10
MONEY AND BANKING
QUICK
Exchange means act of give and take. There are two types of exchanges:
1. Barter Exchange,
2. Monetary Exchange.
MONEY
Kinds of Money
Money is the most useful and necessary invention. It has undergone a long process of evolution:
1. Commodity Money
2. Metallic Money: Upto first half of the 18th century, the medium of exchange were metals' coin particular
gold and silver, copper, nickel etc. Metallic money is further classified into standard money, token money
and subsidiary money.
(i) Standard Money: Standard money is that whose face value is equal to their intrinsic value. Holder of such
coins may use them as metal by melting them or as money, because the value of the metal in the coins is the
same as their monetary value. Standard money is therefore known as full bodied money.
(ii) Token Money: Token money is representative money whose intrinsic value of the metal is less than its
face value. The rupee coin in circulation in India is a token coin.
(iii) Subsidiary Money: Subsidiary money is to assist the token money. All coins of the denominations from 5
paisa to 25 paisa in India are subsidiary money. Such coins are limited legal tenders in which payments can
be done only upto 25 in India.
3. Paper Money: From 1930's onward most countries are using paper currency as a prominent and nearly
exclusive medium of exchange. Paper money can be classified into the following types:
(i) Representative Paper Money: It is also known as representative full bodied money because it is fully
backed by gold coins or gold bullion held by the treasury.
(ii) Convertible Paper Money: Convertible paper money is that which does not have 100 per cent backing in
the form of standard coins or bullion. But the holder of paper money can get it converted into bullion or coins
on demand.
(iii) Inconvertible Paper Money: The paper money which does not have any backing of standard coins or
bullion and is also not convertible into them is known as inconvertible paper money. Notes issued by Central
Banks of all countries represent inconvertible paper money. They are also known as fiduciary money.
(iv) Fiat Money: Fiat money is a type of money widely accepted all over the world. Fiat money has no intrinsic
value, but having value for making transactions which promised by Government or currency issuing
authority. It is the existing type of money in the world. Fiat money is a legal tender.
ISC HANDBOOK OF ECONOMICS 1
,MONEY AND BANKING
Money which the state and people accept as the means of payment and for discharge of debts is known as
legal tender. All notes and coins issued by the Government and the Central Bank of a country are
compulsorily a legal tender in that country. It can be further divided into two parts:
(a) Limited Legal Tender: It is a type of money through which payments can be made legally upto a certain
limit only. All coins of the denominations of 5 paisa to 50 paisa are limited legal tender in India. Payments in
them can be made upto a limit of 50 only.
(b) Unlimited Legal Tender: A money is unlimited legal tender when payments can be made in it in
unlimited amount. All paper notes and coins above 50 paise and 1 are unlimited legal tender in India.
(v) Credit Money/Bank Money: It refers to the deposits in the bank. Credit money or bank money is
transferred by a commercial bank in the form of cheque or draft. But a cheque or draft is not money. Demand
deposits in a bank is money which is withdrawable by a holder of the deposit through cheque or draft. Thus, it
is demand deposit which is credit or bank money that is transferable from one person to another through
cheque or draft, but a cheque or draft is not legal tender and may not be accepted as a medium of exchange or
means of payment.
(vi) Near Money: Deposit money, bonds, securities, debentures, bills of exchange, treasury bills, insurance
policies, etc. are known as near money.
(vii) Plastic Money: All kind of cards like credit and debit cards are known as plastic money.
Money: Meaning and its Functions
Meaning of Money: According to Walker, "Money is what money does"?
According to Seligman, "Money is one thing that possess general acceptability".
According to Cole, "Money is anything that is habitually and widely used as a means of payment and its
generally acceptable in the settlement of debts".
1. Primary Functions
The two primary functions of money are to act as a medium of exchange and a measure of value.
(1) Medium of Exchange: This is the central function of money. For performing this function, money should
have general acceptability. Medium of exchange simply refers using money for buying and selling goods and
services.
(ii) Measure of Value: Money serves as a unit of account. It measures the value of economic goods. Money
works as a common denominator into which the values of all goods and services are expressed. When we
express the value of a commodity in terms of money is known as price.
2. Secondary Functions
(i) Store of Value: Wealth can be stored in the form of money. Money can be stored without loss in value.
Savings are secured and can be used whenever there is need. In this way, money acts as a bridge between the
present and the future.
