Q1: Explain the concept of "credit" and its importance in modern economies. Compare and contrast formal credit and informal credit, highlighting their advantages and disadvantages.
Ans: Credit refers to the borrowing of funds by individuals or businesses for various purposes. It is crucial for economic development as it facilitates investment, consumption, and entrepreneurship. Formal credit is obtained from institutions like banks and cooperatives, offering regulated terms, lower interest rates, and protection for borrowers. Informal credit involves borrowing from sources like moneylenders, friends, or relatives, often with flexible terms but higher risks. Formal credit encourages financial discipline, provides legal recourse, and supports larger investments. However, informal credit might be more accessible for marginalized sections. The drawback of informal credit is the risk of exploitation and higher interest rates, while formal credit might involve complex procedures and stringent eligibility criteria.
Q2: Describe the working of the modern banking system and the role of commercial banks in creating credit. Discuss the concept of "money multiplier" and its significance in money supply.
Ans: Modern banking involves a fractional reserve system where commercial banks create credit by lending out a portion of the deposits they receive. When a person deposits money in a bank, the bank holds a fraction as reserve and lends out the rest. This process continues, leading to the creation of multiple layers of credit in the economy. The concept of the "money multiplier" refers to the potential expansion of the money supply based on the reserve ratio. If the reserve ratio is 10%, a deposit of Rs. 10,000 can create a potential credit of Rs. 90,000. This process influences the money supply, impacting inflation and economic growth. The money multiplier highlights the interconnectedness of deposits, lending, and money creation within the banking system.
Q3: Examine the advantages and disadvantages of digital payments and online banking. How do they contribute to financial inclusion and promote a cashless economy?
Ans: Digital payments and online banking offer convenience, speed, and efficiency in financial transactions. They eliminate the need for physical currency, reducing the risks associated with carrying cash. Digital payments enable quick transfers, bill payments, and purchases, enhancing financial accessibility and transparency. Online banking allows individuals to manage their accounts and transactions remotely, saving time and effort. Additionally, these technologies promote financial inclusion by reaching remote areas where traditional banking infrastructure is lacking. However, the reliance on digital platforms might exclude those without access to technology or digital literacy. Also, concerns about cybersecurity and data privacy must be addressed to ensure the secure adoption of these methods.
Q4: Discuss the concept of 'barter system' and its limitations. How does the introduction of money overcome these limitations and improve the efficiency of exchange in an economy?
Ans: The barter system involves the direct exchange of goods and services without using money. While it worked in simple societies, it had limitations like the double coincidence of wants, lack of a common measure of value, and difficulty in storing value. The introduction of money overcame these limitations and improved exchange efficiency. Money serves as a medium of exchange, eliminating the need for direct swaps. It provides a standardized measure of value, making comparisons and calculations easier. Money also acts as a store of value, allowing people to save for future needs. For example, in a barter system, a farmer needing shoes had to find a cobbler who wanted vegetables. With money, the farmer can sell vegetables for money and buy shoes from any cobbler, regardless of their immediate needs.
Q5: Explain the concept of "creditworthiness" and its significance in borrowing. How do lenders assess the creditworthiness of borrowers, and what factors influence their decisions to lend?
Ans: Creditworthiness refers to a borrower's ability and willingness to repay borrowed funds. Lenders assess this before extending credit. They consider various factors such as the borrower's income, employment stability, credit history, and collateral. A higher creditworthiness indicates a lower risk of default and enhances the borrower's chances of obtaining favorable terms. Lenders analyze credit scores, which are numerical representations of a borrower's creditworthiness based on their financial behavior and repayment history. Other factors influencing lending decisions include the purpose of the loan, the borrower's debt-to-income ratio, and prevailing economic conditions. A borrower with a stable income, good credit history, and valuable collateral is likely to be seen as more creditworthy and thus eligible for better loan terms.
Q6: Explain the two different credit situations and their impact on the borrowers in rural areas.
Ans:
- Credit in rural areas is provided by formal and informal sources. Formal sources include banks and cooperatives, and informal sources include moneylenders, traders, employers, relatives, and friends.
- In the first situation, where credit is taken from formal sources, the borrowers have to provide collateral and the rate of interest is also low. This makes repayment easier for the borrower and reduces the chances of falling into a debt trap.
- In the second situation, where credit is taken from informal sources, the rate of interest is very high and there is no requirement for collateral. This makes repayment very difficult for the borrower and increases the risk of falling into a debt trap. In some cases, the borrowers may end up losing the collateral they pledged for taking credit.
Q7: Explain the role of credit in development.
Ans: Credit plays a crucial role in a country's development. It helps in the growth of an economy by providing the necessary financial resources for different sectors of the economy such as agriculture, industry, and services. It enables entrepreneurs to start new businesses, which leads to the creation of employment opportunities. It also facilitates technological upgradation, thereby increasing the productivity of various sectors. Credit helps in maintaining the economic stability of a country by smoothening the income and consumption patterns of individuals and firms. However, the distribution of credit should be fair and inclusive for it to contribute to a country's development.
Q8: Discuss the terms of credit with respect to interest rate, collateral and documentation, and mode of repayment.
Ans: The terms of credit refer to the conditions under which credit is lent.
These include:
- Interest Rate: The interest rate is the cost of borrowing. It is the amount charged by the lender to the borrower for the use of assets. The interest rate is usually expressed as a percentage of the principal amount.
- Collateral: Collateral is an asset that the borrower owns (like land, building, vehicle, livestock, deposits with banks) and uses this as a guarantee to a lender until the loan is repaid.
- Documentation: Documentation involves the preparation and submission of necessary papers related to the credit. These may include proof of identity, proof of residence, income certificate, etc.
- Mode of Repayment: The mode of repayment refers to the way in which the loan is to be repaid. It could be in the form of monthly installments or a lump sum amount at the end of the loan period.
Q9: What is a Self Help Group (SHG)? Discuss its functioning.
Ans: A Self Help Group (SHG) is a small voluntary association of poor people, preferably from the same socio-economic background. They come together for the purpose of solving their common problems through self-help and mutual help.
The SHG promotes small savings among its members. The savings are kept with a bank. This common fund is in the name of the SHG. Usually, the number of members in one SHG does not exceed twenty. The functioning of an SHG involves regular meetings, savings by members, credit from the bank, and repayment of loans.
Q10: What are the advantages of formal sources of credit over informal sources?
Ans: Formal sources of credit have several advantages over informal sources:
- Lower Interest Rates: The rate of interest charged by formal sources of credit is usually lower compared to that charged by informal sources.
- Regulated by the RBI: Formal sources of credit are regulated by the Reserve Bank of India, which lays down the rules and guidelines for their functioning. This ensures that the borrowers are not exploited.
- Avoidance of Debt Trap: Since the formal sources of credit provide loans at reasonable interest rates, the borrowers are less likely to fall into a debt trap.
- Encourages Rural Development: Banks and cooperatives provide credit facilities in the rural areas, which promotes rural development.
- Collateral and Documentation: Formal sources of credit require collateral and proper documentation, which protects the interests of both the lender and the borrower.
