Class 7 Social Science Chapter 20: Banks and the Magic of Finance

The other kind of infrastructure

The last chapter was about things you can touch. This one is about what pays for them, and what moves money between people.

Financial infrastructure is the name for it: a network of stock markets, payment systems, banks and other financial institutions. Governments, businesses and people all use it to manage money and to make transactions happen.

Why a cupboard is the wrong place

Start with one man and three thousand rupees. Navdeep saves that much from his salary every month.

A cupboard at home is not a safe place for that much, so the money goes into a bank instead. That is a deposit, and it is the first half of the story.

The other half of the story

Rima makes bamboo products, and her business needs money for a few operations. Friends and family could not help as much as she needed.

So she takes a loan from the bank, to repay later. The surplus Navdeep handed over is what the bank gives Rima, and neither of them had to find the other.

What a bank is, in one sentence

Put the two halves together and the definition writes itself.

A bank is the financial institution that gathers money from people as deposits, and lends that money out to borrowers as loans. Saving, withdrawing and borrowing are the services, and they make transactions involving money easier.

Who uses one

The chapter is careful to say this is not a service for a particular sort of person.

Nurses use banks. So do shopkeepers, and farmers, and institutions, and businesses. First you open a bank account, and then you are a bank account holder, and then the services are yours.

Three kinds of account

Here is where many people go wrong, because the three are not interchangeable. Each exists for a different pattern of use.

A savings account suits an individual who saves regularly. It opens with a minimum deposit, earns interest, and lets money be added or taken out, though how often it may be withdrawn each month is limited.

For a business, and for a long wait

The second kind is built for traffic rather than for growth.

A current account suits traders and businesses that make and receive payments often. There is no interest on it, but generally no limit either on how many times money goes in or out.

Money locked away

The third kind is the opposite choice.

A fixed deposit account takes one deposit, once, and keeps it for a set period, say three years or five. At the end the bank hands back the original sum together with interest, and that interest is usually higher than a savings account would have paid.

What a deposit actually is

The margin of the chapter defines the word, and the definition has two parts worth separating.

Money placed in a bank account is a deposit. It can be withdrawn, but only as the terms of the bank allow, and it often earns interest.

Why the bank pays you at all

This is the part that puzzles most people. Why should anybody pay you for keeping your own money somewhere?

Because the bank does not merely keep it safe. It lends your money to other people and to businesses. The extra money it gives you in return, over a regular period such as monthly or quarterly or annually, is interest, and it is what encourages people to save.

A thousand rupees, and one year

Now the arithmetic, which is easier than it looks. Your mother gives you 1,000 rupees for your birthday and you deposit it. The bank pays 6 per cent a year if you leave it alone.

Six per cent of 1,000 is 60. So the year ends with 1,000 plus 60, which is 1,060 rupees.

The second year is the interesting one

Leave it another year and something changes. The interest is now worked out on 1,060, not on 1,000.

Six per cent of 1,060 comes to 63.60. The second year therefore closes at 1,060 plus 63.60, which is 1,123.60 rupees.

What that process is called

Notice what happened: you earned interest on interest. The 60 rupees from the first year is itself earning now.

Compounding is the name for earning interest on interest already earned, and the yearly amounts keep rising, from 60 rupees to 63.60 and onwards. Keep going for twelve years and the 1,000 becomes 2,012.20.

A chessboard, and a bad bargain

The chapter tells one story to show how fierce this can get. A king of Ambalappuzha in Kerala, who loved chess, challenged a visiting sage and offered any reward if the sage won.

The sage asked for rice. A single grain on square one, and then a doubling at every square after it, right across all 64 of them.

How small the demand looked

The king was surprised at how little the sage had asked for, and agreed. Then he lost the game.

His courtiers began laying out grains. The eighth square, the last of the top row, took 128. The ninth took 256, the tenth 512, the eleventh 1,024.

How big it got

Then the doubling did its work.

By the sixteenth square the count stood at 32,768 grains. By the thirty-second it had passed 210 crore. The king learnt how powerful exponential growth is, but he learnt it only after paying a heavy price.

Keeping track of it all

A bank account has deposits and withdrawals running through it constantly, so how does anybody keep count?

The bank gives you a passbook, which is a diary-like document recording all the payment and receipt transactions. It can be brought to the bank and updated whenever you like.

Two words in a passbook

The entries in a passbook use a pair of terms that are worth getting the right way round.