(ii) Standard of Deferred Payment: Credit has become the life and blood of a modern capitalist economy. In
millions of transactions instant payments are not made. The debtors make a promise that they will make
ISC HANDBOOK OF ECONOMICS 2
,MONEY AND BANKING
payment on some future date. It has become possible because money has general acceptability its value is
stable, durable and homogeneous.
(ii) Transfer of Value: Value of any asset can be transferred from one person to another person or to any
institution or to any place by transferring money. The transfer of money takes place irrespective of places,
time and circumstances. Transfer of purchasing power, which is necessary in commerce and other
transactions, has become available because of money.
3. Contingent Functions
(i) Basis of Credit.
(ii) Basis of Distribution of Income.
(iii) Maximisation of Satisfaction.
(iv) Liquidity: It is again through money transaction that immovable property can be changed into liquid
form. Money helps to bring about liquidity and uniformity of wealth.
(v) Best Utilisation of Resources: Money helps in utilising all the resources to the fullest.
Money Supply: Meaning and Its Measures
Meaning of Money Supply: The supply of money means the total stock of all the forms of money supply
(paper money, coins and bank deposits) which are held by the public at any particular point of time. Two
points need to be noted in this connection: (i) Supply of money is a stock variable because it is related to a
point of time, (ii) Stock of money always refers to the stock of money held by the public which is always
smaller than the total stock of money in existence.
Here, the term public includes all economic units like households, firms, local administration and banking
financial institutions, etc. except producers of money and the producers of money are Central Government,
RBI and all the banks which accept demand deposits.
Measures of Money Supply (Money Stock): In India RBI uses four alternative measures of money supply
called M1, M2, M3 and M4.
(i) M₁ = C + DD + OD
where C = Currency held by public,
DD Net demand deposits of the bank,
OD = Other deposits held with the RBI.
These are the deposits of quasi Government institutions like industrial development, Bank of India, IMF,
World Bank, etc. with RBI.
M1 is a narrow definition of money. My is the most liquid and easiest for transactions.
(ii) M₂=M1+Saving deposits with post office saving banks. M₂ is also narrow money but broader than M₁. In
addition to M1, it also includes saving deposits with post office saving bank.
(iii) M3: M3 is broad money. It is most commonly used measure of money supply. M3-M1 + Net time deposits
with the commercial banks.
(iv) M4: M4 money supply is still broader. It is broader than Mg.
M4 = M3+ Savings with post offices (other than in the form of National saving certificates).
ISC HANDBOOK OF ECONOMICS 3
, MONEY AND BANKING
Important Facts about Measures of Money Supply:
(i) The four measures of money supply represent different degrees of liquidity, with M, being most liquid and
M4 being the least liquid.
(ii) My is widely used as a measure of money supply and it is known as aggregate monetary resources of the
society.
(iii) My and M₂ are generally known as narrow money supply concepts, whereas M3 and M4 are known as
broad money supply concepts.
High Powered Money: It includes currency with the public and cash reserves with the banks.
The difference between money and high powered money lies in the fact that money consists of currency and
demand deposits while high powered money consists of currency and cash reserves with banks.
BANKING
Commercial Bank
A commercial bank is that financial institution which accepts deposits from the people, gives loans for
various purposes and performs various agency functions.
Functions of Commercial Bank
1. Acceptance of Deposits: The bank accepts different types of deposits from the public:
(i) Current Account Deposits.
(ii) Saving Account Deposits.
(ii) Fixed/Term Deposits.
(iv) Recurring Deposit Accounts.
(v) Fixed Deposit Accounts.
2. Giving Loans: The deposits received by the banks are not allowed to lie idle by the bank After keeping a
certain portion of the deposits as reserves, the bank gives the balance to borrowers as loans and advances.
The different types of loans and advances made by the banks are as follows:
(i) Cash Credit.
(ii) Demand Loan or Outright Loan.
(iii) Short Term Loans.
(iv) Overdraft Facility.
(v) Discounting of Bills of Exchange.
(vi) Facilitation of Payments through Cheques.
(vii) Transfer of Funds: Banks help in remittance or transfer of funds from one place to another through the
use of various credit instruments, like cheques, drafts, mail transfer and telegraphic transfers.
(viii) Agency Functions: Banks provide various agency functions for their customers. The banks charge
commission or service charge for such functions.
(ix) General Utility Services: They perform miscellaneous services for the benefit of the customers. They act
as custodians of the valuables of the customers. They provide locker facility to their customers and take some
service charges for it.
