MONEY AND BANKING Barter refers to the direct exchange of goods and services.

In this way, barter system refers to that system by which one commodity is exchanged for another without use of money. Under this system, an individual produces some goods in greater quantity than what he could consume, so as to exchange the surplus with another person for something he needed in return. For instance, if one person who has surplus wheat wants cloth and another person having surplus cloth wants wheat. When both the persons meet and exchange their surplus goods, such exchange is barter. There are certain problems in barter system which are discussed below. Problems/Difficulties of Barter System Some important problems of barter system are: 1. Lack of double coincidence. Double coincidence is the most difficult problem of barter system. In barter system a person having a surplus of one commodity should be able to find another person. Who not only want that commodity, but has something acceptable to offer in exchange. Unless the double coincidence of wants on the part of those engaged in the barter is not matched exactly, no exchange will take place. 2. Lack of divisibility. There are certain costly goods, such as horse, cow, table etc. which on be useful as a whole. They will lose their identity and utility is these are cut into small pieces. These commodities cannot be exchanged in pieces for different things. For example, person A has a horse and he wants to take shoes from person B and wheat from a different C. He can not enter into transaction with A, B, and C, because he cannot cut his horse in pieces. 3. Lack of measure of value. There is no common measure in the barter system. All Commodities do not possess equal values. Suppose, a goat is to be exchanged for rice. It is difficult to decide the amount of rice worth a goat i.e. in what proportion the two goods are to be exchanged. It is also difficult to settle the terms of exchange, as there is no common measure in terms of value. 4. People of store of value. Barter system does not provide any method of storing purchasing power. People can store purchasing power for further by holding of stocks of certain commodities is subject to certain problems like spoilage, cost of storage, depreciation of stock etc., Meaning of Money Money may be anything chosen by common consent as a medium of exchange. Other say, anything that performs the functions of money is money. Money is what money does It is given and received irrespective of the standing of the person who offers it in payment. All commodities are expressed and valued in terms of money. In wider sense, the term money includes all medium of exchange gold silver, copper, paper cheques, commercial bills of exchange etc., This definition is too wide. Therefore, some writers offered the narrow definition that is, anything that is generally accepted as a means of exchange and that at the same time, acts as a measure and as a store of value. Is money. Definitions of Money.

Money as a concept is defined by various writers in different ways. Some important views about money are as follows: According to Dr. Naseem Akhtar Azad, Money does serve both as a medium of exchange and as a measure of value. In the words of Prof. Colborn It is the means of valuation and of payment as both the unit of account and the generally acceptable medium of exchange. According to Walker, Money is what money does. Robertson defined money as anything which is widely accepted in payment for goods, or in discharge of other kinds of business obligations. In the words of G.D,H. Cole, Money is anything that is habitually and widely used as a means of payments and is generally acceptable in the settlement of debts. Sir John presents a simple definition, anything is money which is used as money. According to Kent, money is anything which is commonly used and generally accepted as a medium of exchange or as a standard of value. With the study of above definitions, we have come to the conclusion that money can be medium of exchange , measure of value, store of value and transfer of value. Money is classified as (i) Fiat Money and (ii) Fiduciary money. Fiat money, also known as currency is a legal tender . It has legal power to discharge debts. The creditor cannot refuse it. Fiduciary money is the demand deposits is the demand deposits of the bank. It is accepted as money on the basis of the trust that their issues command. A person can refuse to accept bank money ( cheque), because there is no guarantee that the cheque will be honoured. In India, coins and paper money constitute supply and are known together as currency. CLASSIFICATION OF MONEY Money can be classified on the basis of relationship between the value of money as money and the value of money a commodity. CLASSIFICATION OF MONEY A. Full-bodied Money B Representative full bodied Money C. Credit Money A. Full-bodied Money. The money, whose value as a commodity for non-monetary purposes is as great as its value as a money is known as full-bodied money. Gold coins in gold standard, silver coins in silver standard or gold and silver coins in bimetallic standard were the examples of full9bodied money. In the metallic standard the precious metal like gold and silver was wasted by the process of gradual depreciation, so full bodied money was replaced by representative fullbodied money. B. Representative Full-bodied Money Instead of actual metallic coins paper money is used. Though its non-monetary value if negligible but it represents in circulation an amount of money with a commodity, value equal to the value of money. The money which has higher face value than its intrinsic value is known as Representative Full bodied Money. The paper money is lighter, easy to carry, convenient to use and also avoids wastage of precious metal as depreciation. C. Credit Money.

