FORMAL AND INFORMAL SECTORS-WHO GETS WHAT?--MONEY AND CREDIT

FORMAL AND INFORMAL CREDIT –WHO GETS WHAT?
Importance of formal and informal sectors in urban areas
Poor households-85% from informal sector &15% from formal.
Households with few assets-53% from informal &47% from formal.
Well-off households-28% from informal & 72% from formal.
Rich households-10% from informal &91% from formal.

**This shows that rich households are availing cheap credit from formal lenders whereas the poor households have to pay price for borrowing.
**All this suggests that the formal sector still meets only about half of the total credit needs of the rural people & remaining are met by the informal sector.
**Similar pattern is also seen in the rural areas.
Q.Why does formal sector need to lend more?
1.As most loans from informal lenders carry a very high rate of interest and do little to increase the income of the borrowers. Thus it is necessary that the banks and cooperatives increase their lending particularly in the rural areas, so that the dependence on informal sources of credit reduces.
2.While formal sector loans need to expand, it is also very necessary that everyone receives these loans. At present it is the richer households who receive formal credit whereas the poor have to depend on the informal sources. It is important that the formal credit is distributed more equally so that the poor can benefit from the cheaper loans.
Q. Why do you think that share of formal sector is higher for the richer households compared to the poorer household?
This is mainly because rich people have collaterals and therefore they can easily fulfil the requirements of documentations.
Q. Why are poor households still dependent on the informal sources of credit?
There are several reasons for it as;
1.Banks are not present every where in rural India.
2.Even when they are present, getting loan from them is much more difficult than taking a loan from informal sources, as they require proper documents and collateral.
3. Informal lenders know the borrowers personally and hence are often willing to give a loan with collateral, & the borrowers can, if necessary, approach the lender even without repaying their earlier loans.
NEWER WAYS—SHG’s
In the recent years people have tried new ways of providing loans to the poor.
The idea is to organize rural poor, in particular women into small Self Help Groups and pool their savings.
Q.What is an SHG?
A typical SHG has 15-20 members usually belonging to a neighbourhood, who meet and save regularly.
--Saving per month varies from 25-100 rupees or more depending upon the ability of the people.
--Members take small loans from group itself to meet their needs.
--The group charges interest but it is still less than what a moneylender charges.
--After year or two if the group is regular it becomes eligible for availing loans form the banks. Loan is sanctioned in the name of the group and is meant to create self employment opputunities for all its members.
--Loans are provided for releasing mortgaged land, for meeting working capital needs as buying seeds,fertilizers,raw materials, for acquiring assets like sewing machine, handlooms, cattle, etc.
--Important decisions regarding the savings, loan activities are taken by the group members.
The group decides –the purpose, amount, interest to be charged, repayment schedule etc.
Non repayment is taken seriously, because ofthis feature of repayment banks are willing to lend loan especially to women when organized in SHG.even when they have no collateral as such.

Q.Why SHG’s are becoming popular?
SHG’s are becoming popular for the following reasons:
1.They help borrowers overcome the problem of lack of collateral.
2.They can get timely loans for variety of purposes and at a reasonable interest rate.
3. They are building blocks of the organization of the poor.
4. It helps women to become self-reliant.
5.The regular meetings of the group provide a platform to discuss and act on various social issues as health, nutrition, domestic violence, etc.

Q Analyse the role of credit for development?
Credit plays a very positive & crucial role in the development.
--It helps in self-development and self-reliance.
--It helps in growth and expansion of industries and business.
--It boosts production capacity of economy and in turn leads to capital formation.
--It also helps in speeding the process of industrialization.

DIFFERENT SITUATIONS IN CREDIT--MONEY AND CREDIT

CREDIT--(LOANS)--A large number of transactions in our day to day activities involve credit in some form or the other.
CREDIT:it refers to an agreement in which lender supplies the borrowers with money, goods, services in return for the promise of future payments.
Credit plays a vital and positive role as well as a negative role.
Whether credit will be useful or not depends upon the risks in the situation & on whether there is some support, in case of loss.
Credit—in its negative role—(debt-trap)
In the rural areas the main demand for the credit is for the crop production. Crop production involves considerable cost on seeds, fertilizers, pesticides, water, electricity, repair of equipment etc..
Farmers usually take crop loans at the beginning of the season and repay loan after harvest.
Repayment of the loan is dependent on the income from farming.
At times repayment of the loan becomes difficult and credit instead of improving the earnings,
pushes the borrower into a situation from which recovery is very difficult & painful .
this situation is called DEBT TRAP..
TERMS OF CREDIT
Q. What do you understand by terms of credit?
--Interest rate
--collateral
--documentation requirement
--mode of payment together comprise terms of credit.
These terms of credit vary substantially from one credit arrangement to another.
They may vary depending on the nature of lender and borrower.

Every loan agreement specifies an interest rate which the borrower has to pay to the lender along with the repayment of the principal.
In addition to this lenders may demand COLLATERAL(security) against the loans.
COLLATERAL—is an asset that the borrower owns such as land, building, vehicle, livestocks, deposits with banks and uses this as a guarantee to a lender until the loan is repaid.
If the borrower fails to repay the loan, the lender has the right to sell the asset or collateral to obtain the payment.
Q. Why do lenders ask for collateral while lending?
It is to ensure repayment and is a security of the lender.

