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Banks and the Magic of Finance Class 7 Social Science Notes

Introduction

While physical infrastructure like roads and railways helps move people and goods, financial infrastructure is the network that helps move money. It is made up of banks, payment systems, stock markets, and other financial institutions. This system allows people, businesses, and the government to carry out financial transactions and manage their money, which is essential for funding everything from daily purchases to the construction of large infrastructure projects.

What are banks and what do they do?

A Bank is a financial institution that collects money from people as deposits and lends that money to others as loans. Banks make it easier for everyone—from farmers and shopkeepers to large businesses—to save, withdraw, and borrow money. To use these services, a person or business must first open a bank account.

Hold deposits

One of the main functions of a bank is to accept and safely hold money, or deposits, in a bank account. Banks not only keep this money safe but also pay account holders interest, which is extra money that helps savings grow over time. This encourages people to save.

There are different types of bank accounts to suit different needs:

Savings account: This is for individuals who want to save money regularly. The bank pays interest on the saved amount, but there may be limits on how many times you can withdraw money each month.
Current account: This account is designed for businesses and traders who make frequent transactions. It usually does not earn interest, but there are no limits on deposits or withdrawals.
Fixed deposit account: This involves depositing a sum of money for a fixed period (e.g., 3 or 5 years). In return, the bank pays a higher rate of interest compared to a savings account. The money can only be withdrawn after the fixed period ends.

The Magic of Compounding

When you save money in a bank, it grows not just because of the interest you earn on your original deposit, but also because you start earning interest on the interest itself. This is called compounding.

Example

Imagine you deposit ₹1,000 in a bank that pays 6% interest per year.

After one year, you earn ₹60 in interest (6% of ₹1,000), so you have ₹1,060.
In the second year, you earn interest on the new total of ₹1,060. The interest will be ₹63.60 (6% of ₹1,060). Your new total becomes ₹1,123.60.

As you can see, you earned more interest in the second year than the first. Over a long period, this "magic of compounding" can make a small amount of savings grow into a very large sum. The story of the king and the sage with rice on a chessboard illustrates this power of exponential growth.

Note

To keep track of all transactions, banks provide a passbook. This is a small booklet that records all your deposits (credit) and withdrawals (debit), helping you see how your money is moving.

Offer loans or credit

The second major function of banks is to provide loans or credit. A loan is an amount of money borrowed from a bank that must be repaid over time with interest.

Individuals might take loans to buy a house, a car, or fund their education.
Businesses borrow money to buy new machinery, raw materials, or launch new products.

Just as banks pay interest to savers, they charge interest to borrowers.

How Banks Earn Money

Banks make a profit from the difference between the interest they pay on deposits and the interest they charge on loans. They always charge a higher interest rate on loans than they pay on savings.

Example

Anand deposits ₹200 in a bank and earns 2% interest. The bank then lends that ₹200 to Shreya and charges her 5% interest.

The bank pays Anand ₹4 in interest (2% of ₹200).
The bank receives ₹10 in interest from Shreya (5% of ₹200).
The bank's income from this transaction is the difference: ₹10 - ₹4 = ₹6.

How the Jan Dhan Yojana revolutionised banking in India

Before 2014, many Indians, especially those with low incomes, did not have bank accounts and relied entirely on cash. The Pradhan Mantri Jan Dhan Yojana, launched in 2014, aimed to change this by allowing every Indian to open a bank account with no minimum balance requirement.

Since its launch, over 50 crore new accounts have been opened, mostly by women. This has brought banking services to people from all walks of life. Now, workers can receive wages directly in their accounts, and students can get scholarships without middlemen. This has made the distribution of funds faster and more transparent.

Other Financial Institutions

Besides banks, other institutions also provide financial services:

Indian Post Offices: Offer various savings schemes like National Savings Certificates (NSC) and are accessible even in remote areas.
Industrial Finance Corporation of India (IFCI): Funds large businesses in sectors like power and textiles.
National Bank for Agriculture and Rural Development (NABARD): Supports rural development by funding banks that provide loans for farming, village industries, and rural infrastructure.

Reserve Bank of India - Banker to Banks

The Reserve Bank of India (RBI) is India's central bank. It acts as the supervisor of the entire Indian banking system, setting the rules that all other banks must follow.

Established in 1935, the RBI was transferred to the Government of India after Independence and has been functioning as the central bank since 1949.

Key functions of the RBI include:

Printing and distributing Indian currency (banknotes).
Setting the benchmark interest rate, which is the base rate at which it lends money to other banks. This influences the loan and savings rates for all citizens.
Maintaining the accounts of other banks and providing them with loans when needed.

Payment Modes and Systems

Payment systems are a key part of the financial infrastructure that helps transfer money between people. There are several ways to access and move money.

How to Withdraw Cash

Withdrawal Slip: You can fill out a form at the bank and present it at the counter to withdraw cash from your account.
Debit Cards and ATMs: Banks issue debit cards to account holders. These cards can be used at Automated Teller Machines (ATMs), which are like mini-banks available 24/7. To withdraw cash, you insert your card, enter your secret PIN (Personal Identification Number), and select the amount you need.

How to Transfer Money Between Accounts

Cheque: A cheque is a written order to your bank to pay a specific amount of money from your account to another person. This method requires a physical visit to the bank and can take time to process.
Debit cards and Point of Sale (POS) machines: When you shop at a store, you can use your debit card at a POS machine. You swipe or insert the card, enter your PIN, and the money is instantly transferred from your account to the store owner's account.
Internet Banking (Netbanking): This allows you to manage your account online through the bank's website or mobile app. You can check your balance, view transactions, and transfer money to others from your computer or smartphone.
Mobile Payments: Digital payment apps on mobile phones have made transactions very easy. Many of these apps use the Unified Payments Interface (UPI) system.

Unified Payments Interface (UPI) - India's gift to the world of payment systems

Launched in 2016 by the National Payments Corporation of India (NPCI), UPI is a digital payment system that allows for instant, fast, and secure money transfers. It replaced the slow, paper-based process of using cheques and reduced the reliance on cash.

With UPI, you can send or receive money using just a phone number or by scanning a QR code. It became extremely popular during the COVID-19 pandemic for enabling contactless payments. Today, UPI is so successful that other countries like France, Sri Lanka, and the UAE have started adopting it.

Stock Market

The stock market is a place where people buy and sell shares of companies. A share represents a small piece of ownership in a company. When you buy a share, you become a part-owner of that company. A collection of shares is often called a stock.

Why do companies issue shares? To raise money for their operations and expansion.
Why do people buy shares? As an investment, hoping that the company will do well and the value of their shares will increase over time.

The buying and selling of shares happens at a stock exchange. India's Bombay Stock Exchange (BSE), established in 1875, is one of the oldest in the world. Today, these transactions are done digitally.

Share prices can rise and fall based on many factors.

A stock market boom happens when the share prices of many companies rise.
A stock market crash occurs when the prices of many companies fall suddenly.

Factors that cause prices to fluctuate include:

Company Performance: If a company is profitable, more people will want to buy its shares, and the price will go up. If it faces losses or problems, the price will fall.
Economic Factors: Government policy changes, new tax rules, political instability, wars, or economic shocks (sudden events like a pandemic or natural disaster) can all affect share prices.

Financial frauds and how to prevent them

While digital payments are convenient, they also come with risks. Fraudsters may try to trick you into sharing your personal bank details or One-Time Passwords (OTPs) through fake calls or messages.