UNIT :7 MONEY AND BANKING (8 MARKS)

Money :- It is anything which is generally acceptable as a medium of exchange and at the same time acts as a measure of value, store of value and means of deferred payments. Functions of Money (1) Medium of Exchange :- It is generally accepted means of payment for exchange of goods and services. - Facilitates trade, widens area of market by separating act of sale and purchase. - Reduces time and labour needed for trade in case of using goods for trade (Barter System). (2) Measure of Value or Unit of Value :- All goods and services can be given one unique value (Price) by expressing them in terms of money. -It is common unit of measurement of all goods. Thus makes exchange easier. -Helps developing efficient accounting system. Goods and services can be accounted for easily in terms of rupees. It would have been difficult to make account in many units like litres, quintals, meters etc. and adding up different units is not possible. -Comparisons can be made. -Its value remains constant. 3. Store of Value -It is liquid store of value. -It comes in convenient denominations. -Value remains constant, its not perishable easily portable, requires less place to store & there is no storage cost. 4.Standard of deferred Payments -Or future payments like salaries, pension, interest etc. -Facilitates borrowing and lending. -It led to creation of financial institutions as it overcomes disagreements and risks that are there is barter system regarding future payments to be made as value of money reaming constant.

FUCNTIONS OF CENTRAL BANK

1) Currency Aut !r"ty:- The central Bank is the sole authority for the issue of currency in the country. All the currency issued by the central bank is its monetary liability. This means that the central bank is obliged to back the currency with assets of equal value. ) B#n$er t! t e %!&ern'ent:- The central bank acts as a banker acts as a banker to the government both central as well as state governments. !t carries out all the banking business of the government and the government kee"s its cash balances on current account with the central bank. #) B#n$er( )#n$ #n* (u+er&"(!r :- As the banker to banks$ the central bank holds a "art of the cash reserves of banks$ lends them short term

funds and "rovides them with centrali%ed clearing and remittance facilities. &) C!ntr!,,er !- M!ney Su++,y #n* Cre*"t :- The central bank controls the money su""ly and credit in the best interests of the economy by various instruments as quantitative and qualitative instruments. .u#nt"t#t"&e In(tru'ent:/ A)B#n$ R#te 0!,"cy:/ The bank rate is the rate at which the central Bank lends funds as a lender of last resort to banks against a""roved securities or eligible bills of e'change. B) O+en M#r$et O+er#t"!n(: ("en market o"erations is the buying and selling of government securities by the central bank from to the "ublic and banks on its own account. The sale of government securities to banks have the effect of reducing their reserves. C) 1#ry"n% Re(er&e Re2u"re'ent( (Le%#, Re(er&e R#t"!): Banks are obliged to maintain reserves with the central bank on two accounts. (ne is the c#( re(er&e r#t"! and the other is (t#tut!ry ,"2u"*"ty R#t"!. )*+ is the fraction of legal reserves$ the banks are required to kee" as cash within the bank itself. The ,++ is the ratio the banks are required to kee" with ,entral bank. -arying ,++ and )*+ are tools of monetary and credit control. II) .u#,"t#t"&e Cre*"t C!ntr!,3 A) !m"osing margin requirement on secured loans: A margin is the difference between the amount of the loan and market value of the security offered by the borrower against the loan. The advantages of this instrument are manifold.

B) M!r#, (u#("!n: This is a combination of "ersuasion and "ressure that the ,entral Bank a""lies on the other banks in order to get them to fall in line with its "olicy. ,) Se,ect"&e cre*"t c!ntr!,(: These can be a""lied in both a "ositive as well as a negative manner.

Quantitative credit control measures used by RBI are :1. Cash Reserve Ratio (CRR) :- It is of certain ratio of commercial banks net demand deposits & times liabilities which it has to keep with central bank RBI as cash. If RBI increases CRR, Banks have to keep larger percentage of their deposits with RBI, their credit giving ability decreases and money supply decreases. Similarly if RBI decreases CRR ,money supply increases, 2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total demand & time liabilities of commercial banks which they have to keep in form of liquid assets as excess reserves, they have to invest in government securities or in securities approved by RBI and current account balances with other banks. If RBI increases SLR then credit giving ability of bank decreases and money supply decreases. If RBI decreases SLR banks credit giving ability and thus money supply increases. 3. Open Market Operations (OMO) :- It is the buying and selling of government security by the Central Bank from/to the public and banks on its own account. Sale of government securities will reduce reserves. * RBI sells securities Bank gives RBI a cheque for the securities. * The RBI collects the amount by reducing the banks reserves by the particular amount. * This directly reduces banks ability to give credit. * Therefore this decreases money supply in the economy. When RBI buys securities from banks * RBI gives the bank a cheque drawn on itself in the payment for the securities. * When cheque clears, RBI increases reserves of the bank by the particular amount. * This directly increases the banks ability to give credit. * Thus money supply increases. 4. Bank Rate Policy Bank rate is the rate at which Central Bank lends funds to commercial banks. If bank rate increases: * Cost of borrowng from RBI increases. * So banks borrow less * Their credit giving ability decreases. * Banks also increase lending rates i.e. rate at which they lend to public. * This discourage businessmen from taking loans. This reduces volume of credit and money supply. A decrease in bank rates on the other hand will increase credit and money supply. Measure of Money Supply are :M1 is most liquid measure of money supply M1 = C + DD + OD C = Currency held by public (currency & coins). Demand Deposits (DD) :- Only net demand deposits of banks are included in money supply, as other part of demand deposit that represents inter-bank deposits held by

one bank with another does not constitute demand deposit held by public. Other Deposit (OD) with RBI :- These are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of public financial institution (like IDBI) foreign central banks, foreign government, the IMF, the World Bank etc.