ISC HANDBOOK OF ECONOMICS 4
MONEY AND BANKING
QUICK
Exchange means act of give and take. There are two types of exchanges:
1. Barter Exchange,
2. Monetary Exchange.
MONEY
Kinds of Money
Money is the most useful and necessary invention. It has undergone a long process of evolution:
1. Commodity Money
2. Metallic Money: Upto first half of the 18th century, the medium of exchange were metals' coin particular
gold and silver, copper, nickel etc. Metallic money is further classified into standard money, token money
and subsidiary money.
(i) Standard Money: Standard money is that whose face value is equal to their intrinsic value. Holder of such
coins may use them as metal by melting them or as money, because the value of the metal in the coins is the
same as their monetary value. Standard money is therefore known as full bodied money.
(ii) Token Money: Token money is representative money whose intrinsic value of the metal is less than its
face value. The rupee coin in circulation in India is a token coin.
(iii) Subsidiary Money: Subsidiary money is to assist the token money. All coins of the denominations from 5
paisa to 25 paisa in India are subsidiary money. Such coins are limited legal tenders in which payments can
be done only upto 25 in India.
3. Paper Money: From 1930's onward most countries are using paper currency as a prominent and nearly
exclusive medium of exchange. Paper money can be classified into the following types:
(i) Representative Paper Money: It is also known as representative full bodied money because it is fully
backed by gold coins or gold bullion held by the treasury.
(ii) Convertible Paper Money: Convertible paper money is that which does not have 100 per cent backing in
the form of standard coins or bullion. But the holder of paper money can get it converted into bullion or coins
on demand.
(iii) Inconvertible Paper Money: The paper money which does not have any backing of standard coins or
bullion and is also not convertible into them is known as inconvertible paper money. Notes issued by Central
Banks of all countries represent inconvertible paper money. They are also known as fiduciary money.
(iv) Fiat Money: Fiat money is a type of money widely accepted all over the world. Fiat money has no intrinsic
value, but having value for making transactions which promised by Government or currency issuing
authority. It is the existing type of money in the world. Fiat money is a legal tender.
ISC HANDBOOK OF ECONOMICS 1
,MONEY AND BANKING
Money which the state and people accept as the means of payment and for discharge of debts is known as
legal tender. All notes and coins issued by the Government and the Central Bank of a country are
compulsorily a legal tender in that country. It can be further divided into two parts:
(a) Limited Legal Tender: It is a type of money through which payments can be made legally upto a certain
limit only. All coins of the denominations of 5 paisa to 50 paisa are limited legal tender in India. Payments in
them can be made upto a limit of 50 only.
(b) Unlimited Legal Tender: A money is unlimited legal tender when payments can be made in it in
unlimited amount. All paper notes and coins above 50 paise and 1 are unlimited legal tender in India.
(v) Credit Money/Bank Money: It refers to the deposits in the bank. Credit money or bank money is
transferred by a commercial bank in the form of cheque or draft. But a cheque or draft is not money. Demand
deposits in a bank is money which is withdrawable by a holder of the deposit through cheque or draft. Thus, it
is demand deposit which is credit or bank money that is transferable from one person to another through
cheque or draft, but a cheque or draft is not legal tender and may not be accepted as a medium of exchange or
means of payment.
(vi) Near Money: Deposit money, bonds, securities, debentures, bills of exchange, treasury bills, insurance
policies, etc. are known as near money.
(vii) Plastic Money: All kind of cards like credit and debit cards are known as plastic money.
Money: Meaning and its Functions
Meaning of Money: According to Walker, "Money is what money does"?
According to Seligman, "Money is one thing that possess general acceptability".
According to Cole, "Money is anything that is habitually and widely used as a means of payment and its
generally acceptable in the settlement of debts".
1. Primary Functions
The two primary functions of money are to act as a medium of exchange and a measure of value.
(1) Medium of Exchange: This is the central function of money. For performing this function, money should
have general acceptability. Medium of exchange simply refers using money for buying and selling goods and
services.
(ii) Measure of Value: Money serves as a unit of account. It measures the value of economic goods. Money
works as a common denominator into which the values of all goods and services are expressed. When we
express the value of a commodity in terms of money is known as price.
2. Secondary Functions
(i) Store of Value: Wealth can be stored in the form of money. Money can be stored without loss in value.
Savings are secured and can be used whenever there is need. In this way, money acts as a bridge between the
present and the future.
