Class 12 – ISC Economics Project 2

Page 1- Topic – Money and Banking

Page 2- Index/Content (Make a Table with 3 column -
Serial No , Topic , Page Number )
Divider Page – WRITE TOPIC - MONEY
Page 3- Introduction
Page 4- History of Money
Page 5- Functions of Money
Page 6 – Barter System and It’s Limitations
Page 7- Money Supply – Meaning and Measures in India
Divider Page – Write Topic – Banking
Page 8- Introduction –
Page 9 –Commercial Banks -Meaning and Functions
Page 10 – Credit Creation by Commercial Bank
Page 11- Central Bank – Meaning and Functions
Page 12- Conclusion –
Page 13- Bibliography
Page 3- INTRODUCTION
Money is any item or verifiable record that is generally accepted as payment for
goods and services and repayment of debts, such as taxes, in a particular
country or socio-economic context.
The concept money came into existence to overcome the drawbacks of the
barter system. Earlier, people use to exchange goods and services as a form of
commerce. This often led to many disadvantages, one of which was the double
coincidence of wants. To solve this problem, a standard medium of exchange,
money, was introduced.
There are three functions of money: Primary, secondary, and other functions.
The primary functions which distinguish money are: medium of exchange, a unit
of account, a store of value and sometimes, a standard of deferred payment.
The money supply of a country comprises all currency in circulation (banknotes
and coins currently issued) and, depending on the particular definition used, one
or more types of bank money (the balances held in checking accounts, savings
accounts, and other types of bank accounts). Bank money, whose value exists
on the books of financial institutions and can be converted into physical notes or
used for cashless payment, forms by far the largest part of broad money in
developed countries.

Page 4- History Of Money

Money has been part of human history for at least the past 5,000 years in
some form or another. Historians generally agree that a system
of bartering was likely used before this time. Bartering involves the direct
trade of goods and services. For instance, a farmer may exchange a bushel
of wheat for a pair of shoes from a shoemaker.
The world’s oldest known, securely dated coin minting site was located at
Guanzhuang in the Henan Province of China. The mint began striking spade
coins sometime around 640 BCE, likely the first standardized metal coinage.
The Chinese moved from coins to paper money around 700 CE. By the time
Marco Polo visited China in approximately 1271 CE, the emperor of China
had a good handle on both the money supply and its various denominations.
The history of money is still being written. The system of exchange has
moved from swapping animal skins to minting coins to printing paper money,
and today, we appear to be on the cusp of a massive shift to electronic
transactions. Ancient transaction forms have been co-opted: for example,
bartering still occurs on the margins in some markets such as the business-
to-business (B2B) space and some consumer services. The monetary
system will surely continue evolving as long as humans require a medium of
exchange.

Page 5- Functions of Money

Functions of money can be broadly categorized into two parts –
1. Primary functions of money
Primary functions can be further divided into two subcategories.
(i)Money as an Exchange Medium:
One of the primary functions of money is as a medium of exchange as it can
be used for any or all transactions wherein goods or services are purchased
or sold. Therefore, one can buy or sell products in exchange for money.
(ii)A measure of Value:
Money can be treated as the parameter of measuring the value of a product
or service. To put it simply, the value of every product or service can be
expressed in monetary form. The money also follows a standard and is
accepted worldwide even though the currency does differ from one country to
another.
For instance, the value of each product is determined in monetary terms. The
value of 1 egg is supposedly Rs.5 in India, and the value of a pack of bread
is around Rs.15. So, money is a measure of the value of all products (and
services) and is the amount that is required to be paid/received while
transacting. Therefore, it is one of the essential four functions of money.

2. Secondary Functions of Money –

The secondary function can be further segregated into three parts as
mentioned below –
(i) Store of Value -
Being crucial functions of money, it can be stored or conserved. One can
store it for future purposes, and it is economical as well as convenient to
store money.
(ii)Standard of Deferred Payments
Money can be used conveniently for deferred payments which need to be
paid by individuals. It has become the standard for payments made presently
or in the future. For instance, if someone borrows a certain amount from
another individual, they need to repay the amount with interest. With money
in purview, it is convenient to pay the interest or make deferred payments.
(iii) Transfer of Value
The utility of money stretches to the transfer of value as it can be used to
purchase goods not only within the country but beyond the domestic line.
One can sell or purchase goods in the domestic or international market with
money as a standard tool.