The money whose money value is greater than the commodity value of the material from which the money is made is known as credit money. It can be in the forms of token coins, representative token money, circulating promissory notes, issued by central government and deposit at banks. Forms of Credit Money 1. Token coins. Metallic coins of the value of 5 paise, 10 paise , 20 paise Re. 1 Rs. 2 and Rs. 5 circulating in the country are token coins. The value of these coins as money is far above the value of the metal contained in them. 2. Representative token money. It is usually made of paper. It is just like a circulating warehouse receipt for token coins or an equivalent amount of bullion, which is backing it. Here, also the value of money as money is greater than the value of money as a commodity or the bullion if it is made of metal. 3. Circulating promissory notes issued by central Bank. These are the currency notes issued by Reserve Bank in India. These notes are worth Rs. 1,000, Rs. 500 Rs. 100, Rs. 50 Rs. 20 Rs. 10 Rs. 5 and Rs. 2. On these notes we find. I promise to pay the bearer the sum of Rs written and signed by the Governor, Reserve Bank of India. These notes are simply circulating promissory notes signed by governor, Reserve Bank of India. 4. Deposits at banks. Deposits are claims of creditors (depositros) against bank. These deposits can be transferred from one person to another through the cheques. Indian Monetary System We have adopted at present managed paper currency standard with a minimum reserve system of note issue in India. The legal money, in which the government discharges its obligations is known as standard money. India is on paper currency standard because Indias monetary authority, the Reserve Bank of India has adopted standard currency made of paper. Paper currency in India is unlimited legal tender, it means that it can be used to make payments and settle debts upto an unlimited amount. Light and cheap metal coins are also used to facilitate small payments. These coins are limited legal tender, because these coins can be accepted in limited quantity. Reserve Bank of India has the sole responsibility to issue currency notes except Re. 1 note and coins, which are issued by Ministry of Finance , Government of India. This authority has been granted to the government by Indian Coinage Act. The circulation of these coins is made by Reserve Bank of India. The special feature of Indian Monetary System is that it has adopted Minimum Reserve System. Paper Currency is not convertible into precious metal (gold) that is backing it. Thus, currency is said to be inconvertible. Functions of Money

Money plays a very important role in an economy due to its various functions. As we have discussed in the above definitions that money is medium of exchange, measure of value, store of value and transfer of value, but apart from these functions some other important functions are also performed by money which are explained as follows: Functions of Money A. Primary Functions B. Secondary Functions C. Contingent Functions As we know money is what money does not money is used primary as medium of exchange and measure of value So, these are the two primary functions of money, which are discussed as follows: PRIMARY FUNCTIONS 1. Medium of Exchange OF MONEY 2. Measure of Value 1. Medium of exchange. Money as a medium of exchange or medium of payments is used in the sale and purchase of goods and services. Anyone can get commodities in exchange of money. It means that we can get goods and services in exchange of money available with us. In this way, money removed the problem of double coincidence of wants, faced in the Barter System and thus reduced time and energy in the transaction. Money is also called as bearer of options or generalized, purchasing power. The money in this way offer freedom of choice. Its owner can use it at the article, place and the way he likes. 2. Measure/Unit of value. Money measures value of goods and services of facilitate sales and purchases of goods and services. The value of each good and service is expressed as a price, which is the number of monetary units for which the goods and services can be exchanged. Measure value of goods and services in terms of money simplifies accounting as all items are recording in the books of accounting in terms of monetary value. Money is defined as the purchasing power, which increase or decreases with the money supply. The more is the supply of money, the lesser will be its value. Rs. 40 per kg. Rs. 20 a dozen, Rs. 15 per litre etc., represent measure of value. B. Secondary functions of Money Apart from primary or main functions of money, there are some other functions of money. Which are called secondary functions. These secondary functions are expressed as given below: SECONDARY FUNCTIONS OF MONEY 1. Store of value 2. Standard for deferred payments 3. Transfer of value.

