There is no sphere of human life today that does not involve money as the transactional unit in exchange for rendering services. Any person who owns money can get anything he needs and wishes for, in exchange for that money. And then the service provider can use this money to buy anything he needs, and the cycle goes on.
MONEY AS A MEDIUM OF EXCHANGE
For instance, if a shoemaker is in need of some wheat, he sells the shoes he makes in exchange for money. And then use that money to purchase wheat as per his needs. However, the absence of any such exchange medium would have made the situation much more complicated, as in the previously followed Barter system. In this system, payment was made in the form of grain or cattle, instead of money.
So, a shoemaker in need of some wheat would have to find a farmer not only willing to sell wheat but also, buy shoes. This is ‘the double coincidence of wants’. And this is a rare possibility. Thus, money makes our lives simpler by eliminating the need for this double coincidence of wants. Money acts as a crucial intermediate step and is known as the medium of exchange.
MODERN FORMS OF MONEY
Historically, grains and cattle were the only form of money available. This later transitioned into the use of coins made of gold, silver, copper, iron, etc. which was prevalent until the last century.
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Modern money includes currency- paper notes and coins. The coins are not made of precious metals. The notes are made of paper. Therefore, the real value of modern money is less than its face value and does not have use of its own. These can only come into use as the medium of exchange.
Indian currency is authorized by the government of India. The Reserve Bank of India is the only institution in our country that has the authority to issue currency on behalf of the government. This currency is the accepted medium of exchange for all transactions all over the country. No one can legally refuse the currency authorized by RBI in exchange for a transaction.
Deposited in Banks
Another form in which people possess modern money is in Banks. People tend to deposit their savings and spare cash in banks by opening an account. This ensures them a monthly income on their money as interest from the bank. It also ensures the safety of their money. People can withdraw this money at any moment on demand. This is a demand deposit.
Another form of payment facility is provided by a bank in the form of a cheque. A cheque is an order by a person to a bank to pay the specified amount of money from his bank account to the person mentioned on the document. Thus, people can transfer their money directly to the intended person without the involvement of cash.
LOAN ACTIVITIES OF BANKS
Banks have a lot of depositors and consequently, huge amounts of money deposits. However, itchy keeps only 15 percent of this amount to pay the depositors who wish to withdraw their money. And lend the rest of the amount to the people in need of money for economic activities, charging a rate of interest. The banks thus act as the intermediate between the depositors and the borrowers.
The rate of interest charged on loaned money is always greater than the interest given on the deposited money. The difference between the two determines the income of the bank.
TWO DIFFERENT CREDIT SITUATIONS
A credit situation is one in which a person borrows money from a lender to bear the current costs of production, with a promise to repay the debt with the profits earned from said production.
Two credit situations might happen in such a case-
• In the first situation, a person borrows some money for the cost of production of goods and services and promises to repay at the end of the year. He makes a huge profit from his produced goods. He repays his debt on time as well as having some spare cash left with him. The credit situation helped him positively and left him in a better condition than before.
• In the second situation, a person borrows money for production expenses with a promise to repay at the end of the year. But his production fails for some reason, and he suffers a huge loss. He is left unable to repay his debt and falls into a debt trap. This forces him torepay the debt by selling off his property or other possessions in the end. This credit situation left the borrower in a condition way worse than before.
TERMS OF CREDIT
The rate of interest, collateral and documentation requirements, and the mode of repayment together constitute the terms of credit. Every agreement of credit has a rate of interest that the lender asks for, along with the repayment of the borrowed sum. Along with that, a lender may also demand collateral against the loan.
Collateral is the form of security that lender demands in form of property, vehicle, land, jewelry, livestock, etc. In case of failure of repayment of the borrowed amount, the lender has the right to sell these assets or collateral.
FORMAL SECTOR CREDIT IN INDIA
There are two types of sources of credit present in an economy-
• Formal Sector of Credit- Formal sources include the banks and the cooperatives.
• Informal Sector of Credit- Informal sources include traditional moneylenders, traders, friends, relatives, employers, etc.
The loaning activities in formal sources of credit in India are supervised by the Reserve Bank of India. Therefore, the rate of interest and collateral are supervised and regulated by legal authorities to prevent any injustice. Informal sources, on the other hand, are unsupervised and can demand any amount of interest.
This supervision over the formal sources of credit helps in the development of the country. It makes sure that the banks lend money to not only profit-making businesses but also small cultivators. RBI’s supervision has also made cheap and affordable loans possible for these small cultivators.
SELF-HELP GROUPS FOR THE POOR
Since the facilities of banks are not yet expanded to reach the rural areas, the poor people are forced to be dependent on informal sources of credit. Additionally, it is not easy to get a loan from a bank, especially in absence of collateral. And since the moneylenders who know their borrowers personally are willing to lend without collateral, the idea of borrowing from them appeals to the poor.
An organization is thus formed by the rural people called the Self-Help Group. These groups are constituted of 15- 20 people from the same neighborhood who collect their savings together. These savings vary from Rs. 25 to Rs. 100. These groups help each other and lend out money to their members with a smaller rate of interest than the moneylenders.
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