Page 6 – Barter System and It’s Limitations

A transaction system in which participants directly exchange goods or

services for other goods or services without using a medium of exchange,
such as money, is called a barter system. The Barter system is defined as a
system of exchange of goods and services without the participation of
money. In other words, it is a transaction of giving and receiving a product.
For example, if a farmer exchanges 5 kg of wheat for a pair of shoes, this
system of exchanging products without the use of money is called the barter
system of exchange.
LIMITATIONS OF BARTER SYSTEM

• Lack of Common Measure of Value: One of the disadvantages of the

Barter system is having no common unit to measure the worth of goods
and services. Hence, the problem arises with the proportion of goods to
be shared.
• Lack of Double Coincidence of Wants: It is unlikely that two people
want to exchange their products or services at the same time. If one
needs a product, it is possible that the other person might not have the
demand for the product offered in return.
• Problems in Storing Wealth: Unlike money, it is difficult to store goods
and services for a longer duration of time. Products must be consumed
within a specific time frame. Hence, there is difficulty in storing wealth
in the Barter system.
• Division of Certain Products is not possible: A trader cannot divide
certain goods such as shoes, animals, cupboards, etc in half. Therefore,
coming at a common rate of exchange becomes difficult.
• Lack of Specialization: In the Barter system, a high specialization is
difficult to achieve.
 • Difficulty in Making Future Payments: Having a debt contract for future
payments is difficult to make in the Barter System.

Page 7- Money Supply – Meaning and Measures

Money Supply can be defined as all the currency and other liquid instruments in an
economy of a country on the date measured. It includes both cash and deposits of
money present in an economy at a certain point in time. Money Supply is also
known as money stock. The bank regulators have an impact on the Money Supply
available to the public by imposing reserve requirements on the banks,
determining how to extend credit, and other money matters.

Money supply, a fundamental concept in macroeconomics and monetary policy,

plays a crucial role in shaping an economy’s financial landscape.

MEASUREMES OF MONEY SUPPLY

The measurement of the Money Supply is done with the help of Money
aggregates. The supply of money is measured by the Reserve Bank of India on a
weekly basis in India. There are three types of bank deposits – Current Account,
Fixed Deposit, and Recurring Deposit Account.

M1= C + DD + OD (Narrow Money)

• Where C= Currency held by the public

• DD= Demand Deposits with Banks
• OD= Other Deposits

The Demand Deposits (DD) can be withdrawn only on the demand of banks,
and Time Deposits (TD) can be withdrawn only after a specific period of time.

• Total Deposits= TD+DD

M1:Is the narrow money because it includes 100% liquid deposits. (Currency
with the public + Deposit money of the public)

M2: includes M1 and the saving account deposits with the post offices. M2=
M1+ Savings deposits with Post Office saving banks.

M3: Broad Money (M1+TD)

 M4: M3+ All deposits with post office savings banks (excluding National
Savings Certificates).

BANKING – (On divider page )

Page 8- Introduction
Banking is directly or indirectly connected with the trade of a country and the life
of each individual. It is an industry that manages credit, cash, and other financial
transactions. In banking, the commercial bank is the most influential institution for
any country’s economy or for providing any credit to its customers.

In India, a banking company is responsible for transacting all the business

transactions including withdrawal of cheques, payments, investments, etc. In
other words, the bank is involved in the deposit and withdrawal of money,
repayable on demand, savings, and earning a decent amount of profits by lending
money.

Banks also help to mobilise the savings of an individual, making funds accessible
to businesses and help them to start a new venture.

Types of Banking

Banks are further segregated into four types.

Commercial banks: These banks are regulated by Banking Regulation Act, 1949.
They accept the public deposit from the public for lending or investment.

Cooperative banks: Cooperative banks are undertaken by the State Cooperative

Societies Act and give cheap credit to their members. The rural population is
dependent on the cooperative banks for its financial backup.

Specialised banks: These banks provide financial help to special industries,

foreign trade, etc. Few examples of specialised banks are foreign exchange
banks, export and import banks, development banks, etc.

Central banks: These banks manage, check, and monitor all the activities of the
commercial banks of a country.
Page 9- Commercial Banks-Meaning and Functions
A commercial bank is a kind of financial institution that carries all the operations
related to deposit and withdrawal of money for the general public, providing loans
for investment, and other such activities. These banks are profit-making
institutions and do business only to make a profit.

The two primary characteristics of a commercial bank are lending and borrowing.
The bank receives the deposits and gives money to various projects to earn
interest (profit).