1. Store of value. Money serves as a store of value (i.e. wealth in liquid form).In modern world, people want to have some currency notes or coin in their pocket. Home, bank account etc. to use any time for the purchase of anything. It is possible only with the help of money. We can store value in the form of generalized purchasing power and can use the moment, we like.

C.

1.

2.

3.

4.

5.

2. Standard for deferred payments. Money is also helpful in payment for goods and services after a lapse of time. It means that with the help of money, people can buy and sell goods and services only on commitment and payment can be made in the form of instalmetns, loans , etc., are the examples of deferred payments. 3. Transfer of value. Sale and purchase of movable and immovable property can also be made with the help of money. In simple words, value available with a person in the form of assets can be transferred to another person. Now, it is also possible to sell goods and services at one place, realize the proceeds in money and purchase the other necessary goods and services at other place from this money. Contingent Functions of Money In addition to primary and secondary functions of money there are some contingent functions which are related to generally modern and developed economies. These functions are: CONTINGENT 1. Basis of credit FUNCTIONS 2. Liquidity OF MONEY 3. Maximum utilisation of resource 4 . Guarantor of solvency 5 . Distribution of national income Basis f credit. The progress of business activity is fully linked with the credit system of the country. The entire strength of the credit system is based upon money. It is the changes in the quantity of money that brings about the changes in supply of credit in the country. Money supply affects the credit system of the country. Liquidity. Money is the most liquid asset which can be converted into other assets quickly. Money is also helpful to avail of the opportunity of investment into business by which an investor can get good amount of profit. Maximum Utillisation of resources. Money is a common rod of measurement. It helps the producers in measuring the value of their products also. In this way, both in the field of consumption and production, the best use of resources is possible in accordance with law if substitution. Guarantor of Solvency. Money is the guarantor of solvency of a person. If a person is able to pay his debt, he will be called solvent. On the other hand, if a person fails to honour its obligations, he will be called as insolvent or bankrupt. Distribution of national income. Money is helpful in measuring the contribution of national income of various parts of the country. In this way, we can assess the distribution of national income of various parts of the country. In this way, we can assess the distribution of national income among the people through money. Importance/Significance /Need of Money Money is the lubricant of an economy. Without money economic activities such as production consumption, capital formation (investment) cannot be performed. This shows that money is the life blood of an economy. Some important significance of money are given below. IMPORTANCE/ 1. Importance of money in consumption SINGIFICANCE/ 2. Importance of money is trade

NEED OF MONEY 1.

2.

3.

4.

5.

3. Importance of money in budgeting 4. Importance of money to measure national income 5 . Importance of money in production. Importance of money in consumption. As we know that money is the medium of exchange. So, we can exchange money with any commodity and services at any time and can satisfy our wants. Importance of money in trade. With the help of money, trading process becomes easy. Money can be given in the exchange of goods and received against the sale of goods. So, money is also helpful in the process of trading. Importance of money in budgeting. Government revenue and expenditures can be measured in terms of money. Economic policies of tax and interest on loan are also formulated on the basis of money. Budgets are also prepared and presented in money. Importance of money to measure national income. National income of the country is calculated in terms of money which shows the standard of living of people. Without money measurement of national income cannot be done. Importance of money is production. In production process entrepreneur has to compensate all factors of production for their contribution for which he pays rent to land, wages to labour, interest to capital and profit to enterprise. Without money we cannot assess the exact compensation of factors of production.

