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Money and Banking

The document provides information about money and banking systems. It discusses the limitations of barter systems and how monetary exchange systems developed as a result. It defines money and describes its key functions like being a medium of exchange, store of value, etc. It also discusses money supply, different types of money, and the roles and functions of commercial banks and central banks in managing monetary systems. In particular, it explains how commercial banks create money through the process of credit creation and how the money multiplier works.

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111 views20 pages

Money and Banking

The document provides information about money and banking systems. It discusses the limitations of barter systems and how monetary exchange systems developed as a result. It defines money and describes its key functions like being a medium of exchange, store of value, etc. It also discusses money supply, different types of money, and the roles and functions of commercial banks and central banks in managing monetary systems. In particular, it explains how commercial banks create money through the process of credit creation and how the money multiplier works.

Uploaded by

sujitha
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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MONEY AND BANKING

TERM I PROJECT

BY SUJITHA K
XII-CN
BARTER SYSTEM

▪ Barter exchange refers to exchange of goods for goods.


▪ An economy where there is a direct barter of goods and services, is
called a ‘Barter Economy’
▪ Barter system can work when there exists ‘double coincidence of
wants’.
LIMITATIONS OF BARTER SYSTEM

▪ Lack of double coincidence of wants


▪ Lack of common measure of value
▪ Lack of standard of deferred payment
▪ Lack of store of value
With so many difficulties, barter exchange could not continue for a long
time. As a result it was replaced by monetary exchange.
DEFINITION OF MONEY

▪ Money is anything which is generally accepted as a medium of exchange,


measure of value, store of value and means of standard of deferred payment.
▪ Legal tender money: Money which can be legally used to make payment of debts
or other obligations.
(i) Limited legal tender: It refers to that form of legal ender money which can
be paid in discharge of a debt up to a certain limit.
(ii) Unlimited legal tender: It refers to that form of legal tender money, which
can be paid in discharge of a debt to any amount.
▪ Non-legal tender money: It refers to that form of money which is generally
accepted but legally one is not bound is accept it
▪ Bank money refers to demand deposits created by the commercial banks
MONEY SUPPLY

▪ Money Supply refers to total volume of money held by the public at a


particular point of time in an economy
COMPONENTS OF MONEY SUPPLY:
 Currency with public – paper notes and coins
 Demand deposits with banks – bank money {term deposits are not
included}
FUNCTIONS OF MONEY

PRIMARY FUNCTIONS
i. Medium of exchange – It means that money can be used to make
payments for all transactions of goods and services
ii. Measure of value – It means that money works as a common
denomination, in which values of all goods and services are expressed
SECONDARY FUNCTIONS
iii. Standard of deferred payments – It means that money acts as a standard
for payments, which are to made in future
iv. Store of value – It means that money can be used to transfer purchasing
power from present to future.
CLASSIFICATION OF MONEY

▪ Full bodied money: Any unit of money, whose face value and intrinsic
value are equal, is known as full bodied money, i.e. Money value =
commodity value
▪ Representative full bodied money: It refers to that money which is
usually made of paper. The value of representative full bodied money
is much higher that its value as a commodity. They are two type
namely convertible paper money and inconvertible paper money.
▪ Credit money: It refers to the money whose intrinsic value is much
lower than its face value, i.e. Money Value > Commodity value
Full bodied money representative full bodied money credit money
DEMAND FOR MONEY

▪ Transaction motive: It refers to demand for money for conducting day-


to-day transactions.
▪ Precautionary motive: It refers to the desire of people to hold cash
balances for unforeseen contingencies.
▪ Speculative motive: It refers to desire of the holder to keep cash
balances as an alternative to financial assets like bonds
COMMERCIAL BANK

▪ Commercial bank is an institution which performs the functions of


accepting deposits, granting loans and making investments, with the
aim of earning profits.
FUNCTIONS OF COMMERCIAL BANK

PRIMARY FUNCTIONS

1. Accepting deposits

(i) Current account deposits: The deposits refer to those deposits which are repayable by the banks on demand

(ii) Fixed deposits: It refer to those deposits in which the amount is deposited with the bank for a fixed period of time

(iii) Saving deposits: These deposits combine features of both current account deposits and fixed deposits

2. Advancing of loans

(i) Cash credit: Cash credit refers to loan given to the borrower against his current assets like shares, stocks, bonds,
etc.

