Economics Ch. 3: Money and Credit

EXERCISES

1. In situations with high risks, credit might create further problems for the borrower. Explain.

Answer: Taking credit involves an interest rate on the loan and if this is not paid back, then the borrower is forced to give up his collateral or asset used as the guarantee, to the lender. Thus, in situation with high risks, if the risks affect a borrower badly, then he ends up losing more than he would have without the loan.

2. How does money solve the problem of double coincidence of wants? Explain with an example of your own.

Answer: Money solves the problem of double coincidence of wants by acting as a medium of exchange. For example, if an ice-cream vendor wants a bicycle but the bicycle manufacturer wants clothes, not ice-cream, then the vendor can use money to obtain a bicycle. Similarly, the bicycle manufacturer can the use that money to buy clothes.

3. How do banks mediate between those who have surplus money and those who need money?

Answer: Those with surplus money are encouraged to invest with the bank and are paid a certain rate of interest. Those who need loans are required to pay an interest on their loans. The difference between the interest of the loan and deposits comprises the banks earning. Thus, the banks mediate between those who have surplus money and those who need money.

4. Look at a 10 rupee note. What is written on top? Can you explain this statement?

Answer: A ten rupee not has ‘Reserve Bank of India’ written on the top, along with a statement “guaranteed by the central government”, following it. It is a promissory note and can only be used by the Reserve Bank of India. RBI is the central organ in the working of money-related activities.

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

Answer: To reduce dependence on informal sources of credit because the latter charge high interest rates and do not benefit the borrower much. To provide loans to a large number of people who trust government sanctioning more than a private loaning system.

6. What is the basic idea behind the SHGs for the poor? Explain in your own words.

Answer: The basic idea behind the SHGs for the poor is to provide them with a platform for self-help in financial areas. If the SHG runs for over a year, then it becomes eligible for loans from banks. Thus, they become economically upgraded.

7. What are the reasons why the bank might not be willing to lend to certain borrowers?

Answer: Banks might not be willing to lend loans to people who cannot provide collateral, who do not have steady earnings or jobs, and who have a history of non-repayment of loans.

8. In what ways does the Reserve Bank of India supervise the functioning of banks? Why is this necessary?

Answer: The Reserve Bank of India supervises the functioning of banks in the following ways:

(i)  The RBI monitors the banks in maintaining a minimum cash balance out of the deposits they receive.

(ii) The RBI sees that the bank give loan not just to profit-making business and traders but also to small cultivators,  small scale industries, commoners, etc.

This monitoring is necessary to ensure that equality is preserved in the financial sector, and that small industries are also given an outlet to grow.

9. Analyze the role of credit for development.

Answer: Credit plays a crucial role in a country’s financial development. It helps in increasing the economic activities of the country. Thus improve the living standard of people if used properly. It may improve the economic condition of the poor and landless. It helps in establishment of industries.

10. Manav needs a loan to set up a small business. On what basis will Manav decide whether to borrow from the bank or the moneylender? Discuss.

Answer: Manav will see the following factors: 

a. Rate of interest

b. Requirements availability of collateral and documentation required by bank.

c. Mode of repayment.

Depending on these factors and of course, easier terms of repayment, Manav has to decide whether he has to borrow from the bank or the moneylender. 

11. In India, about 80 per cent of farmers are small farmers, who need credit for cultivation.

(a) Why might banks be unwilling to lend to small farmers?

Answer: Bank loans require proper documents and collateral as security against loans. But most of the times the small farmers lack in providing such documents and collateral. Besides, at times they even fail to repay the loan in time because of the uncertainty of the crop. So, banks might be unwilling to lend to small farmers.

(b) What are the other sources from which the small farmers can borrow?

Answer:  Apart from bank, the small farmers can borrow from local money lenders, agricultural traders, big landlords, cooperatives, SHGs etc.

(c) Explain with an example how the terms of credit can be unfavourable for the small farmer.

Answer: The terms of credit can be unfavorable for the small farmer which can be explained by the following:

Ramu, a small farmer borrows from a local moneylender at a high rate of interest i.e. 3 per cent to grow rice. But the crop is hit by drought and it fails. As a result Ramu has to sell a part of land to repay the loan. Now his condition becomes worse than before.

(d) Suggest some ways by which small farmers can get cheap credit.

Answer: The small farmers can get cheap credit from the different sources like – Banks, Agricultural Cooperatives, and SHGs.

12. Fill in the blanks:

(i) Majority of the credit needs of the Poor households are met from informal sources.

(ii) High costs of borrowing increase the debt-burden.

(iii) Reserve Bank of India issues currency notes on behalf of the Central Government.

(iv) Banks charge a higher interest rate on loans than what they offer on deposits.

(v) Collateral is an asset that the borrower owns and uses as a guarantee until the loan is repaid to the lender.

13. Choose the most appropriate answer.

(i) In a SHG most of the decisions regarding savings and loan activities are taken by

  (a) Bank.

  (b) Members.

  (c) Non-government organisation.

Answer: (b) Members.

(ii) Formal sources of credit does not include

  (a) Banks.

  (b) Cooperatives.

  (c) Employers.

Answer: (c) Employers.