Money is not the only way to exchange goods and services. But it solves a problem that a pure barter system cannot.
In a barter economy, a trade can happen only if there is a double coincidence of wants. What one person wants to sell must be exactly what the other person wants to buy. And it must work the other way round, too. A shoe manufacturer who wants to sell shoes and buy wheat must find a wheat-grower who wants to buy shoes back. That is a demanding coincidence to arrange.
Money removes this requirement. The shoe manufacturer sells shoes for money, then uses that money to buy wheat from anyone selling it — with no need for that same person to want shoes in return. Because a person holding money can exchange it for any good or service, everyone prefers to be paid in money. This is what makes money a medium of exchange.
Modern money takes two forms: currency — paper notes and coins — and, as the next section shows, bank deposits. Earlier periods used grain and cattle, and later metallic gold, silver, and copper coins, as money. Modern currency is different. It is not made of a precious material, and it has no everyday use of its own.
It works as money only because it is authorised by the government. In India, the Reserve Bank of India issues currency notes on the central government's behalf, and by law no one else may issue currency. The law also makes the rupee legal tender. No one in India can legally refuse a payment made in rupees — which is exactly why it is so widely accepted.
The other form people hold money in is a bank deposit. Rather than keep surplus cash idle, people open a bank account. The bank accepts the deposit, pays interest on it, and lets the depositor withdraw the money whenever needed — which is why these are called demand deposits.
A demand deposit can also be paid to someone else without any cash changing hands, using a cheque. A cheque is a paper instructing the bank to pay a set amount to the person named on it. Shoe manufacturer Salim pays a leather supplier by cheque. The supplier deposits it into his own account, and the two banks transfer the money between accounts within a couple of days.
No cash ever moves, and the payment still settles. Because demand deposits are accepted this widely, they count as money too, right alongside currency.
Banks do not hold onto most of what is deposited with them. In India, banks keep only about 5 per cent of their deposits as cash. That is enough to pay the depositors who withdraw money on any given day, since not all of them come at once.
The remaining, much larger share is lent out to borrowers who need funds for their own activities. A bank mediates between two groups this way: depositors, who earn interest for keeping their surplus with the bank, and borrowers, who pay interest on what they take out. Banks charge a higher rate on loans than they pay on deposits, and that gap is the bank's main source of income.
A very large share of everyday economic transactions involve credit — a loan — in some form. It is an agreement where a lender supplies money, goods, or services now, in return for a promise of future payment.
Rural India's biggest demand for credit is for crop production. There is usually a gap of three to four months between when a farmer buys inputs — seeds, fertilisers, water, equipment repair — and when the harvested crop is finally sold. Farmers typically take a crop loan at the start of the season and repay it after harvest — so repayment depends entirely on how that harvest turns out.
Whether credit helps or harms a borrower depends on the risk in the situation, and on whether help is available if things go wrong. Credit is not automatically good, and not automatically bad.
Salim, a shoe manufacturer, takes credit — leather on account, a cash advance from a trader — to meet a large festival-season order. He completes it on time, makes a good profit, and repays what he borrowed. Credit plays a vital, positive role here, meeting a real working-capital need.
Swapna, a small farmer growing groundnut, borrows from a moneylender to cover her cultivation costs, hoping the harvest will cover it. Pests destroy the crop despite expensive pesticides, and she cannot repay. The debt grows through the next year too, because even a normal harvest is not enough to cover the old loan on top of new costs. She is forced to sell part of her land to clear the debt — a debt trap, credit pushing a borrower into a spot recovery from is very painful.
Every loan agreement specifies an interest rate the borrower pays along with repaying the principal. Lenders may also demand collateral — an asset the borrower already owns, such as land, a vehicle, or bank deposits — held as a guarantee until the loan is repaid. If the borrower fails to repay, the lender may sell the collateral to recover payment.
Together with any documentation the lender requires, and the agreed mode of repayment, these make up the terms of credit. They vary substantially from one arrangement to another, depending on the lender and the borrower.
Megha's house loan makes the bundle concrete. She borrows Rs 5,00,000 from a bank at 12 per cent annual interest, repayable over 10 years in monthly instalments. The bank required her salary records as documentation, and held the new house's own papers as collateral, to be returned once the loan is fully repaid.
In Sonpur, a small irrigated village, three residents face three very different terms of credit for the same underlying need: crop cultivation or daily survival.
Shyamal, a small farmer with 1.5 acres, used to borrow from the village moneylender at 5 per cent a month — 60 per cent a year. For the last few years he has instead borrowed from an agricultural trader at 3 per cent a month. But the trader also makes him promise to sell his crop only to the trader, who then buys it at a low post-harvest price.
Arun, with seven acres, is one of the few in Sonpur to get a bank loan for cultivation: 8.5 per cent a year, repayable within three years, with no resale condition attached. Rama, a landless labourer with no land to offer as collateral, depends entirely on her employer, who charges 5 per cent a month — the same rate Shyamal's old moneylender charged. She repays by working off the debt, is often forced to take a fresh loan before clearing the last one, and currently owes Rs 5,000. The person with no collateral to offer pays the highest rate of all three, from the narrowest set of choices.
Besides banks, cooperative societies are the other major source of cheap rural credit — farmers' cooperatives, weavers' cooperatives, and others, formed by members pooling their resources for a shared purpose.
