basically, the use of money, in any form is to make and receive payments in return for goods or services. Traditionally RBI issues the currency notes which can be used to make monetary transactions. But of late, several new modes of payment have also entered the market. In order for a currency or a means of payment to be an authorized means, it requires the authorization from the Reserve Bank of India. Therefore, only those means of making and receiving payments that have the authorization of RBI will be considered valid means of payments. Whether it is the paper money or digital money. Forms of Money As already mentioned, money comes in several forms, not just the paper currency. Let us find out what are the different forms in which money circulates in the market. Bank Deposits We do not use all the money that we earn. Bank deposits are one of the most common forms of money, as they are the means by which people save their money. It is always encouraged to deposit money in the bank, as that way the money does not remain stagnant and keeps circulating in the market and the depositor can earn a certain amount of interest. These deposits are also called demand deposits as they are withdraw-able on demand.
Cheque A cheque is another form of money. At times we do not have cash in our hands, or the transaction is of a hefty sum that cannot be given in cash money, in that situation, a person can write a cheque in the name of the bearer. The bearer can present the cheque to the concerned bank and get the money either in cash or have it deposited in his or her bank account. This form of money is attached to your bank deposits. You must have a bank account before you can use a cheque. Credit Credit is a means of lending. People often need money to start a business or pay for college fees and other such huge expenses, which may not be possible to meet in cash and in one go. For such situations there are credits. In credit, you borrow money from the bank to meet your expenses, whether to pay off a college fee, or to pay the vendors for any business supply, or to purchase a new house, or car. Basically, anything that requires a huge sum of money. Thus, credit is an important part of monetary circulation in the market. It is this money that generates more money for the bank, which bank can again put into circulation, thereby raising the GDP of the country. How does bank give credit? As per RBI guidelines, banks are expected to keep few cash deposits with themselves. This is normally 15% of the total cash deposit. It is called cash reserve ratio. Banks circulate the money deposited by customers in the banks by lending it out to businesses at a rate of interest as a credit, which then acts as the income of the bank. At times it may happen that a certain depositor comes to withdraw money but their money is in circulation. During such times bank pays the depositor out of their reserve deposits. The money in circulation is called as the credit money. It is payable by the debtor after a certain fixed period of time, often with a certain amount of interest. Credit Cards Another form of money is credit cards. They are used by people to make huge sums of payments for goods and services where they do not have sufficient cash. These payments are done electronically and are a kind of loan to the person who availed the credit facility. Most people prefer using cards as it eliminates the need for carrying cash. In both the cases, money and credit are circulated in the market generating more money and assisting in development. Therefore it is important to understand the concept of money and credit. It is this money and credit that helps us in improving our economy further.
Other Forms of Money Deposits with Banks: Most of the people need only some currency for their daily needs. Rest of the amount is usually kept as deposit in banks. Money which is kept in a bank is safe and it even earns an interest. One can withdraw money from his account as and when required. Since deposit in the bank account can be withdrawn on demand, these deposits are called demand deposits. One can use a cheque; instead of cash to settle payments. Moreover, one can also buy a demand draft from a bank to make payments. Credit: Banks keep a small proportion of their deposits as cash with themselves. This is usually 15% of their deposits as cash. This amount is kept as provision to pay the depositors who may come to withdraw the money on any day. This amount is enough because only a small fraction of people come to withdraw money on a given day. The rest of the amount is used by the banks to give money on credit to people who need the credit. A bank charges interest on the loan which it gives to its creditors. The interest rate charged by a bank no loans is higher than the interest rate given by it on deposits. Thus, interest is the main source of income for banks. Credit/Debit Cards: Now-a-days, credit/debit cards are in vogue. A debit card allows you to make payments from the amount which is lying in your bank account. A credit card, on the other hand, provides money on credit. Payment through credit/debit card is done electronically and this removes the need of carrying cash. Terms of Credit People often need to borrow money for various purposes. Many businessmen need to borrow to buy raw materials and machineries. Many farmers need to borrow to buy seeds, fertilisers, farm equipments, etc. People usually buy vehicles and houses by borrowing from banks. Thus, credit plays an important role in the economy. Every loan agreement specifies terms and conditions; regarding the rate of interest and term of payment. In most of the cases, the banks fix an EMI (Equated Monthly Installment) for repayment of loan. Collateral: An asset which is owned by the borrower and is used as a guarantee to a lender until the loan is repaid is called the collateral. Land, house, vehicle, livestocks, deposits with banks, insurance policy, gold, etc. are examples of assets. If the borrower fails to repay the loan, the lender reserves the right to sell the collateral to obtain payment. Terms of Credit: The terms of credit include rate of interest, collateral and mode of repayment. The terms of credit varies from one loan agreement to another and also on the nature of the lender and the borrower. Sources of Credit Formal Sector: The formal Sector comprises of banks and cooperative societies. Informal Sector: The informal sector consists of money lenders and friends and relatives, merchants and landlords.
