Money as Medium of Exchange and Modern Banking

Money as Medium of Exchange

• Before money, goods were exchanged using the barter system, requiring a direct exchange of goods or services where both individuals had mutual needs.
• Money was invented to facilitate transactions regardless of the needs of the other party involved.
• Money acts as a medium of exchange.
• Precious metals and cattle were used as early forms of money.

Modern Forms of Money

• Currency notes, authorized by the government, are a common form of modern money used for transactions.
• The Reserve Bank of India (RBI) is the sole entity authorized to issue currency in India.
• Deposit accounts in banks are another form of modern money.
• Banks operate on a demand deposit system, allowing depositors to withdraw funds whenever needed.
• Demand deposits enable transactions through checks, eliminating the need for physical cash in many cases.

Functions of Banks

• Banks accept deposits from individuals and lend money to those who need it.
• Banks charge interest on loans they provide.
• Banks pay interest on customer deposits, however, the interest offered to depositors is usually lower than the interest charged on loans.
• This difference in interest rates is the primary source of income for banks.
• Banks maintain reserves to ensure adequate funds for daily operations and customer withdrawals.

Credit

• Credit is a temporary loan of money.
• Individuals can access credit from banks or other sources like individuals.
• Credit is used for purchasing goods, services, or investment purposes.
• Credit use can be beneficial or detrimental depending on how it is used and an individual's ability to repay.

Terms of Credit

• Understanding and agreeing upon credit terms is crucial before taking out a loan.
• Credit terms include documentation (necessary paperwork), collateral (asset for security against defaults), mode of repayment (schedule), and the interest rate (percentage charged for borrowing).
• Credit terms vary depending on lenders (e.g., banks, moneylenders).

Formal and Informal Sources of Credit

• Formal credit sources, like banks and cooperatives, have transparent terms regulated by the Reserve Bank of India (RBI).
• Formal sources are monitored for fair interest rates and loan allocation, ensuring transparency and accountability.
• Informal credit sources, including moneylenders, friends, or relatives, operate without regulation.
• Informal sources can have less transparent lending practices and potentially higher interest rates.

Challenges with Credit

• High interest rates from informal credit sources can easily create debt traps.
• Formal credit sources sometimes require documentation and collateral that might be inaccessible to some individuals, pushing them to informal lenders.

Self-Help Groups (SHGs)

• Self-help groups (SHGs) provide financial inclusion and access to credit for marginalized communities.
• Typically composed of 15-20 members in a local area, saving and lending to each other.
• SHG members enjoy lower interest rates and flexible repayment schedules, lowering the risk of debt traps.
• SHGs promote financial discipline and community support.
• Building evidence of financial responsibility allows SHGs to gain trust from banks to secure larger loans for their members.
• SHGs empower individuals by providing financial independence and community involvement.
• Grameen Bank of Bangladesh, founded by Muhammad Yunus, is a notable SHG example that promotes responsible financial practices, focusing on empowering the underprivileged.

Explore the evolution of money from the barter system to modern currency and banking functions. This quiz covers the role of banks, the significance of demand deposits, and the historical context of money as a medium of exchange. Test your knowledge of financial systems and the principles governing them.