Credit means money arriving in an account, which is the inflow of cash, such as income. Debit means money leaving the account, the outflow of cash, such as an expense. Keeping a record of financial transactions is the whole point of the book.

Scenario:

Three people walk into the same branch on the same morning. Meena is a tailor who puts aside a little every week and wants it to grow, but may need some of it for cloth. Ravi runs a hardware shop and makes or takes twenty payments a day. Shabana has just received 40,000 rupees from the sale of a field and will not need it for five years. The clerk has three kinds of account on the form in front of him, and each of the three wants the one that suits them.

Analysis:

A tailor, a shopkeeper and a woman with a windfall, choosing between three accounts.

Activity:

Ask at home which of the three kinds of account your family uses, and why.

Title:

Work out your own compounding

Safety:

No hazards here.

What You Notice:

The circled numbers rise every single year, and that is the whole point: each year the interest is worked on a bigger base. The chapter own case goes 60, then 63.60, and after twelve years 1,000 rupees has become 2,012.20.

By the thirty-second square of the chessboard the rice had passed 210 crore grains.

A fixed deposit usually pays more than a savings account because the money cannot be touched.

A current account earns no interest at all.

Savings for a saver, current for a trader, fixed for a waiter.

Credit comes in, debit goes out.

The other side of the counter

Holding deposits is half of what a bank does. Lending is the other half, and the word for what it lends is a loan.

Money goes out to borrowers for particular purposes, and the chapter gives examples at two scales: what a household borrows for, and what a business borrows for.

What a household borrows for

Three purposes, and you will have heard of all three.

Education has to be funded. A vehicle has to be bought. A house has to be bought, which is the largest borrowing most families ever do.

What a business borrows for

A business borrows for other things, and the list is longer.

New products have to be launched in markets. Products have to be transported. Raw materials have to be purchased, and so does new machinery. None of that waits for profits to accumulate first.

What a loan is

The margin of the chapter defines it, and one phrase in the definition does the work.

An amount borrowed from a bank or financial institution is a loan, and it carries an obligation: to repay it later, with interest.

Interest runs in both directions

Here is the symmetry that makes a bank work.

Interest is paid by the bank to its depositors on their savings. Interest is charged by the bank to its borrowers on their loans. After a specified period the borrower returns the loan amount, and the interest with it.

The two rates are not the same

And here is the part that is easy to miss, because both rates are called interest.

On savings deposits the bank pays a lower rate. On loans it charges a higher rate. That difference between the two rates is a source of income for the bank.

Two hundred rupees, and two per cent

Follow the money. Anand puts 200 rupees into his bank account, and the bank offers him 2 per cent on his savings.

Two per cent of 200 is 4 rupees. So what Anand will get back is his 200 plus 4, which comes to 204 rupees.

The same money, at five per cent

That 200 does not sit still. The bank lends it to Shreya, charging her 5 per cent.

Five per cent of 200 is 10 rupees. So Shreya repays the original 200 together with 10 rupees of interest on the loan, making 210 in all.

What the bank keeps

Now put the two halves side by side.

In comes 210 rupees from the borrower. Out goes 204 rupees to the depositor. The bank is left with 6 rupees, and that is how a bank makes money: not by charging either person something hidden, but by the gap between two openly stated rates.

Why the gap is not a trick

It is worth being fair to the bank here.

The bank, not Anand, has to find Shreya and judge whether she will repay. If she does not, Anand still gets his 204. The 6 rupees pays for that work and that risk.

Money that is never lent

One line in the chapter prevents a serious misunderstanding.

Banks keep reserve money. They do not lend out all of the deposits they hold, whether to individuals or to businesses. Some has to stay, because depositors turn up wanting their own money.

India before 2014

All of this assumes you have an account. For most Indians, not very long ago, that assumption was wrong.

Only 15 crore Indians held a bank account before 2014. Most people relied on cash instead, which means most people were outside everything this chapter describes.

What the Jan Dhan Yojana set out to do

The Pradhan Mantri Jan Dhan Yojana was launched in 2014, and its aim was stated plainly.

Every Indian was to have access to a bank account, and low-income earners especially. No minimum balance would be required, and no fees.

Why those two conditions mattered

Those two words, balance and fees, are the whole design.

A minimum balance is impossible for somebody with nothing spare, and a fee makes a small account cost more than it holds. Remove both and an account becomes possible for a person with very little.