MONEY SUPPLY Money supply or supply of money means total amount of money available in an economy. In other words. Money supply refers to the volume of money held by the people in the country for transactions or for settlement of debts. In an economy, production consumption and capital formation (i.e. investment) are the continuing process. These transactions (i.e. sale and purchase of goods and services) depend upon money. The buyer gives money to shopkeeper for getting goods to satisfy his wants and shopkeeper uses this money to purchase other goods which are required by him. In this process of transaction, amount of money is the economy remains stables with the flow of money from one hand to another hand. Therefore, the supply of money of a country at any point of time is the total amount of money is circulation or in existence. Definitions of money supply The supply of money in an economy is the total quantity of money to exchange goods and services during the period. Thus all these things which are used as medium of exchange are called money and the total of all of them constitute the supply of money in a country during a given period. Dr. Naseem A. Azad

It includes supply of money plus deposits of the banks, building societies, loan associations and deposits of other credit and financial institutions. In real practice the deposits of non-bank financial institutions are not included in the definitions of supply of money. Gurby and Shaw Money to be supplied is defined as the currency with the public and demand deposits with the commercial banks. Demand deposits are current account of the depositors. Depositors can withdraw this amount through cheque at any time. Demand deposits with the commercial banks plus currency with the public are together denoted as M1 and the supply of money. Keynes The money supply at any time refers to literally the number of dollars (currency units) people are carrying around in their credit at banks in the form of demand deposits and also commercial bank time deposits. Milton Friedman Which is widely accepted in payments of goods or in discharge of other kinds of business obligations is called supply of money. D.H. Robertson Factors Determining /Affecting/Influencing money supply Modernisation increase the money supply for the satisfaction of production and consumption needs, because people want more money to fulfil their increasing needs and wants. Following factors are also responsible for change in money supply. 1. Central bank. Central bank is the first determinant of supply of money, because central bank is responsibilities to issue currency notes in the country. So, it may increase or decrease supply of money. 2. Commercial bank. Commercial bank of a country also affect the money supply. Amount deposited by the public may or may not be tended by the commercial banks. If commercial banks keep more amount within the bank, the supply of money will be less and vice-versa. 3. Government. Government is also responsible to make change in money supply, because government decrease money supply with the increase in public revenue charged in the form of taxes under its fiscal policy. On the other hand, if government increase its expenif government increases its expenditures by providing more salary to its employees, the money supply will increase. 4. Volume of trade. Volume of trade (i.e. volume of sale and purchase of goods and services) also affects the money supply. An increase in the volume of trade necessitates a large of money and vice-versa. 5. Balance of payment. The change in the foreign assets also changes the money supply. The foreign exchanges are available in the country to pay for imports. This will increase the

6.

7.

8.

9.

10.

money supply in the country. In order to meet this adverse balance of payment, the country will have to dispose off some of its foreign assets. There will be less money supply in the country. Velocity of circulation of money. If the velocity of circulation of money increase, the money supply also increase and the decrease in velocity of circulation of money decrease the money supply. High price level. A high price level. A high level price level of goods and services necessitates a larger supply of money of recover payment of goods and services. If the price level of commodities is lower, supply of money will also be less due to less requirement. Distribution of national income. If the distribution of national income will be unequal (i.e. high gap between have and have not) money supply requirement will be more and viceversa. Banking habits of people. This influences the currency component of money supply. Whether the currency component of money will be high or low depends upon the banking habits of the public people would prefer to conduct the transactions through cheques rather than coins and notes. Thus, we find that the supply of money varies directly with the changes in the monetary base and inversely with the currency and required reserve ratio. Amount of demand deposits. Demand deposits means the things available in place of money as a medium of exchange. High availability of demand deposits deceases the money supply and less availability of demand deposits increases the money supply. Measurement of Money supply Or money stock Measures The Reserve Bank of India has been publishing data on four alternative measures of money supply. These are M1, m2, m3, and M4 Measures of Money supply M1= C+DD+OD Here, C= Currency held by the public DD= Demand Deposits with Bank OD= Other Deposits with the RBI M2= M1+ Savings Deposits with Post Office Saving Banks M3=M2 +Net time Deposits of Banks M4= M3+Total Deposits with Post Office Saving Organisation (excluding National Saving Certificates) It should be noted that Currency includes both paper currency and coins. Demand deposits includes only net deposits with the Bank. Other deposits (OD) includes demand deposits of Financial Institutions, Foreign banks and Government, IMF World Banks etc.,M1 and M@ measure narrow money, whereas M3 and M4 measure Broad money. Ma is the most liquid and M4 is the least liquid.