(ii) Demand Loans: Demand loans refers to those loans which can be recalled on demand by the bank at any time

(iii) Short term loans: They are given as personal loans against some collateral security
SECONDARY FUNCTIONS
1. Overdraft facility: It refers to a facility in which a customer is allowed to
overdraw his current account up to an agreed limit
2. Discounting bills of exchange: It refers to facility in which holder of a bill
of exchange can get the bill discounted with bank before the maturity
3. Agency functions: Commercial bank perform certain agency functions
for their customers like transfer of funds, income tax consultancy, letters
of reference
4. General utility functions: Commercial banks render some general utility
services like locker facility, letter of credit, underwriting securities
MONEY CREATION

Through the process of credit creation, commercial banks are


able to create credit, which is in far excess of the initial or
primary deposits. The deposits held by banks are used for
giving loans. Commercial banks open a deposit account in the
name of borrower and credit the loan the amount in this
account. This is called secondary deposits. However banks
cannot use the whole deposit for lending. It is legally
compulsory for the banks to keep certain minimum fraction of
their deposits as reserves. This fraction is called the legal
reserve ratio. Bank keeps reserves only to the extent indicated
by the bank.
MONEY MULTIPLIER

▪ Money multiplier is the number by which total deposits can increase


due to a given change in deposits. It is inversely related to legal
reserve ratio
▪ Money multiplier is the process by which the commercial banks
create credit, based upon the reserve ratio and initial deposits.
MONEY MULTIPIER = 1/LRR
▪ The value of money multiplier is determined by LRR. Higher the value
of LRR, lower is the value to money multiplier and less money is
created by the banking system.
CENTRAL BANK

▪ Central bank is an apex body that controls, operates, regulates, and


directs the entire banking and monetary structure of the country
▪ India’s central bank is the Reserve Bank of India. RBI was established
in april 1, 1935
FUNCTIONS OF CENTRAL BANK

CURRENCY AUTHORITY
▪ Central bank has the sole authority for issue of currency in the
country. In India RBI issues paper currency notes and Ministry of
Finance issues one rupee notes and coins.
BANKER TO THE GOVERNMENT
▪ As a banker, it carries out all the banking business of the government
▪ As an agent, it has the responsibility of managing the public debt
▪ As a financial advisor, it advises the government on economic,
financial and monetary matters.
BANKER’S BANK AND SUPERVISOR
▪ As the banker to banks, it functions in three capacities: custodian of
cash reserves, lender of last resort and clearing house.
▪ As a supervisor, it regulates and controls the commercial banks
CONTROLLER OF MONEY SUPPLY AND CREDIT
Money supply is regulated by RBI through its monetary policy
▪ Repo rate: Repo rate is the rate at which the central bank of a country
lends money to commercial banks to meet their short term needs
(INCREASE IN REPO RATE REDUCES CREDIT CREATING POWER AND VICE VERSA)
▪ Bank rate: Bank rate is the rate at which the central bank of a country
lends money to commercial banks to meet their long term needs
(INCREASE IN BANK RATE REDUCES CREDIT CREATING POWER AND VICE VERSA)

▪ Reverse repo rate: Reverse repo rate is the rate of interest at which
commercial banks can deposit their surplus funds with the central
bank, for a relatively shorter period of time (INCREASE IN REVERSE RATE
REDUCES CREDIT CREATING POWER AND VICE VERSA)

▪ Open market operations: It refers to buying and selling of government


securities by the central bank from/to the public and commercial
banks. (SALE OF SECURITIES REDUCES THE CREDIT CREATING POWER AND VICE
VERSA)
▪ Legal reserve requirements:
(i) Cash reserve ratio: It refers to the minimum percentage of net
demand and time liabilities, to be kept by commercial banks with central
bank. (INCREASE IN CRR REDUCES THE CREDIT CREATING POWER AND VICE VERSA)
(ii) Statutory liquidity ratio: It refers to the minimum percentage of
net demand and time liabilities which commercial banks are required to
maintain with themselves. (INCREASE IN SLR REDUCES THE CREDIT CREATING
POWER AND VICE VERSA)

▪ Margin requirements: Margin is the difference between the amount of


loan and market value of the security offered by the borrower against
the loan. If the margin fixed by the central bank is 40%, then commercial
banks are allowed to give a loan only up to 60% of the value of security.
THANK YOU!

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