What actually happened

The result is one of the larger numbers in this book.

Over 50 crore accounts have been opened since, and women opened most of them. People from every walk of life now use banking services.

Three people, three uses

The chapter gives three examples of what an account makes possible, and they are three different kinds of person.

A farmer borrows money, either to start a small business or to expand his agricultural activities. A worker receives wages straight into the account. A student who does well academically receives a scholarship from an institution into the account.

Why direct is better

That word straight, or directly, is doing something important in all three cases.

Such direct transfers have reduced middlemen, and they ensure that funds are disbursed on time. Money that passes through fewer hands arrives sooner, and arrives whole.

What the two halves add up to

Step back and the shape of the topic is simple.

A bank gathers small savings and lends them out in useful lumps, paying less than it charges and keeping the difference. An account is what lets a person join that arrangement, which is why opening 50 crore of them changed the country rather than just the banks.

Scenario:

In 2013 a fieldworker visits a village and finds nobody with a bank account. A woman who sells vegetables keeps her takings knotted in a cloth. A labourer is paid in cash by a contractor who deducts an unexplained share every month. A girl has won a state scholarship but the money has not arrived, and the office says it was sent to somebody who was to pass it on. The fieldworker returns in 2020 and all three have accounts.

Analysis:

Three villagers without accounts in 2013, and with accounts by 2020.

Activity:

Ask at home whether any payment comes directly into an account.

Title:

Be the bank for a day

Safety:

Use paper amounts only; do not use real money for this.

What You Notice:

Whatever rates you chose, the number you kept equals the gap between them applied to the same sum. With 200 rupees at 2 and 5 per cent the chapter gets 6 rupees, and your own figures will behave the same way.

The 50 crore Jan Dhan accounts were opened mainly by women.

A bank never lends out everything it holds; some is reserve money.

Before 2014 most Indians dealt only in cash.

Pay two, charge five, keep six.

No minimum balance, no fees, fifty crore accounts.

Not only banks

Banks are the obvious part of the financial system. They are not the whole of it.

Apart from them, the post offices of India offer a variety of financial services, and savings schemes are among the most used of those.

Three schemes at the post office

The chapter names three by name, and the names are worth knowing.

Sukanya Samriddhi accounts. Kisan Vikas Patra accounts. And National Savings Certificates, which you will see written as NSC.

Why a post office, of all places

There is a good reason the post office matters here, and it has nothing to do with the schemes themselves.

Its network is vast, and its presence reaches even remote locations. Being there at all is what makes it a popular savings option, in places where a bank branch may not exist.

Institutions for one sector

Other financial institutions exist to support particular sectors rather than the public at large.

Take the Industrial Finance Corporation of India. It funds businesses in areas such as textiles, and such as power.

A bank that funds banks

The second example is more unusual, because of who it lends to.

NABARD is the National Bank for Agriculture and Rural Development, and it backs rural development by funding banks. Those banks then give out the loans.

What NABARD money is for

Three purposes, and one of them connects this chapter to the last one.

Loans for infrastructure such as irrigation and roads. Loans for village industries. And loans for farming.

Who makes the rules

With so many banks and financial institutions about, clear rules that everyone follows are essential. So somebody has to set them.

The Reserve Bank of India is the supervisor of the whole Indian banking system, and it is also called the central bank of India.

Central banks elsewhere

India is not unusual in having one.

Several countries have central banks of their own, which supervise their banking systems and manage the policies that go with them.

Two dates that matter

The RBI has two beginnings rather than one, and both are worth keeping.

Established in 1935, it then carried out part of the work of a central bank. After Independence it passed to the Government of India, and from 1949 it has functioned as the central bank, the banker of banks.

Banker to the banks

That phrase, banker of banks, is exact rather than poetic.

Accounts of other banks are maintained by the RBI, and the exchange of funds between those banks is something it facilitates. It also provides loans, both to the banks and to the government.

The two rules it sets

The chapter lists two kinds of rule the RBI makes, and the first you handle every day.

Fixing of the benchmark interest rates is one. Printing and distributing Indian currency, such as banknotes, is the other.

What a benchmark rate is

The margin defines it, and the word base is the one to hold on to.

The benchmark interest rate is the base rate the RBI fixes for its own lending to commercial banks. Every other rate in the country takes its cue from that one.