(ii) Standard of Deferred Payment: Credit has become the life and blood of a modern capitalist economy. In
millions of transactions instant payments are not made. The debtors make a promise that they will make
ISC HANDBOOK OF ECONOMICS 2
,MONEY AND BANKING
payment on some future date. It has become possible because money has general acceptability its value is
stable, durable and homogeneous.
(ii) Transfer of Value: Value of any asset can be transferred from one person to another person or to any
institution or to any place by transferring money. The transfer of money takes place irrespective of places,
time and circumstances. Transfer of purchasing power, which is necessary in commerce and other
transactions, has become available because of money.
3. Contingent Functions
(i) Basis of Credit.
(ii) Basis of Distribution of Income.
(iii) Maximisation of Satisfaction.
(iv) Liquidity: It is again through money transaction that immovable property can be changed into liquid
form. Money helps to bring about liquidity and uniformity of wealth.
(v) Best Utilisation of Resources: Money helps in utilising all the resources to the fullest.
Money Supply: Meaning and Its Measures
Meaning of Money Supply: The supply of money means the total stock of all the forms of money supply
(paper money, coins and bank deposits) which are held by the public at any particular point of time. Two
points need to be noted in this connection: (i) Supply of money is a stock variable because it is related to a
point of time, (ii) Stock of money always refers to the stock of money held by the public which is always
smaller than the total stock of money in existence.
Here, the term public includes all economic units like households, firms, local administration and banking
financial institutions, etc. except producers of money and the producers of money are Central Government,
RBI and all the banks which accept demand deposits.
Measures of Money Supply (Money Stock): In India RBI uses four alternative measures of money supply
called M1, M2, M3 and M4.
(i) M₁ = C + DD + OD
where C = Currency held by public,
DD Net demand deposits of the bank,
OD = Other deposits held with the RBI.
These are the deposits of quasi Government institutions like industrial development, Bank of India, IMF,
World Bank, etc. with RBI.
M1 is a narrow definition of money. My is the most liquid and easiest for transactions.
(ii) M₂=M1+Saving deposits with post office saving banks. M₂ is also narrow money but broader than M₁. In
addition to M1, it also includes saving deposits with post office saving bank.
(iii) M3: M3 is broad money. It is most commonly used measure of money supply. M3-M1 + Net time deposits
with the commercial banks.
(iv) M4: M4 money supply is still broader. It is broader than Mg.
M4 = M3+ Savings with post offices (other than in the form of National saving certificates).
ISC HANDBOOK OF ECONOMICS 3
, MONEY AND BANKING
Important Facts about Measures of Money Supply:
(i) The four measures of money supply represent different degrees of liquidity, with M, being most liquid and
M4 being the least liquid.
(ii) My is widely used as a measure of money supply and it is known as aggregate monetary resources of the
society.
(iii) My and M₂ are generally known as narrow money supply concepts, whereas M3 and M4 are known as
broad money supply concepts.
High Powered Money: It includes currency with the public and cash reserves with the banks.
The difference between money and high powered money lies in the fact that money consists of currency and
demand deposits while high powered money consists of currency and cash reserves with banks.
BANKING
Commercial Bank
A commercial bank is that financial institution which accepts deposits from the people, gives loans for
various purposes and performs various agency functions.
Functions of Commercial Bank
1. Acceptance of Deposits: The bank accepts different types of deposits from the public:
(i) Current Account Deposits.
(ii) Saving Account Deposits.
(ii) Fixed/Term Deposits.
(iv) Recurring Deposit Accounts.
(v) Fixed Deposit Accounts.
2. Giving Loans: The deposits received by the banks are not allowed to lie idle by the bank After keeping a
certain portion of the deposits as reserves, the bank gives the balance to borrowers as loans and advances.
The different types of loans and advances made by the banks are as follows:
(i) Cash Credit.
(ii) Demand Loan or Outright Loan.
(iii) Short Term Loans.
(iv) Overdraft Facility.
(v) Discounting of Bills of Exchange.
(vi) Facilitation of Payments through Cheques.
(vii) Transfer of Funds: Banks help in remittance or transfer of funds from one place to another through the
use of various credit instruments, like cheques, drafts, mail transfer and telegraphic transfers.
(viii) Agency Functions: Banks provide various agency functions for their customers. The banks charge
commission or service charge for such functions.
(ix) General Utility Services: They perform miscellaneous services for the benefit of the customers. They act
as custodians of the valuables of the customers. They provide locker facility to their customers and take some
service charges for it.
ISC HANDBOOK OF ECONOMICS 4