Krishak Cooperative, near Sonpur, has 2,300 farmer members. It accepts deposits from its own members, then uses those pooled deposits as collateral to get a large loan from a bank. Those bank funds are lent out again to members, for equipment, cultivation, trade, and house construction. Once a round of loans is repaid, the cycle begins again for the next round.
All the credit sources seen so far group into two sectors. The formal sector — banks, including cooperative banks, and cooperative societies — is supervised by the Reserve Bank of India. The RBI checks that banks keep the cash-reserve share they are required to. It also checks that they lend to small cultivators and small businesses too, and requires periodic reports on how much is being lent, to whom, and at what rate.
The informal sector — moneylenders, traders, employers, relatives, friends — has no such supervisor. Informal lenders can charge whatever interest rate they choose, and no one stops them using unfair means to recover what they are owed.
Nationally, most rural credit in India, as of 2019, still comes from the formal sector. Commercial Banks supply 51 per cent of loans; Cooperative Banks and Societies a further 10 per cent; Other Formal Agencies 5 per cent — a combined formal share of about two-thirds.
The rest comes from informal sources. Moneylenders alone supply 23 per cent, with Relatives and Friends at 7 per cent, Other Informal Agencies at 3 per cent, and Landlords at 1 per cent. The chapter's own summary calls the formal sector's share only "about half" of rural credit needs — a looser, rounder claim than the graph's own roughly 66 per cent formal share. Both figures come from the same source, and do not quite agree.
Most informal lenders charge a much higher interest rate than formal lenders. Borrowing informally costs far more. A larger share of a borrower's earnings then goes toward repaying the loan, leaving less to live on. In the worst cases, the amount owed can even exceed what the borrower earns, pushing them toward rising debt.
The reverse is also true. If banks and cooperatives lend more, and more cheaply, incomes rise, and more people can afford to farm, trade, or start a small enterprise on borrowed capital. Cheap, affordable credit is, in the chapter's own words, "crucial for the country's development."
Formal credit is not shared out evenly by wealth. Among urban households in 2019, only 46 per cent of the loans taken by poor households come from formal sources — 54 per cent are informal.
That formal share rises steadily with wealth. It is 62 per cent for households with a few assets, 73 per cent for well-off households, and 83 per cent for rich households, who take only 17 per cent of their loans informally. Rural areas show a similar pattern — richer households reach cheap formal credit, while poorer households pay far more to borrow informally.
The poor stay dependent on informal credit for structural reasons, not by choice. Banks are not present everywhere in rural India, and even where one exists, getting a loan from it is far harder than borrowing informally.
As Megha's example showed, formal loans need documentation and collateral — and lacking collateral is one of the biggest reasons the poor are shut out. Informal lenders, by contrast, know their borrowers personally and are often willing to lend without any collateral at all. This is why even a landless labourer like Rama can always get a loan from her employer. The trade-off is steep, though: moneylenders charge very high interest, keep no formal record, and can harass borrowers for repayment, with no supervising body to stop them.
It is easy to assume a bank loan is available to anyone who needs one — that getting formal credit is simply a matter of asking. That overlooks the collateral and documentation gate that keeps much of rural India, especially the poor, out of the formal system entirely.
Formal credit is legally open to all, but practically gated by the collateral and documentation banks require, and by how few banks reach rural India. That is why a landowning farmer like Arun can get a bank loan at 8.5% a year. A landless labourer like Rama, with no collateral, can only borrow from her employer, at 60% a year. It is also why only 46% of poor urban households' loans are formal, against 83% for rich households.
Self-Help Groups, or SHGs, are a newer way of getting credit to the poor — especially women, who often lack collateral. A typical SHG has 15 to 20 members, usually from one neighbourhood, who meet and save regularly: anywhere from Rs 25 to Rs 100 or more a month per member, depending on what they can afford.
Members can borrow small amounts from the pooled savings, still cheaper than a moneylender's rate. After a year or two of regular saving, the group as a whole becomes eligible for a bank loan sanctioned in the GROUP's name, not any one member's. The group decides how it is then lent out to its own members, and is collectively responsible for repaying the bank.
Because the whole group answers for any one member's default, banks are willing to lend even though no individual member has collateral. Beyond credit, SHGs also give members a platform to discuss shared issues — health, nutrition, and domestic violence among them.
Grameen Bank of Bangladesh is the chapter's headline example of this idea working at national scale. Started as a small project in the 1970s, by 2018 it had grown to over 9 million members across roughly 81,600 villages — almost all of them women from the poorest sections of society.
It is held up as one of the biggest success stories in reaching the poor with credit on reasonable terms. Its founder, Professor Muhammad Yunus, received the 2006 Nobel Prize for Peace. Credit made available to the poor on reasonable terms, he said, can let millions of small pursuits add up to "the biggest development wonder."
Modern money — currency plus demand deposits — is inseparable from the banking system that connects depositors and borrowers. Credit itself is neither automatically good nor automatically bad. It can meet a real working-capital need and pay off, as it did for Salim. Or, in a high-risk situation with no support to fall back on, it can trap a borrower in growing debt, as it did for Swapna.
Credit is also unevenly available. Formal, cheaper sources still leave a large share of rural need to be met informally, at much higher cost. Within the formal sector itself, access skews toward the wealthy, leaving poorer households paying more to borrow the same money.
Expanding formal credit, and making sure it reaches the poor, is essential for development, in the chapter's own framing. Routes like cooperatives and Self-Help Groups do this by solving the collateral problem directly, instead of waiting for it to go away on its own.