Two statues at a gate

Walk up to the RBI office in Delhi and a pair of statues flanks the way in: a yaksha, and a yakshini.

In Hindu mythology the yakshas are a class of demigods, and their work is to guard the treasures of Kubera, who is the God of Wealth.

Why those statues are an argument

It would be easy to read the statues as decoration. The chapter reads them as a comparison.

Kubera is who the RBI could be compared to, since it holds the sole right of issuing currency and is banker to the banks. A guardian of treasure at the gate of a guardian of treasure.

Banks before there were banks

Now go back much further. In ancient India the institution that behaved like a bank was the temple.

There was one clear difference. Public deposits were not accepted by temples in the way a modern bank accepts them.

Who the temples lent to

What they did do was lend, and the list of borrowers is specific.

Money went to the local government, for building infrastructure. It went to merchants. And it went to artisans.

How we know any of this

Here is the part that makes it history rather than guesswork.

Contracts between a temple and the party concerned were etched onto copper plates, and those plates have survived. They give us a glimpse of how the arrangement worked.

One inscription, with interest

The chapter gives a single example, and it has everything in it.

There is an inscription found at Kodumbalur in Tamil Nadu which dates to the thirteenth century. It refers to communities who borrowed money from the Tirumudukunramudaiya-Nayanar temple. The agreement was that they would pay interest on it.

Scenario:

A district officer receives four requests in one week. A weaving unit wants funds to buy looms and expand. A village co-operative wants loans for irrigation channels and a village pottery. A woman in a hamlet forty kilometres from the nearest bank branch wants somewhere safe to save a little each month. And a commercial bank in the district town wants to know what rate it will have to pay if it borrows. Each request belongs to a different part of the financial system.

Analysis:

Four requests in one district, each needing a different institution.

Activity:

Find out whether your nearest post office runs a savings scheme.

Title:

Trace a rupee to its source

Safety:

No hazards here.

What You Notice:

The missing arrow is NABARD straight to the farmer: it funds banks, and the banks lend. The RBI is the box that never deals with you directly either, although it printed the note in your pocket and set the rate on your loan.

The RBI office in Delhi has a yaksha and a yakshini flanking its entrance.

NABARD lends to banks rather than to farmers directly.

Temple loan contracts were etched onto copper plates.

NSC, Kisan Vikas Patra, Sukanya Samriddhi.

1935 founded, 1949 banker of banks.

Modes, and systems

Another key part of the financial infrastructure is made up of payment modes and payment systems, and what they do is move money from one person to another.

Debit cards, cheques and cash are modes of payment. A payment system is something larger, and the Unified Payments Interface, UPI, is the one that has become popular for being quick and convenient.

Getting cash out, the old way

Before moving money anywhere, how do you get your own out? The chapter gives two methods, and the first needs a visit.

Fill out a withdrawal slip, submit it at the cash counter of the bank, and take the cash from your account.

The machine that never closes

The second method is the one you will have seen. A debit card is given to customers when an account is opened, and it draws cash from an Automated Teller Machine.

ATMs are self-service machines, mini-banks really, available 24 hours a day and seven days a week, at public places: malls, airports, railway stations, local shopping markets, bus depots.

Four steps, and a secret number

Using one is a fixed procedure.

The card goes in. The PIN is entered. The exact amount to be withdrawn is typed. The cash is collected. A PIN is a numeric code of four to six digits, usually, and it provides authentication and security in a financial transaction such as one at an ATM.

A piece of paper that pays

To send money rather than collect it, the older instrument is a cheque, which is a paper instrument letting you pay somebody directly from your account. The bank gives you a cheque book with several in it.

Say you owe Rohan 5,000 rupees. You write the exact amount, his name, and your signature. He deposits it at his own bank, the sum is debited from your account, and it is credited to his.

Why that is slow

Notice what the cheque route costs.

Somebody has to visit a bank physically, and the whole thing takes time. Electronic payment methods, by contrast, move money instantly from the account of the sender to the account of the receiver.

Cards in shops, and banking at home

Two electronic methods come first.

A debit card works in a chemist, a clothing store or a grocery, transferring money from the customer to the store owner. It is swiped or inserted into a POS machine, the amount is put in, the PIN is entered, and the sum leaves the account at once. Internet banking does a different job: through the website or mobile application of the bank, an account holder can transfer money, and check his balances and his transaction history.