BANKING- COMMERCIAL BANKS Banking is defined as the accepting for the purpose of lending or investment of deposits, money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise, commercial banks are the most important part an economy. They help as a custodian of money to traders manufacturers, producers, sellers and even a normal household. Therefore, a commercial bank is an establishment for safe custody of money. Which it pays out on customers demand. Order or otherwise institutions accepting chequable deposits and granting loans are called commercial banks. Post office saving banks are not banks, because they accept chequable deposits but do not sanction loans. In the same way, LIC is not bank because it does not grant loans in general . In modern time, the world Bank has become so popular and common that it is useless to define it. Functions of Commercial Banks Commercial banking is the most significant portion of modern banking set up. These days, the functions of commercial banks are confined not only to advance loans to the public and accepting their deposits, their contribution in accelerating the rate of economic growth in underdeveloped and developing countries like India is most effective. The most important functions of commercial banks are explained below: 1.Accepting deposits the most significant and traditional function of commercial bank is accepting deposits of public under saving account, current account and fixed deposits. They play as a custodian role of money. In monetary analysis deposits are classified as demand deposits and time deposits. Demand deposits are payable on demand through cheques or withdrawal slips. Other term deposits are called time deposits. 2. Providing loans. The second important of commercial banks is advancing loans to the public to fulfil their needs of money. Loan may be granted in the form of cash credit, ordinary loans, overdraft, discounting of bills etc., Cash credit. Under this scheme and eligible borrower is first sanctioned a credit limit upto which he may borrow from bank. The actual withdrawal depends upon the withdrawing power of the borrower. 3 . Credit creation. Money deposited by the people is given to other people in the form of loan to satisfy their wants of money. People, who take loan from banks do no to spend whole money they also deposit excess money in their bank account. The process continues. In this way money multiplies and banks make a system of credit creation. 4 . Transfer of funds. Commercial banks are also able to transfer funds of a customer to other customers account through the cheques, draft, credit card, cash order etc., Through this facility people do not worry about cash payment for purchase. 5 . Agency functions. In modern time, commercial banks also act as an agent of the customer. They accept subscription for shares from various shareholders and on behalf of their respective company. In

simple word, they sell and purchase silver, gold and securities (i.e. shares, debentures banks etc.,) on behalf of their clients. 6 . Other functions. Apart from above important and most popular functions. Commercial banks also perform some other functions, such as: 1. 2. 3. 4. 5. 6. 7. Payment or credit letters and travelers cheques. Issuing of letters of credit travelers cheques and bank drafts. Dealing in foreign exchange. Investment suggestions to clients and advisory functions. Collection of statistics regarding trade and industry. Locker services. Underwriting securities.

Consolidated Balance Sheet of Indian Commercial Banks Liabilities 1. Capital 2. Reserves and surplus 3. Deposits 4. Borrowings 5. Other liabilities Total Liabilities Amount 21,472.67 62,686.91 12,02,699.42 1,07,180.18 14,143.95 15,35,513.13 % to Total 1.40 4.08 78.33 6.98 9.21 100.00

Assets 1. 2. 3. 4. 5. 6.