A) Primary Functions
Accepting Deposits and Advancing of Loans are the two primary functions
performed by commercial banks.
1. Accepting Deposits:
One of the most essential functions of commercial banks is accepting deposits.
Commercial banks accept deposits from their customers in different forms
based on the requirements of different sections of society. The main types of
deposits include:
• Demand Deposits or Current Account Deposits: The deposits which
are repayable on demand by the banks are known as demand
deposits or current account deposits. In general, these kinds of
deposits are maintained by businessmen to make transactions with
these deposits. One can get the amount deposited as demand
deposits by a cheque without any restriction. Besides, commercial
banks do not pay any interest to the depositors on these accounts;
 instead, they charge some amount as a service charge for running
these accounts.
• Fixed Deposits or Time Deposits: The deposits in which the
depositor, deposits money with the bank for a fixed time period are
known as fixed deposits or time deposits. These deposits do not
enjoy a cheque facility and carry a high interest rate.
• Saving Deposits: The deposits, which include combined features of
demand deposits and fixed deposits are known as saving deposits.
The depositors have the cheque facility to withdraw money from their
accounts, but there are some restrictions on the number and amount
of withdrawals. The restrictions are imposed to discourage the
frequent use of saving deposits. Besides, the interest rate on saving
deposits is less than the interest rate on fixed deposits.
2. Advancing of Loans:
The banks are not allowed to keep the amount deposited with them, idle.
Therefore, commercial banks have to keep some amount of the total deposits
as cash reserves and lend the rest of the balance to needy borrowers and
charge interest from them. The interest received by commercial banks from
advancing loans is the main source of their income. Some of the different types
of loans and advances made by commercial banks are:
• Cash Credit: The loan given to the borrowers against their current
assets like stocks, bonds, shares, etc., is known as cash credit. For
this, a credit limit is sanctioned to the borrower, and money is
credited to this account. The borrower can now withdraw any amount
at any time within his credit limit. Interest is charged from the
borrower on the amount actually withdrawn by him.
• Demand Loans: The loans given by the banks which they can recall
at any time on demand are known as demand loans. The entire
amount of the demand loan is credited to the borrower’s account, and
interest is charged on that amount.
• Short-term Loans: Personal loans given to borrowers against some
collateral security are known as short-term loans. The amount taken
as a loan is credited to the account of the borrower, and he can
withdraw that money from his account. Interest is charged on the
entire sum of the loan granted.
B) Secondary Functions
Besides primary functions, commercial banks also perform some secondary
functions.
1. Overdraft Facility:
A facility that allows the customer to overdraw from the amount of his current
account upto an agreed limit is known as an overdraft facility. In general, an
overdraft facility is given to respectable and reliable customers for a short
period. Besides, the customers have to pay interest on the amount overdrawn
by them.
2. Discounting Bills of Exchange:
A facility in which the holder of a bill of exchange, before its maturity date can
get the bill discounted with the bank. The bank pays the amount to the holder
after deducting some amount as commission. Now, on the date of maturity, the
party which has accepted the bill pays back the money to the bank.
3. Agency Functions:
There are some agency functions performed by commercial banks for which
they charge some commission from their clients. Some of these functions are:
• Transfer of Funds: With the help of instruments like mail transfers,
demand drafts, etc., commercial banks provide their customers with
the facility of easy and economical remittance of funds from one
place to another.
• Collection and Payment of Various Items: Commercial banks
provide their customers with the service of collecting bills, interest,
subscriptions, rents, and other periodical receipts on their behalf.
They also make payments for insurance premiums, taxes, etc., on
their customer’s standing instructions.
• Purchase and Sale of Foreign Exchange: The central bank gives
authority to commercial banks to deal in foreign exchange.
Commercial banks, on the behalf of their customers, buy and sell
foreign exchange and also helps in promoting international trade.
• Purchase and Sale of the Securities: Commercial banks on behalf of
their customers, purchase and sell government securities and stocks
and shares of private companies.
• Income Tax Consultancy: Commercial banks provide advice to their
customers related to income tax. They also help them in the
preparation of their income tax returns.
 • Trustee and Executor: Commercial banks play the role of a trustee
and preserve the will of their customers and as an executor, execute
the will after their death.
• Letters of Reference: Commercial banks provide information about
the economic position of their customers to the traders and vice-
versa.
4. General Utility Functions:
Some of the general utility functions performed by commercial banks are:
• Locker Facility: Commercial banks provide their customers with the
facility of lockers or safety vaults so they can keep their valuable
things in safe custody.
• Traveller’s Cheques: To avoid the risk of taking cash on their journey,
commercial banks provide their customers with the facility of
traveller’s cheques.
• Letter of Credit: Sometimes people need to show their
creditworthiness for various reasons. Commercial banks certify the
creditworthiness of their customers whenever required.
• Underwriting Securities: Commercial banks also performs the
function of underwriting securities. And as the public has full faith in
the bank’s creditworthiness, they do not hesitate in purchasing the
securities which are underwritten by banks.
• Collection of Statistics: Commercial banks advice their customers on
financial matters by collecting and publishing statistics related to
commerce, trade, and industry.

Page 10- Credit Creation By Commercial Banks

One of the most important functions of a commercial bank is the creation
of credit.
A commercial bank is a dealer of credit. It creates money based on cash
deposits. Further, it issues new money through its loan operations and
creates credit or expands the monetary base of a country.