The following diagram shows share of different sources of credit in rural households in India in 2003. Fig: Sources of Credit for Rural Households in India in 2003 While the formal sector is bound by the rules and regulations of the RBI and charge the prevalent rate of interest as per RBI guidelines; the informal lenders are not bound by such rules. The informal lenders usually charge a very high rate of interest. A higher cost of borrowing is often detrimental to the borrower. It usually results in a debt trap for the borrower. The borrower is seldom able to escape the never ending cycle of loan repayment. Many people are too poor to qualify the requirements of credit-worthiness of banks and cooperatives. There are many others who may not have enough documents; like residential certificate or income certificate. Such people are usually at the mercy of informal lenders. Self Help Groups Self Help Groups (SHGs) are recent phenomena. An SHG is comprised of small number of people; like 15 20 members. The members pool their savings. The collection is then utilised to lend small amounts of money which may be required by any of the members. The group charges interest on the loan. The arrangement of loans through Self Help Groups is also known as microfinance because the small amount of loan is involved. It was the Grameen Bank of Bangladesh which began experimenting with microfinance. The founder of Grameen Bank, Mohammad Yunus was conferred with Nobel Prize in 2006 for his efforts at improving the lot of the poor. SHGs have helped immensely in reducing the influence of informal lenders in rural areas. Many big corporate houses are also promoting SHGs at many places in India. Cooperatives These are actually a group of people of same profession who pool their resources and share the benefit earned if we talk in context of Industries. When we talk about credit, the pooled resources are given to members as credit and an interest is
also charged which the borrower have to pay back. Self Help Groups Self help Groups are mainly the groups of rural women who saves money from their earnings and deposit it within the group. They can deposit money ranging from 25 rupees to 100 rupees. The collected money is used to give loans to the members and an interest is also charged. After a period of time, when the savings of the group grows they become eligible to register in a bank. The account is made in the name of the group, not any member. The banks are interested to give loans to the self help Groups without collateral also because it is the responsibility of all the members of the groups to repay the loan and they help it's members to repay the loan to the banks. Shg also offer a platform for women to discuss issued related to health, domestic violence etc. in their regular meetings. SHGs also helps in women empowerment and give loans to members for generating self empowerment opportunities for these women or for repairing houses or releasing mortgaged land. Difference The main difference between cooperatives and Self help Groups is that cooperatives are a group of Professionals usually belonging to same profession like farming. While self help Groups are the groups of rural women who belong to different occupations, they may be house maids, labourers etc. The resources pooled in cooperatives is large and of high value while the in SHGs the collection is small made from the wages of the poor women. The pooled resources in cooperatives are used in their industrial purpose like setting up a dal mill, sugar Mill etc or The resources are submitted in banks as collateral to avail for large loans. While the SHGs, as discussed above use the money to give loans to it's members for repairing their houses, generate self employment opportunities like tailoring, for releasing mortgaged land etc. Cooperative societies are formed so that these people can pool their resources, generate huge profits and share it among themselves and increase their incomes while SHGs are formed in places where banks are not easily available. Features: A close analysis of different definitions on co-operative society reveals the following essential characteristics which are sometimes called as Principles of co-operative society. These are: The membership of a co-operative organization is voluntary and open to all adult persons. It is a self governing institution. Capital is raised from members in the form of share capital. It managed democratically. These are subject to government control as these are registered under Co-operative Societies Act, 1919. Each member has one vote irrespective of shareholdings. Advantages: Co-operative society as a form of business organization has the following advantages: It is easy to form as no legal formalities are required for formation. It is managed democratically as it is based on the principles of one man one vote.
