Chapter 3: Money and Credit
Overview
This chapter explores the concept of money and credit, their roles in the economy, the banking system, and how credit impacts different sectors. It explains how money evolved as a medium of exchange, the role of financial institutions, and the impact of credit on economic development. The chapter also discusses the formal and informal credit sectors and their effects on borrowers.
Money as a Medium of Exchange
Money is anything that is widely accepted as a means of exchange for goods and services.
Evolution of Money
- Barter System: Before money, people exchanged goods directly, which had limitations like the lack of a common measure of value.
- Use of Precious Metals: Gold and silver coins were used as early forms of money.
- Paper Currency: Governments introduced printed currency, which is widely used today.
- Digital Transactions: Online banking, UPI, and digital wallets have modernized money exchange.
Modern Forms of Money
Modern economies use various forms of money, including:
- Currency: Issued by the central bank (e.g., RBI in India).
- Deposits in Banks: People keep their money in banks, which can be withdrawn when needed.
- Cheques and Digital Payments: Electronic transactions, mobile banking, and credit/debit cards facilitate money transfers.
- Cryptocurrency: A new form of digital money that operates independently of central banks, such as Bitcoin and Ethereum.
- E-money and Mobile Wallets: Apps such as Paytm, Google Pay, and Apple Pay allow seamless digital transactions.
Credit and Its Importance
Credit refers to an agreement where a lender provides money or goods to a borrower with the promise of repayment in the future.
Types of Credit
- Formal Sector Credit:
- Provided by banks and cooperatives.
- Regulated by the government (e.g., RBI in India).
- Lower interest rates, legal protection, and transparency.
- Informal Sector Credit:
- Provided by moneylenders, traders, employers, and friends.
- High interest rates and lack of government oversight.
- Can lead to debt traps for poor borrowers.
Case Study: Credit in Different Scenarios
- Positive Impact: Farmers taking loans for modern equipment, leading to higher productivity.
- Negative Impact: A borrower unable to repay a high-interest loan, falling into a debt trap.
Credit and Economic Development
- Credit enables businesses to expand, invest in new technology, and generate employment.
- It allows consumers to buy goods and services, stimulating demand in the economy.
- Excessive debt or poor credit management can lead to financial crises and economic downturns.
- Example: The 2008 global financial crisis was triggered by excessive credit in the housing market.
Role of Banks in Credit Creation
- Accepting Deposits: Banks store money safely and pay interest.
- Providing Loans: Banks use deposits to provide loans to businesses, farmers, and individuals.
- Reserve Ratio: A portion of deposits is kept as reserves while the rest is loaned out, creating credit in the economy.
- Multiplier Effect of Credit: Money deposited in banks circulates in the economy through lending, increasing economic activity.
- Role of RBI:
- Regulates banking operations.
- Controls interest rates and inflation.
- Ensures the stability of the financial system.
Self-Help Groups (SHGs) and Microfinance
- What are SHGs? Groups of people, especially women, who pool savings and provide loans to members.
- Benefits:
- Reduces dependence on moneylenders.
- Encourages self-employment and small businesses.
- Promotes financial literacy and community development.
- Helps rural communities access formal banking services.
- Success Story: Grameen Bank in Bangladesh, founded by Muhammad Yunus, has helped millions escape poverty through microloans.
The Need for Formal Credit
- Ensures fair interest rates.
- Provides legal protection.
- Encourages economic growth by supporting industries and businesses.
- Helps in reducing poverty and promoting financial inclusion.
- Improves investment opportunities for individuals and businesses.
- Encourages Financial Discipline: Borrowers must adhere to repayment schedules, reducing bad debts.
Challenges in the Credit System
- Financial Exclusion: Many people in rural areas still rely on informal credit due to lack of access to banks.
- High Interest Rates in the Informal Sector: Borrowers in the informal sector face exploitation and debt traps.
- Lack of Financial Awareness: Many borrowers do not understand loan terms, leading to financial mismanagement.
- Loan Defaults: Non-repayment of loans can affect economic stability and lead to banking crises.
- Collateral Requirements: Many poor individuals cannot provide assets as security for loans.
Steps Taken by the Government to Improve Credit Accessibility
- Jan Dhan Yojana: Encourages banking for the unbanked population.
- Microfinance Institutions: Provide small loans without collateral to low-income individuals.
- Interest Subsidies for Farmers: Government schemes reduce the burden of agricultural loans.
- Regulation of Moneylenders: Laws and policies to prevent exploitation by informal lenders.
- Mudra Yojana: Provides small-scale entrepreneurs with easy access to credit.
- Digital Financial Inclusion: Expanding mobile banking and UPI to reach more people.
Future of Money and Credit
- Digital and Cashless Economy: Increasing adoption of mobile banking, cryptocurrency, and digital wallets.
- Blockchain Technology: Secure, decentralized transactions could revolutionize the financial system.
- Artificial Intelligence in Banking: AI-driven credit scoring and risk assessment for better financial decisions.
- FinTech Revolution: The rise of financial technology startups offering quick and hassle-free loans.
- Green Finance: Promoting credit for eco-friendly and sustainable businesses.
Conclusion
Money and credit are vital components of the economy. While formal credit supports development and growth, the informal sector can sometimes lead to exploitation. Expanding access to banking services, promoting SHGs, and improving financial literacy can help create a more inclusive and sustainable financial system. With increasing digitalization, financial transactions are becoming easier and more efficient, but ensuring equal access to credit remains a challenge that needs continuous policy intervention and financial education.