Therefore, this process of credit creation leads depositors to believe that

they have money with the bank. Also, borrowers believe that they owe a
certain amount of money to the bank. Let’s understand credit creation
through an example.
 Example -
Let’s say that a bank receives a sum of Rs.1,000 as a demand deposit.
Also, let’s assume that the Cash Reserve Ratio (CRR) is 20%.
Therefore, the bank retains Rs.200 and lends the remaining Rs.800 to a
borrower. While the depositor claims that he has Rs.1000 with the
bank, the borrower has Rs.800 too.
Therefore, a single bank manages to create a credit of Rs.800.
If we extend this example to the entire banking system, then it offers an
interesting insight.
Let’s say that the borrower takes a loan of Rs.800 from Bank A and
deposits it with another bank (Bank B). Bank B retains 20% of the
deposited amount (Rs.160 = 800×20%) and lends the remaining Rs.640
to another borrower.
Further, let’s say that the second borrower deposits the loan amount of
Rs.640 with Bank C. This bank also retains the CRR of 20% (Rs.128 =
640×20%) and lends the remaining Rs.512 to the third borrower. This
process continues until the time that the deposited sum is nearly equal
to the CRR.
Just to give you a perspective, a single deposit of Rs.1000 with a CRR of
20% (1/5th) leads to the credit creation of Rs.5000. Therefore, the size
of the multiplier is 5 (1000×5 = 5000).

Page 11- Central Banks-Meaning and Functions

Central bank is regarded as an apex financial institution in the banking
system. It is considered as an integral part of the economic and
financial system of a nation. The central bank functions as an
independent authority and is responsible for controlling, regulating and
stabilising the monetary and banking structure of the country.
In India, the Reserve Bank of India is regarded as the central bank. It
was set up in 1935. Central banks are responsible for maintaining the
financial stability and economic sovereignty of the country.

The functions of a central bank can be discussed as

follows:
1. Currency regulator or bank of issue
2. Bank to the government
3. Custodian of Cash reserves
4. Custodian of International currency
5. Lender of last resort
6. Clearing house for transfer and settlement
7. Controller of credit
8. Protecting depositors interests
The above mentioned functions will be discussed in detail in the
following lines.
Currency regulator or bank of issue: Central banks possess the
exclusive right to manufacture notes in an economy. All the central
banks across the world are involved in issuing notes to the economy.
This is one of the most important functions of the central bank in an
economy and due to this the central bank is also known as the bank of
issue.
Earlier all the banks were allowed to publish their own notes which
resulted in a disorganised economy. To avoid this situation the
government around the world authorised the central banks to function
as the issuer of currency, which resulted in uniformity in circulation and
balanced supply of money in the economy.
Bank to the government: One of the important functions of the central
bank is to act as the bank to the government. The central bank accepts
deposits and issues funds to the government. It is also involved in
making and receiving payments for the government. Central banks also
offer short term loans to the government in order to recover from bad
phases in the economy.
In addition to being the bank to the government, it acts as an advisor
and agent of the government by providing advice to the government in
areas of economic policy, capital market, money market and loans from
the government.
In addition to that, the central bank is instrumental in formulation of
monetary and fiscal policies that help in regulation of money in the
market and controlling inflation.
Custodian of Cash reserves: It is a practice of the commercial banks of
a country to keep a part of their cash balances in the form of deposits
with the central bank. The commercial banks can draw that balance
when the requirement for cash is high and pay back the same when
there is less requirement of cash.
It is for this reason that the central bank is regarded as the banker’s
bank. Central bank also plays an important role in the credit creation
policy of commercial banks.
Custodian of International currency: An important function of the
central bank is to maintain a minimum balance of foreign currency. The
purpose of maintaining such a balance is to manage sudden or
emergency requirements of foreign reserves and also to overcome any
adverse deficits of balance of payments.
Lender of last resort: The central bank acts as a lender of last resort by
providing money to its member banks in times of cash crunch. It
performs this function by providing loans against securities, treasury
bills and also by rediscounting bills.
This is regarded as one of the most crucial functions of the central bank
wherein it helps in protecting the financial structure of the economy
from collapsing.
Clearing house for transfer and settlement: Central bank acts as a
clearing house of the commercial banks and helps in settling of mutual
indebtedness of the commercial banks. In a clearing house, the
representatives of different banks meet and settle the inter bank
payments.
Controller of credit: Central banks also function as the controller of
credit in the economy. It happens that commercial banks create a lot of
credit in the economy that increases the inflation.
The central bank controls the way credit creation by commercial banks
is done by engaging in open market operations or bringing about a
change in the CRR to control the process of credit creation by
commercial banks.
Protecting depositors interests: Central bank also needs to keep an eye
on the functioning of the commercial banks in order to protect the
interests of depositors.

Page 12- Conclusion –

Page 13- Bibliography

SUBMISSION DATE_ 10th NOVEMBER