BANKING AND FINANCIAL INSTITUTIONS

Module 1: Introduction.
Money: Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given socio-economic context orcountry.[1][2][3] The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past, a standard of deferred payment.[4][5] Any kind of object or secure verifiable record that fulfills these functions can be considered money.

Functions of money 1. Medium of exchange When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the 'double coincidence of wants' problem. 2. Unit of account A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements that involve debt. To function as a 'unit of account', whatever is being used as money must be: Divisible into smaller units without loss of value; precious metals can be coined from bars, or melted down into bars again. Fungible: that is, one unit or piece must be perceived as equivalent to any other, which is why diamonds, works of art or real estate are not suitable as money. A specific weight, or measure, or size to be verifiably countable. For instance, coins are often milled with a reeded edge, so that any removal of material from the coin (lowering its commodity value) will be easy to detect. 3. Store of value To act as a store of value, a money must be able to be reliably saved, stored, and retrieved and be predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain stable over time. Some have argued that inflation, by reducing the value of money, diminishes the ability of the money to function as a store of value.[4] 4. Standard of deferred payment While standard of deferred payment is distinguished by some texts,[5] particularly older ones, other texts subsume this under other functions.[4][20][21] A "standard of deferred payment" is

an accepted way to settle a debt a unit in which debts are denominated, and the status of money as legal tender, in those jurisdictions which have this concept, states that it may function for the discharge of debts. When debts are denominated in money, the real value of debts may change due to inflation and deflation, and for sovereign and international debts via debasement and evaluation. 5. Measure of value Money acts as a standard measure and common denomination of trade. It is thus a basis for quoting and bargaining of prices. It is necessary for developing efficient accounting systems. But its most important usage is as a method for comparing the values of dissimilar objects. Process of Capital Formation The process of capital formation involves three steps. 1. Increase in Savings Power and will to save the power to save and the will to save. The power to save of the community depends upon the size of the average family and the standard of living of the people. Other things being equal if the income of the people increases or the size of the family is small or people get accustomed to a particular standard of living which does not lean towards conspicuous consumption, the power to save increases.

Perpetuation of income inequalities Perpetuation of income inequalities had been one of the major sources of capita formation in 18th century England and 20th Century Japans most communities. If there is unequal distribution of income the societys upper level incomes accrue to the businessmen, the traders and the landlords who save more and hence invest more on capital formation. Increasing Profits The essential point is that profits of business enterprises should increase because they know how to use them in productive investment. Prof. Lewis is of the view that the ratio of profits to national income should be increased by expanding the capitalist sector of the economy, by providing various incentives and protecting enterprises from foreign countries. Government Measures Similar to Private house holds and enterprises, the government also saves by adopting a number of fiscal and monetary measures. These measures may be in the form of a budgetary surplus through increase in taxation, reduction in government expenditure, expansion of the export sector, raising money by public loans, etc.

2. Mobilisation of Savings

The next step for capital formation is mobilisation of savings through banks, investment trusts, deposit societies, insurance companies and capital markets. The

kernel of Keynes theory is that decisions to save and decisions to invest are made largely by different people and for different reasons.

To bring the savers and investors mutually there must be well grown capital and money markets in the country. In order to mobilise savings, attention must be paid to the starting of investment trusts, life insurance, provident fund, banks, and cooperative societies. Such agencies will not only permit small amounts of savings to be handled and invested conveniently but will allow the owners of savings to retain liquidity individually but finance long-term investment collectively.

3. Investment of Savings

The third step for capital formation is the investment of savings in creating real assets. The profit making classes are an important source of capital formation in the agricultural sectors of a country. They have an aspiration for power and put aside in the form of distributed and undistributed profits and thus spend in productive enterprises. Further there must be a habitual supply of entrepreneurs who are competent, sincere and reliable. To execute his economic function, the entrepreneur entail two things, according to Prof. Schumpeter, first the existence of technical knowledge to produce new products, second, the power of disposal over the factors of production in the form of bank credit. Further, the social, political and economic conditions in the nation must be conducive for the emergence of a growing supply of entrepreneurs. Domestic sources for capital formation are essential to be appendage by peripheral sources. There are two motives for peripheral borrowing, according to Prof. A.J.Brown. One is that it may be the easiest way of getting hold of capital funds at all and the other that it may be the easiest way of getting foreign currency with which to buy imports which are needed for development.

