A note on...... Money & Banking
Barter system
- Exchange of goods for goods
& Services for services.
Defects of Barter system
1.Double coincidence of wants –need to have mutually
exchangeable goods.
2.Indivisibility of commodities
3.Lack of common measure of value
4.Lack of proper store of value.
Money: definition
Money is the
stock of assets that can be readily used
to make transactions.
Primary functions- 1.Medium
of exchange -we use it to buy stuff
•2.Measure of value – goods
& services
Secondary functions- 1.Standard of deferred
payment – future payment
•2.Store of value
•3.Transfer
of value- transfers purchasing power from the present to the future
CONTINGENT FUNCTION- 1.Basis of credit 2.Distribution of
National Income
3.Medium of compensation
4.Liquidity– money is the most liquid of all assets
Classification of money
1.Legal tender money – money which has legal sanction
2.Full
bodied money (standard money) – face value is equal to its intrinsic value
(value of metal)
3.Fiat
money – legal tender money having no intrinsic value. e.g. currency notes and
coins
Indian Monetary System
•Meaning – the monetary
standard and monetary set up of a country.
•The type of standard money
used in the country is its monetary standard .
•The apex monetary authority
of our country is RBI.
The system of currency issue
•The
system of note issue in India
is The Minimum Reserve System( MRS)
•RBI
issues currency notes above Rupee 1.
RESERVE BANK OF INDIA
( RBI ) -
RBI is the Central Bank of our country
FUNCTIONS OF RBI
1. Note issue – RBI issues currency notes & coins
2. Banker, Agent & Adviser to the Govt.
3. Custodian of foreign exchange reserves
4. Bankers’ Bank – RBI controls & regulates the
commercial banks through its Monetary Policy
5.Lender of the last resort – RBI helps the
commercial banks in times of crisis.
6.Controller of credit & money supply – through
its Monetary Policy RBI controls the volume of credit.
7. Publisher of reports – periodical reports on
banking & other monetary matters.
Commercial
Banks
•Accept
deposits from the public
•Lending
money
•Borrowing
rate – the rate of interest offered
by the bank to deposit holders
•Lending
rate – the rate of interest levied for
lending money
•The
difference between lending & borrowing rate is called “spread”, and is the profit appropriated by the banks.
Deposits - 1. savings deposits / demand
deposits— chequeable deposits having low interest
rate.
•2.
Time deposits / fixed deposits / term deposits—
Have a fixed period to maturity
Having high interest
rate
Money Supply -
Legal
definitions of Money - Money Supply is a stock variable.
Money Supply is the total
stock of money in circulation at a particular point of time.
Measures of Money Supply by RBI
•1. M1= CU + DD CU is currency held by the public.
DD is demand
deposits held by the commercial banks.
•2. M2= M1 + Savings deposits with Post Office
savings bank
•3. M3= M1 + Net time deposits of Commercial
Banks
•4. M4= M3 + Total deposits with Post Office savings
organizations
Narrow & Broad Money - M1 and M2 are known as Narrow Money
M3 and M4 are
known as Broad Money
•M1
is the most liquid asset
•M4
is the least liquid asset
AGGREGATE MONETARY
RESOURCE (AMR)
M3 is the
most commonly used measure of money supply and it is the AMR.
MONEY CREATION BY
THE BANKING SYSTEM
•1.
The Currency Deposit Ratio (cdr)
cdr =CU/DD
it reflects people’s preference for liquidity.
2. The Reserve Deposit Ratio
(rdr)
rdr = R/DD
It is the proportion of the total deposits commercial banks
keep as reserves.
Rdr
has two instruments
•1. Cash Reserve Ratio (CRR) – The fraction of commercial banks deposits kept
in RBI is CRR.
•2. Statutory Liquidity Ratio (SLR) – Commercial
banks have to keep a given fraction of their total deposits n the form of
specified liquid assets.
BANK RATE
•To
control the value of rdr RBI uses
another instrument called Bank Rate,
•It
is the rate at which RBI lend money to the commercial banks.
•A
high BR makes borrowing costly for commercial banks.
HIGH POWERED MONEY (H)
•The
total liability of the Monetary authority of the country, RBI, is called the H
or Monetary Base.
•H = CU + R R is the reserves
Demand for money
•Demand for money
balance is liquidity preference.
•Whether to
hold cash or put it in savings bank so as to earn interest.
•People
desire to hold money balance from two
motives —
•1.
The Transaction Motive
•2.
The Speculative Motive
Transaction motive
•Holding money for transactions
•Transaction demand for money
in an economy,
MT can be written as
v.M = T
Where, v is velocity of circulation of money
• T
is the total value of transaction in the economy.
Velocity
•basic
concept: the rate at which money
circulates
•definition: the number of times the average rupee changes
hands in a given time period
•example: In 2010,
•Rs.500
crores in transactions
•money
supply = Rs.100 crores
•The
average Rupee is used in five transactions in 2010
•So,
velocity = 5.
