UNIT – VII: MONEY AND BANKING
MEANING OF MONEY: Money is anything which is generally accepted as medium of
exchange, measure of value, store of value and as means of standard of deferred payment.
FUNCTIONS OF MONEY: Functions of money can be classified into Primary and
Secondary
Primary/Basic functions:-
i) Medium of Exchange: - It can be used in making payments for all transactions of
goods and services.
ii) Measure /Unit of value: - It helps in measuring the value of goods and services. The
value is usually called as price. After knowing the value of goods in single unit
(price) exchanges become easy.
Secondary functions:-
i) Standard of deferred payments: Deferred payments referred to those payments which
are to be made in near future.
Money acts as a standard deferred payment due to the following reasons:
a) Value of money remains more or less constant compared to other
commodities.
b) Money has the merit of general acceptability.
c) Money is more durable compare to other commodity.
ii) Store of value: Money can be stored and does not lose value
Money acts as a store of value due to the following reasons:
a) It is easy and economical to store.
b) Money has the merit of general acceptability.
c) Value of money remains relatively constant
MONEY HAS OVERCOME THE DRAW BACKS OF BARTER SYSTEM:
1. Medium of Exchange: Money has removed the major difficulty of the double
coincidence of wants.
2. Measure of value: Money has become measuring rod to measure the value of goods
and services and is expressed in terms of price.
3. Store of value: It is very convenient, easy and economical to store the value and has
got general acceptability which was lacking in the barter system.
80
, 4. Standard of deferred payments: Money has simplified the borrowing and lending of
operations which were difficult under barter system. It also encourages capital
formation.
MONEY SUPPLY: refers to total volume of money held by public at a particular point of
time in an economy.
M1=currency held by public + Demand deposits + other deposits with Reserve Bank of India.
M2=M1+saving deposits with post office saving bank
M3=M1+net time deposit with the bank
M4=M3 + total deposits with post office saving bank excluding national saving certificate
HIGH POWERED MONEY:
Refers to, currency with the public (notes +coins) and cash reserve of banks.
MONEY CREATION/DEPOSIT CREATION/CREDIT CREATION BY COMMERCIAL
BANK
Let us understand the process of credit creation with the following example.
Suppose there is an initial deposit of Rs. 1000 and L.R.R. is 20% i.e., the banks have to keep
Rs. 200 and lend Rs. 800/-. All the transactions are routed through banks. The borrower
withdraws his Rs. 800/- for making payments which are routed through banks in the form of
deposits account.
The Bank receives Rs. 800/- as deposit and keeps 20% of Rs.800/- i.e., Rs.160/- and lends
Rs.640/- . Again the borrower uses this for payment which flows back into the banks thereby
increasing the flow of deposits.
Deposits Loans (in Rs.) Cash Reserve
(in Rs.) Ratio
(20%)
Initial deposit 1000 800 200
First round 800 640 160
Second round 640 512 128
- - - -
- - - -
- - - -
- - - -
Total 5000 4000 1000
MONEY MULTIPLIER:
81
MEANING OF MONEY: Money is anything which is generally accepted as medium of
exchange, measure of value, store of value and as means of standard of deferred payment.
FUNCTIONS OF MONEY: Functions of money can be classified into Primary and
Secondary
Primary/Basic functions:-
i) Medium of Exchange: - It can be used in making payments for all transactions of
goods and services.
ii) Measure /Unit of value: - It helps in measuring the value of goods and services. The
value is usually called as price. After knowing the value of goods in single unit
(price) exchanges become easy.
Secondary functions:-
i) Standard of deferred payments: Deferred payments referred to those payments which
are to be made in near future.
Money acts as a standard deferred payment due to the following reasons:
a) Value of money remains more or less constant compared to other
commodities.
b) Money has the merit of general acceptability.
c) Money is more durable compare to other commodity.
ii) Store of value: Money can be stored and does not lose value
Money acts as a store of value due to the following reasons:
a) It is easy and economical to store.
b) Money has the merit of general acceptability.
c) Value of money remains relatively constant
MONEY HAS OVERCOME THE DRAW BACKS OF BARTER SYSTEM:
1. Medium of Exchange: Money has removed the major difficulty of the double
coincidence of wants.
2. Measure of value: Money has become measuring rod to measure the value of goods
and services and is expressed in terms of price.
3. Store of value: It is very convenient, easy and economical to store the value and has
got general acceptability which was lacking in the barter system.
80
, 4. Standard of deferred payments: Money has simplified the borrowing and lending of
operations which were difficult under barter system. It also encourages capital
formation.
MONEY SUPPLY: refers to total volume of money held by public at a particular point of
time in an economy.
M1=currency held by public + Demand deposits + other deposits with Reserve Bank of India.
M2=M1+saving deposits with post office saving bank
M3=M1+net time deposit with the bank
M4=M3 + total deposits with post office saving bank excluding national saving certificate
HIGH POWERED MONEY:
Refers to, currency with the public (notes +coins) and cash reserve of banks.
MONEY CREATION/DEPOSIT CREATION/CREDIT CREATION BY COMMERCIAL
BANK
Let us understand the process of credit creation with the following example.
Suppose there is an initial deposit of Rs. 1000 and L.R.R. is 20% i.e., the banks have to keep
Rs. 200 and lend Rs. 800/-. All the transactions are routed through banks. The borrower
withdraws his Rs. 800/- for making payments which are routed through banks in the form of
deposits account.
The Bank receives Rs. 800/- as deposit and keeps 20% of Rs.800/- i.e., Rs.160/- and lends
Rs.640/- . Again the borrower uses this for payment which flows back into the banks thereby
increasing the flow of deposits.
Deposits Loans (in Rs.) Cash Reserve
(in Rs.) Ratio
(20%)
Initial deposit 1000 800 200
First round 800 640 160
Second round 640 512 128
- - - -
- - - -
- - - -
- - - -
Total 5000 4000 1000
MONEY MULTIPLIER:
81
