Money & Banking

Money; meaning, functions, supply of money

Banking; meaning, functions of commercial bank,
central bank and its function, concepts- CRR, Bank
rate, Repo rate, reverse repo rate.
Monetary policy and fiscal policy---its objectives &tools

Money
Can todays world be imagined
without money..
Barter system??????
Drawback: lack of double
coincidence of wants, indivisible
goods, problem of store of value, no
common measure of value, deferred
payments not possible

Journey of Money
From barter system till date the forms of
money has passed through a long journey
in the course of economic evolution
Commodities and animals
Metal money
Paper money
Credit money
Plastic / electronic money

Definitions of money
Money is what money doesits meaning
is actually derived from the functions it
performs
Generally it is defined as anything which is
readily accepted as a medium of exchange
As financial systems, practices and
institutions vary from economy to
economy so its difficult to have a universal
definition of money

What is a good money

Acceptability
Durability
Portability
Divisibility
Scarcity

 Notes, coins, bank cheque, debit cards,

bank deposit transfers, credit cards,
..
More the complex financial system.. Harder
to define money
Narrow money (M1): note, coins, highly
liquid deposits
Broad money(M3): narrow money plus
entire range of liquid assets that can be
used to make purchases

Functions of money

Medium of exchange
Measure of value
Means of deferred payments
Store of value

Importance
Facilitates exchange
Facilitates division of labour and so
trade
Promotes savings
Maximization of satisfaction of
consumers and producers
Helps in proper governance and
reviving the economy from recession
and depression

Supply of Money
Role of money is just not limited to the
functions as a medium of exchange but its
quantity today has a direct effect on general
price level and interest rates;
Supply of money means the stock of money
that is available to the people for the purpose
of buying goods and services or any economic
activity in the country
In short notes and coins circulating in our
economy and deposits with banks make up the
money supply

Money supply and its

measures
Four measures of money supplied are available
based on their functions. This facilitates
prediction on the effect on the economy due to
changes in these measures.
Also single measure of money supply is
inadequate to depend on for monetary analysis
and policy formulations
Since April 1977 RBI like other developed
economies has adopted four concepts of
money supply for analysis of its quantum &
variation

Measures of money supply

in India
M1 ( Narrow money): Its highly liquid
C+DD+OD
where C- currency with public
DD- demand deposit with
public in commercial and cooperative
banks
OD- other deposits held by
public with RBI.( its less that even 1
percent)

 M2. Its broader concept than M1

M2= M1+ savings deposit with
Post office savings bank
savings deposit with post are less
liquid that demand deposit as not
chequable but more liquid than time
deposit

 M3: (Broad money). It is also termed

as Aggregate Monetary Resources
(AMR) and is used used by RBI to
analyse growth of money supply
M3= M1+ time deposit with the
banks
Though it was considered that time
deposits to be not liquid, recently
credits are created against the
deposits easily

 M4: M3+ total deposits with post

office savings organization

Money measures of different nations

U. S. Federal Reserve
M1: notes & coins in
circulation + travelers
cheques of non-bank
issuress+ demand deposits
with banks and other
deposits on which cheques
can be drewn
M2: M1+ savings and
money market deposit, time
deposits less than 1 lakh$,
balance in retail money
market and mutual funds

European Central
Bank
M1: notes, coins &
demand deposits
M2: M1+deposits
redeemable with
notice upto 3 month,
deposit with maturity
upto 2 years
M3: M2+ money
market fund units,
dept security up to
two years of maturity

Bank of Japan
M1: currency in circulation
M2: M1+ certificate of
deposits
M3: M2+ deposits held
with post office, saving
and deposits with financial
institutions
A broad measure of
liquidity includes M3 + all
other liquid assets, govt.
bonds, commercial papers

Banking
A bank is a business organization involved in the
function of accepting deposits and lending the
same for comparatively higher rate of interest.
This act of borrowing and lending creates a
special type of credit . The sole reason for the
existence of bank is credit, as bank borrows to
lend.
Banking plays a vital role in the economy by
transforming savings into investment which
helps in capital formation leading the economy
towards growth.

Types of banks

Commercial banks
Industrial banks
Savings banks
Co-operative banks
Central banks
World bank (IMF)

Functions of commercial
Banks
A) Accepting deposits:
Demand deposits or current accounts deposits
savings deposits
time deposits or fixed deposits
B) Advancing loans:
overdrafts
cash credits
demand loans
C) Discounting bills of exchanges
D) Transfer of money
E) Other miscellaneous functions

Importance of commercial
Banks

Promotes savings
Mobilization savings
Allocation of funds
Promotes production, investment and
trade

Credit creation by Banks

One of the most outstanding function of
commercial banks is credit creation
Given a particular amount of primary
deposits, the banks can create credits from
it many times .
This credits creation is affected by the cash
reserve ration that the bank has to
maintain.
Higher the CRR lower would be the banks
capacity to create credit and vise-visa

Central Bank
The monetary system of an economy
is controlled by its central bank.
It is the apex institutions in the
monetary system that regulate the
supply of money through the
functioning of the commercial banks
to promote economic stability and
development.

Functions of Central Bank

The central bank of India is the Reserve
Bank of India.
The main functions of the RBI are:
Issuing of currency notes
Banker to the banks
Banker to the government
Credit control
Manage exchange rates
Lender of the last resort

Some Important terms

CRR: commercial banks are required to maintain certain amount of their
time and demand liabilities as cash reserves with the central bank
SLR: apart from CRR, banks need to keep liquid assents in form of cash,
gold, approved securities not less than 25% of their demand and time
deposits
BANK RATES: It is the rate at which central bank of the country is willing
to discount first class bills of exchange or advance loans against
securities
REPO RATES: it refers to the transaction in which the participant
acquires funds immediately by selling securities at a rate and agrees to
purchase the same after a specific time at a specific rate
REVERSE REPO RATES: it is opposite of repo rate
Thus what is repo for one is the reverse repo for the other.
It can be inter bank repos or RBI repos. (** repos are higher than
reverse repo rates)