Its membership is open to each and every person irrespective of caste and creed. It has economical operation and as such management cost is less. The liability of members is limited up to the extent of shares purchased. It generally caters the needs of poor people. Despite of a number of advantages, co-operative form of business suffer from the following limitations: Lack of adequate capital as capital is collected from members. It is operated on cash trading basis. There is a lot of political interference. It is difficult to maintain business secrecy. Every body s responsibility becomes no one s responsibility. Lack of unity among the members. Types of co-operative: Co-operative societies are classified in to different categories on the basis of objectives and purposes. The followings are major classification of co-operative societies: Consumer co-operatives formed with the objective of fulfilling needs and requirements of member consumers. Producers co-operatives are formed to assist producers in setting up industrial units, production and marketing of their products. Marketing societies are formed by small producers for marketing products produced by them. Housing co-operatives acquire land from general public, develop it, construct house and provide members. Credit co-operatives provide soft loan or easy loan at a concessional rate of interest. Basis of selection of Ownership Structure: Among different terms of business organization, the following points are taken into account for selecting a particular form of organization: Easy formation Limited liability and the provisions of raising required capital Democratic control and management Stability and continuity in operation Flexibility in operation. Self help groups (SHG): It denotes an association of small group of self employed rural or urban women entrepreneurs for welfare of its members. The primary objective of this group is to provide financial assistance to its members. It provides financial assistance to its members in the form of loan or raw materials for production. It is a voluntary association of women.
It consists of 10-20 members. Groups come together for redressed of common problems. It functions through regular meeting of its members. Its objective is economic empowerment and poverty alleviation. It facilitates co-operative, participative and empowerment culture. Medium of Exchange: Barter System: Before the advent of money, people used to follow the barter system of exchange. Suppose somebody has surplus vegetables and he needs wheat in lieu of that then he could find a person who has surplus wheat and needs vegetables. Double Coincidence of wants:- The major feature or rather drawback of the barter system was the coincidence of wants. It used to be difficult to find a person who can fulfill the coincidence of wants. Moreover, it was impractical and difficult to carry heavy goods for barter. This restricted the economic activity. Money In the historical period coins of precious metals started getting used as medium of exchange and this was the birth of money. As precious metals were difficult to procure so slowly paper money or currency notes began to replace them. Now the government or government authorized body in a country issues currency notes for circulation. In India, the Reserve Bank of India issues currency notes. On the currency note you can observe the statement promising a particular amount to be paid to the bearer of the currency note. Money removed the coincidence of wants factor and smoothened exchange facilitating economic activity. Other Forms of Money Deposits with Banks:- 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. Banks accept the deposits and also pay an interest rate on the deposits. In this way people s money is safe with the banks and it earns an 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. 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.
Credit:- 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. Since, on any particular day, only some of its many depositors come to withdraw cash, the bank is able to manage with this cash. 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. A large number of transactions in our day-to-day activities involve credit in some form or the other. 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. TERMS OF CREDIT- Every loan agreement specifies an interest rate which the borrower must pay to the lender along with the 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. There is a minimum stretch of three to four months between the time when the farmers buy these inputs and when they sell the crop. Farmers usually take crop loans at the beginning of the season and repay the loan after harvest. Repayment of the loan is crucially dependent on the income from farming. Collateral: 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. Terms of Credit:- Interest rate, collateral and documentation requirement, and the mode of repayment together comprise what is called the terms of credit. 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. Sources of Credit Formal Sector:- The formal Sector comprises of banks and cooperative societies. Informal Sector:- The informal sector consists of money lenders and friends and relatives,
merchants and landlords. The following diagram shows share of different sources of credit in rural households in India in 2003. 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. There is no organisation which supervises the credit activities of lenders in the informal sector. 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. Higher cost of borrowing means a larger part of the earnings of the borrowers is used to repay the loan. In certain cases, the high interest rate of 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. For these reasons, banks and cooperative societies need to lend more. 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. Self Help Groups In recent years, people have tried out some newer ways of providing loans to the poor. 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. 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 non repayment 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. Thus, the 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. Moreover, SHGs are the building blocks of organisation of the rural poor. Not only does it help women to become financially selfreliant, 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.