Money as a medium of exchange
In barter, goods are exchanged directly for goods. It needs a double coincidence of wants: what one person wants to sell is exactly what the other wants to buy. This is rare.
Money solves this. It acts as an intermediate step, a medium of exchange: you sell for money and then buy with money.
Modern forms of money
- Currency: paper notes and coins. In India, the Reserve Bank of India (RBI) issues notes. The rupee is accepted because the government authorises it as legal money; no one can refuse it.
- Deposits with banks: people keep extra money in banks. These are demand deposits because they can be withdrawn on demand. Cheques, debit cards and UPI let us pay directly from deposits, so deposits also work as money.
Loan activities of banks
Banks keep only a small part of deposits as cash (about 15%) for people who come to withdraw. They use most deposits to give loans. Banks charge a higher interest rate on loans than they pay on deposits. The difference is the main source of a bank's income.
Two sides of credit
Credit (loan) is an agreement where a lender gives money, goods or services to a borrower, who promises to repay later.
- Good case: a shoe-maker takes a loan to buy leather before the festival season, completes orders and repays with profit. Credit helps income grow.
- Bad case: a small farmer borrows from a moneylender at high interest; the crop fails; he cannot repay and has to sell land or borrow again. This is a debt trap.
Terms of credit
Every loan has terms: interest rate, collateral (an asset like land, a building, vehicle or gold that the borrower pledges as security; the lender can sell it if the loan is not repaid), documents, and mode of repayment.
Formal and informal credit in India
Formal sources: banks and cooperative societies. The RBI supervises them: it checks that banks keep cash reserves and give loans to small farmers and small businesses too, not only to big businesses.
Informal sources: moneylenders, traders, employers, relatives and friends. No one supervises them, so they can charge very high interest and use unfair means to get money back.
Why formal credit matters
- Cheaper loans mean more income left for borrowers; they can grow crops or businesses.
- The share of formal credit is lower for poor households, who depend more on informal lenders.
- Banks ask for collateral and papers that the poor often lack. So formal credit must reach everyone, especially the poor.
Self-Help Groups for the poor
A Self-Help Group (SHG) usually has 15–20 members, often women from one area. They save regularly, say ₹50 to ₹200 a month. Members can take small loans from the group at a fair interest rate.
- After a year or two, if the group repays well, banks lend to the group without collateral.
- The group decides savings, loans, interest and repayment. The whole group is responsible for repayment.
- Members can start small work like tailoring, animal rearing or a shop.
- SHGs help women become financially independent and discuss social issues like health and education.
A similar idea, the Grameen Bank of Bangladesh founded by Muhammad Yunus, reached millions of poor borrowers.
Key formulas and definitions
- Double coincidence of wants: both sides want what the other has.
- Money = medium of exchange.
- Simple interest = Principal × Rate × Time ÷ 100
- Amount to repay = Principal + Interest
- Monthly rate × 12 = yearly rate (simple interest)
- Collateral: asset pledged as security for a loan.
- Formal credit: banks, cooperatives (RBI supervised); Informal: moneylenders, traders, relatives.
Worked examples
1. Find the interest on ₹10,000 from a bank at 12% a year for 1 year.
Interest = 10,000 × 12 × 1 ÷ 100 = ₹1,200. Amount = ₹11,200.
2. A moneylender charges 3% a month. What is the yearly rate?
3% × 12 = 36% a year (simple interest).
3. Find what a borrower repays on ₹10,000 after 1 year at 3% a month.
Interest = 10,000 × 36 ÷ 100 = ₹3,600. Amount = ₹13,600.
4. Compare the two loans above.
13,600 − 11,200 = ₹2,400 more with the moneylender: three times the bank's interest.
5. Why is barter hard for a potter who wants rice?
She must find a rice seller who wants pots at the same time: a double coincidence of wants, which is rare.
6. An SHG of 20 women each saves ₹100 a month. How much after 1 year?
20 × 100 × 12 = ₹24,000.
Common mistakes
- Thinking banks keep all deposits in their vaults. They keep about 15% as cash and lend the rest.
- Treating monthly and yearly interest as the same. 3% a month is 36% a year.
- Believing credit is always good. It depends on the terms and on risk; it can create a debt trap.
- Thinking SHG loans need collateral. Banks lend to SHGs without collateral.