Cash balance with RBI Balances with banks and money at call and short notice Investments Loans and advances Fixed assets Other assets Total Assets

Amount 86,760.51 1,17,518.25 5,88,058.29 6,45,743.04 20,083.74 77,349.74 15,35,513.13

% of Total 5.65 7.65 38.30 42.05 1.31 5.04 100.00

It may be observed from the above consolidated balance sheet that Deposits constitute 78.33% of the total liabilities followed by borrowing about 7%. The assets side shows that loans and advances constitute 42% followed by investments worth38%.

CENTRAL BANK A central bank refers to the bank established to control credit creation and regulation of currency of country. In simple words, a bank which has not engaged itself in ordinary banking activities such as accepting deposits and advancing loans to the public, known as Central bank, It does not aim to making profits like the commercial banks, rather, it aims at controlling the commercial banks and implementing the economic policies of the government. The central bank is owned and managed by the government of the country and used for official purposes of the country. Every country has its only one central bank which is known with different names in different countries. For instance Indian central banks is known as Reserve bank of India Sweden central banks is called Riks Banks of Sweden The Bank of France in France. The Bank of England in England; The Federal Reserve Bank of USA in USA etc., Riks Bank of Sweden was the first central bank of the world which was established in 1668. After that, every country had participated in the race of establishment of Central bank. Such as central bank of Engalnad (1694) ; France (1800); Netherland (1814); Russia (1860); Germany (1875); Japan (1881); USA (1913); Canada (1934); India (1935). Definitions of Central bank Certain important definitions of central bank are: The central bank is the bank which controls the whole economy of the nation and has a monopoly of note issue and rate over the all of banks of the country. Dr. Naseem A. Azad. The central bank is the organ of government that undertakes the major financial institutions so as to support the economic policy of the government. Sayers A central bank is to help control and stabilize the monetary and banking system. A.C.H Day A Central bank is to bank which controls credit N.A Shaw

A central bank is a bank of bankers. Its duty is to control the monetary base and control of this high powered money to control the communitys supply of money. Samuelson A Central bank is that which is the lender of the last resort. Functions of Central bank. Central bank of every country is established with view to regulate currency notes and money supply in the economy. Some important functions of a central bank are given below:

1. Issue of currency. The first and foremost important function of central bank is to issue currency notes. It has its various departments which issue currency notes and coins for the public of a country. 2. Credit control. Central bank controls credit creation capacity of commercial bank to control inflationary and deflationary gap of the economy. For this purpose. It adopts quantitative and qualitative methods of monetary policy which have been discussed in the previous chapter. 3. Banker to the government. The Central Bank acts as a banker to the government, both central and state governments. It carries out banking business of the government and the government keeps its cash balances on current account with the central bank. It accepts government deposits and grants loans. 4. Banker of banks. A central bank is bank of government and other commercial banks of the country. It grants loans to the commercial banks to fulfil their needs of funds. It is not for the common people the country. The Central banks holds a part of the cash reserve of banks, lends them short terms funds and provides them with centralized clearing and remittance facilities. The Central Bank has to supervise, regulate and control the commercial banks. 5. Lender of last resort. The central bank lends to such institutions in order to help them at times of stress, so as to save the financial structure of the nation from collapse. The central acts as lender of the last resort through discount house on the basis of treasury bill, government securities and bonds at the front door. 6. Custodian of foreign exchange reserves. Central bank of a country manages and controls the foreign exchange reserve and gold. It can sell gold to get foreign exchange and also can purchase foreign currencies at international prices. 7. Other functions. Apart from above primary functions, a central bank also performs the following subsidiary functions: (I) Dealing in foreign exchange (II) Discounting bills of different banks (III) Dealing in government securities (IV) Accepting deposits without interest. (V) Managing agricultural credit. (VI) Managing developmental industrial and commercial activities in India Forbidden Functions While a central bank performs essential functions for a country, but a central bank cannot perform the following functions. (i) (ii) (iii) (iv) (v) It cannot grant loans credit facilities directly to customers It cannot allow interest on deposits It cannot subscribe for shares of any company It cannot grant loans on the security of movable property It cannot work in the field of industry and trade.