What is the role of financial institutions in economic development? 1. Providing Funds The underdeveloped countries have low levels of capital formation. Due to low incomes, people are not able to save sufficient funds which are needed for sensing up new units and also for expansion diversification and modernization of existing units. The persons who have the capability of starting a business but does not have requisite help approach to financial institutions for help. These institutions help large number of persons for taking up some industrial activity. The addition of new industrial units and increasing the activities of existing units will certainly help in accelerating the pace of economic development. Financial institutions have large inventible funds which are used for productive purposes

2. Infrastructural Facilities Economic development of a country is linked to the availability of infrastructural facilities. There is a need for roads, water, sewage, communication facilities, electricity etc. Financial institutions prepare their investment policies by keeping national priorities in major and the institutions invest in those aim is which can help in increasing the development of the country. Indian industry and agriculture is facing acute shortage of electricity. All India institutions are giving priority to invest funds in projects generating electricity. These investments will certainly increase the availability of electricity. Small entrepreneurs cannot spare funds for creating infrastructural facilities. To overcome this problem, institutions at state level are developing industrial estates and provide sheds, having all facilities at easy installments. So financial institutions are helping in the creation of all those facilities which are essential for the development of a country 3. Promotional Activities An entrepreneur faces many problems while setting up a new unit. One has to undertake a feasibility report, prepare project report, complete registration formalities, seek approval from various agencies etc. All these things require time, money and energy. Some people are not able to undertake this exercise or some do not even take initiative. Financial institutions are the expense and manpower resources for undertaking the exercise of starting a new unit. So these institutions take up this work on behalf of entrepreneurs. Some units may be set up jointly with some financial institutions and in that case the formalities are completed collectively. Some units may not have come up had they not received promotional help from financial institutions. The promotional role of financial institutions is helpful in increasing the development of a country. 4. Development of Backward Areas Some areas remain neglected because facilities needed for setting up new units are not available here. The entrepreneurs set up new units at those places which are already developed. It causes imbalance in economic development of some areas. In order to help the development of backward areas, financial institutions provide special assistance to entrepreneurs for setting up new units in these areas. IDBI, IFCI, ICICI give priority in giving assistance to units set up in backward areas and even charge lower interest rates on lending. Such efforts certainly encourage entrepreneurs to set up new units in backward areas. The industrial units in these areas improve

basic amenities and create employment opportunities. These measures will certainly help in increasing the economic development of backward areas. 5. Planned Development Financial institutions help in planned development of the economy. Different institutions earmark their spheres of activities so that every business activity is helped. Some institutions like SIDBI, SFCIs especially help small scale sector while IFCI and SIDCs finance large scale sector or extend loans above a certain limit. Some institutions help different segments like foreign trade, tourism etc. In this way financial institutions devise their roles and help the development in their own way. Financial institutions also follow the development priorities set by central and state governments. They give preference to those industrial activities which have been specified in industrial policy statements and in five year plans. Financial institutions help in the overall development of the country 6. Accelerating Industrialization Economic development of a country is linked to the level of industrialization there. The setting up of more industrial units will generate direct and indirect employment, make available goods and services in the country and help in increasing the standard of living. Financial institutions provide requisite financial, managerial, technical help for setting up new units. In some areas private entrepreneurs do not want to risk their funds or gestation period His long but the industries are needed for the development of the area. Financial institutions provide sufficient funds for their development. Since 1947, financial institutions have played a key role in accelerating the pace of industrialization. The country has progressed in almost all areas of economic development. 7. Employment Generation Financial institutions have helped both direct and indirect employment generation. They have employed many persons to man their offices. Besides office staff, institutions need the services of experts which help them in finalizing lending proposals. These institutions help in creating employment by financing new and existing industrial units. They also help in creating employment opportunities in backward areas by encouraging the setting up of units in those areas, Thus financial institutions have helped in creating new and better job opportunities.

Module II: Banking System & Operations