VARIOUS SECTORS OF THE ECONOMY

People obtain loan through various sectors.
There are two sectors which offer loans—Formal and Informal sector.
FORMAL SECTOR / INFORMAL SECTOR
1.Formal sector includes Banks &Cooperatives whereas Informal sector includes moneylenders, traders, employers, relatives and friends etc.
2.RBI—Reserve Bank of India supervises the activities of formal sector and keep the track of their activities but there is no one supervise the functioning of informal sector.
3.Periodically banks have to submit information to the RBI on how much they are lending and to whom, at what interest rate, etc., on the other hand informal sector can lend at whatever interest rate they choose. There is no one to stop them from using unfair means to get their money back.
4. Compared to the formal sector most of the informal lenders charge a much higher interest on loans,& thus cost to the borrower of the informal loans is much higher.
FORMAL SECTOR—FEATURES
--Includes banks & cooperatives
--RBI supervises the functioning of formal sources of loans—To see that the bank maintains a minimum cash balance and monitors that these banks give loans not just to profit-making bussiness and traders but also to small cultivators , small scale industries , to small borrowers etc.
--periodically banks have to submit information to RBI of their activities.
INFORMAL SECTOR—FEATURES
--Includes money lenders, traders, employers, relatives & friends etc.
-- there is no one to supervise their credit activities.
--can charge whatever rate of interest.
--there is no one to stop them from using unfair means to get their money back.
Q. How does high rate of interest affect the borrower?
Though informal sector is catering 48% of credit needs yet it has certain disadvantages for which formal sector has to expand its activities.
--Compared to the formal lenders most of the informal lenders charge a much higher interest on loans it means that the cost to the borrower of the informal loans is much higher.
--higher cost of borrowing ,it means that larger part of earning of the borrowers is used to repay the loan & they have less income left for themselves.
--the high rate of interest of borrowing means that the amount to be repaid is greater than the income of the borrower& it can lead to increasing debt and debt trap.
--people who might wish to start an enterprise by borrowing may not do so because of the high cost of borrowing.
For these reasons banks &cooperatives need to lend more. As it would lead to higher incomes and many people could then borrow cheaply for a variety of needs.(they could grow crops, do business, setup small industries etc.
Cheap and affordable credit is crucial for the country’s development.

MONEY AND CREDIT--CH3- ECONOMICS

Q.What is money?
Money acts as an intermediate in the exchange process & it is called medium of exchange.
In many of our day to day transactions, goods are being bought & sold with the use of money.
--at times we do exchange services with money.
--use of money has made things easier to exchange as we can exchange it for any commodity we need.
Q.Why transactions are made in money?
The reason as to why transactions are made in money is that , a person holding money can easily exchange it for any commodity or service that he or she wants.
Q. What is double coincidence of wants?
When in the exchange, both parties agree to sell and buy each others commodities it is called double coincidence of wants. In the barter system double coincidence of wants is an essential feature.
FORMS OF MONEY
In the earlier times, before the introduction of coins, a variety of objects were used as money. Since ancient times we Indians used metallic coins of –silver, gold & copper—a phase that continued into the last century.
In the modern times
Modern forms of money include currency—paper notes & coins.
--it is not made of precious metals as gold, silver ,copper
--like grains, cattles etc. it is of not of day to day use.It is without any use of its own.
Why have we accepted it as medium of exchange?
--It is accepted as a medium of exchange because the currency is authorized by the govt. of India
--RBI issues notes on the behalf of central govt.
--the law legalizes the use of rupee as a medium of payment that can not be refused in settling.
transactions in India.
DEPOSITS IN BANKS
--People need only some currency for their day to day needs.For instance workers who receive their salaries at the end of each month, have some extra cash.They deposit it with the banks by opening a bank account in their name.
Bank accept the deposits and also pay an interest rate on the deposits.
Q. Why do people deposit money in the banks?
People deposit money in the banks because :
it si safe with the banks
--it earns an interest.
--people also have the provision to withdraw money as and when they require.
Q. What is Demand deposit?
--Since the deposits in the banks accounts can be withdrawn on demand, these deposits are called demand deposits.
--Demand deposits offer another facility that is the facility which lends it an essential characterstics of money, ie.,the payment made by cheques.
The payer who has an account with the bank, makes out a cheque for a specific amount.
This facility of cheques against demand deposits makes it possible to directly settle payments with the use of cash.
--Since demand deposits are accepted widely as a means of payments,along with currency,they constitute money in the modern economy.
Q. What is a cheque?
Cheque is paper insturcting the bank to pay a specific amount to the person in whose name the cheque has been made.
Q.Why demand deposits are considered as money?
Because they share essential features of money.
LOAN ACTIVITIES OF BANKS.
Q.What do banks do with the deposits which they accept from the public?
Banks keep only a small proportion of their deposits as cash with themselves, as a provision to pay the depositiors who might come to withdrawfrom the bank on the given days.
--These days Indian banks hold about 15% of their deposits as cash.
--Banks use their major portion of the deposits to extend loans, there is huge demand of loans for various economic activities.
BANKS
--Banks mediate between those people who have surplus funds (depositors) and those who are in need of those funds(the borrowers).
--banks charge higher rate of interest on the loans than what they offer on deposits.The difference between what is charged from borrowers and what is paid to thee depositors is their main source of income.
CREDIT--LOANS
Alarge number of transactions in our day to day activities involve credit in some form or the other.
CREDIT:
it refers to an agreement in which lender supplies the borrowers with money, goods, services in return for the promise of future payments.