4 '#r$ 2ue(t"!n(3 435 #t "( )#rter (y(te'6 Barter refers to goods were e'changed for goods. 73 5 #t "( '!ney6 .oney is anything that is generally acce"ted as medium of e'change. 83 9 #t #re +r"'#ry -unct"!n( !- '!ney6 .edium of e'change measure of value. :3 9 #t #re (ec!n*#ry -unct"!n( !- '!ney6 )tandard of deferred of "ayments and store of value. ;3 De-"ne '!ney (u++,y6 .oney su""ly means the total stock of money held by "ublic in s"endable form. <3 I( '!ney (u++,y # (t!c$ !r -,!56 .oney su""ly is a stock because it is measured at a "oint of time. 73 De-"ne '!ney cre#t"!n6 .oney creation is the "rocess of credit creation by banks through derivative de"osits. 83 De-"ne centr#, B#n$6 ,entral bank is an a"e' institution that controls monetary and banking structure of the country. /. De-"ne C#( Re(er&e R#t"!3 !t is the ratio of bank de"osits that commercial banks must kee" with the central bank3 4=3 De-"ne B#n$ R#te3 The bank rate is the rate at which the central bank lends funds to banks against a""roved securities or bills of e'change. 443 9 #t "( 'e#nt )y (t#tut!ry ,"2u"*"ty r#t"!6 !t is the ratio of total demand and time de"osits of commercial banks which it has to kee" in the form of s"ecified liquid assets. 473 9 #t 5",, )e t e e--ect !- # r"(e "n )#n$ r#te !n '!ney (u++,y6 .oney su""ly will fall 8 > : '#r$ 2ue(t"!n( 1. )tate two "roblems of barter system of e'change. 0ow does money solve them1 i) L#c$ !- c!''!n 'e#(ure !- &#,ue: Absence of common measure of value in barter system creates great "roblem because a lot of time is wasted to bargain between buyer and seller of different commodities. .oney "rovides a common denomination to all the goods and services by which e'change become convenient. ii) L#c$ !- *!u),e c!/"nc"*ence !- 5#nt(: 2ouble coincidence wants means that two "ersons who want to e'change two goods between each other$ must be in need of each other. But it difficult to find such "erson under barter system. .oney solves this "roblems by medium of e'change act. 73 Ment"!n -!ur -unct"!n( !- '!ney3 E?+,#"n #ny t5!3 1. .edium of e'change . 3nit of value. #. )tandard of deferred "ayment. &. )tore of value

i)
ii)

4'"lain any two Me*"u' !- e?c #n%e: - It is generally accepted means of payment for exchange of

goods and services. Unit of value: - All goods and services can be given one unique value (Price) by expressing them in terms of money. It is common unit of measurement of all goods iii) St#n*#r* !- *e-erre* +#y'ent: Deferred payments means those payments which are to be made in future. Money not only acts as a medium of exchange for current transactions but also future payments like salaries, pension, interest etc, iv) Store of value: Value remains constant, its not perishable easily portable, requires less place to store & there-It is liquid store of value. It is no storage cost. 3. Explain the M1 components of money supply. M1 = C + DD + OD C = Currency held by public (currency & coins). Demand Deposits (DD) :- Only net demand deposits of banks are included in money supply, as other part of demand deposit that represents inter-bank deposits held by one bank with another does not constitute demand deposit held by public. Other Deposit (OD) with RBI :- These are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of public financial institution (like IDBI) foreign central banks, foreign government, the IMF, the World Bank etc. 4. Explain the banker to government function of the central bank. The central bank acts as a banker, agent and financial adviser to the government. As a banker: It maintains the accounts of the central as well as state governments. It receives deposits from government and make shot term advances to the government. As a fiscal agent: The central bank collects taxes and other payments on behalf of the government. As a Financial adviser: The central bank gives advice to the government on economic, monetary, financial and fiscal matters such as deficit financing, foreign exchange etc,. 6 mark question. 1. Explain the quantitative methods to control credit adopted by central bank? 1. Cash Reserve Ratio (CRR) :- It is a certain ratio of commercial banks net demand deposits & times liabilities which it has to keep with central bank RBI as cash. If RBI increases CRR, Banks have to keep larger percentage of their deposits with RBI, their credit giving ability decreases and money supply decreases. Similarly if RBI decreases CRR ,money supply increases, 2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total demand & time liabilities of commercial banks which they have to keep in form of liquid assets as excess reserves. 3. Open Market Operations (OMO) :- It is the buying and selling of government security by the Central Bank from/to the public and banks on its own account. Sale of government securities will reduce reserves. When it wants to expand credit, these securities are bought from the market. 4. Bank Rate Policy Bank rate is the rate at which Central Bank lends funds to commercial banks. If bank wants to expand credit, it reduces bank rate and for contracting credit, this rate is increased.

5re"ared by 5.+amesh 6umar 57T 84,() 9:- 3:A 80.5)