What UPI replaced

The third electronic method needs its history first. Transferring funds used to mean filling in a cheque with the details of the receiver and then dropping it into the drop box of the bank, or handing it to an official.

It took time, and it discouraged most people from using banking services at all. Cash was relied on heavily instead, and every day billions of rupees changed hands with no record kept of them.

The year it changed

In 2016 the National Payments Corporation of India launched UPI, which is a digital payment system that is fast and secure.

Digital payment applications such as BHIM, which stands for Bharat Interface for Money, are built on it. A transfer needs only a QR code, or else the phone number of whoever is being paid.

One payment, five steps

Follow a real one. Kumar is buying vegetables from Piyush.

He scans the QR code of Piyush on a payment application, enters the amount and then his UPI PIN. A payment request then goes from the application to his bank. His bank forwards that request to the NPCI. The NPCI decrypts it, verifies the UPI PIN and processes the transfer. The bank of Piyush receives the funds, and Piyush has his payment.

India's gift to the world

The system has not stayed inside the country.

Nepal was the first to adopt UPI, in 2022. Mauritius, Bhutan, Sri Lanka, France and the United Arab Emirates have since adopted it too, and more countries keep showing interest.

A market for pieces of companies

Now the third part of the financial infrastructure. Picture a giant online book store, except that shares rather than books are bought and sold.

Suppose your small restaurant needs expanding and you lack the money. Friends lend it in exchange for a share of the profits, and that makes them part-owners.

What a share is

The same idea, done formally.

A share is one unit of the ownership of a company, standing for a portion of its capital stock, so buying one makes you a part-owner. Own more and you own more of it. If the company is a big chapati, one share is one piece, and a collection of shares is called a stock.

Where it happens, and since when

Shares are actually bought and sold at a stock exchange, which is the marketplace where financial securities such as stocks are traded.

In India the Bombay Stock Exchange dates from 1875, and few exchanges in the world are older. Paper tickets were used for share transactions then, and digital transactions on advanced computers have replaced them.

Crash, and boom

Share prices rise and fall like any other prices, and the chapter names both extremes.

A stock market crash is what results when many companies see their share prices fall together. A rise across many companies leads instead to a stock market boom.

Why a price moves

Trading shares can bring gains, and it can bring losses, because many things move a price.

A company that is doing well, and that people expect to earn, has shares which become more valuable. If it has a big loss, a workers strike or a bad product, fewer people want them and the price drops. Beyond the company itself come economic shocks, wars, political instability, tax rules and new laws.

The cost of making payment easy

Digital payments have made life easier. The chapter ends by warning that users must beware of scams and fraud.

Fraudsters use fake calls or messages. They trick people into downloading harmful apps, or mislead them into sharing OTPs or bank details. That gives access to the phone or computer, which lets them steal personal data from the device and drain the money from an account.

What an OTP is, and the three rules

An OTP is a One-Time Password: a unique temporary code of letters or numbers, used to verify identity or authorise a transaction. Which is exactly why it is worth stealing.

Three rules follow. Do not keep sensitive banking information such as card PINs or account passwords on your devices. Do not click unknown links or videos arriving in messages. And never give a stranger your OTPs, passwords, home address, account number or phone number. If fraud happens, report it on helpline 1930, or at the National Cybercrime Reporting Portal.

Scenario:

A shopkeeper makes four payments before noon. She hands cash to a delivery boy. She writes a cheque for 5,000 rupees to a wholesaler in the next district. She pays her electricity bill on her bank mobile application. And she scans a QR code to pay a vegetable vendor. At noon a caller says he is from her bank. Her account will be blocked within the hour, he tells her. She must read out to him the code that has just been sent to her own phone by a message.

Analysis:

Four payments by four different methods, and then a caller asking for a code.

Activity:

Find out which payment methods your family uses most, and why.

Title:

A week of payments, counted

Safety:

Record only the method used, never an amount or an account number.

What You Notice:

The app column usually wins now, and the last line is the interesting one: before 2014 only 15 crore Indians had accounts at all, and UPI did not exist until 2016, so the same week would have been almost entirely cash.

The Bombay Stock Exchange of 1875 is one of the oldest in the world.

Nepal was the first country to adopt UPI, in 2022.

Share transactions were once done on paper tickets.

Card in, PIN, amount, cash out.

Scan, amount, UPI PIN: then the banks and the NPCI do the rest.