Chapter 3

What Is Money?
Meaning of Money

• Money (money supply)—anything that is

generally accepted in payment for goods
or services or in the repayment of debts;
a stock concept
• Wealth—the total collection of pieces of
property that serve to store value
• Income—flow of earnings per unit
of time

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Functions of Money

• Medium of Exchange—promotes economic efficiency

by minimizing the time spent in exchanging goods
and services
 Must be easily standardized
 Must be widely accepted
 Must be divisible
 Must be easy to carry
 Must not deteriorate quickly
• Unit of Account—used to measure value in
the economy
• Store of Value—used to save purchasing power; most
liquid of all assets but loses value during inflation
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Evolution of the Payments System

• Commodity Money
• Fiat Money
• Checks
• Electronic Payment
• E-Money

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What Gives Money Its Value?

Our money today has value because of

its general acceptability.
 Money Supply – M1

• M1 = Currency in circulation
• + Demand/Checkable deposits

Currency includes coins and paper money (Bangladesh

Bank notes and Government notes)
Checkable deposits are deposits on which checks can be
written
 Money Supply – M2

• M2 = M1 + Time Deposits (Fixed Deposits)

Time Deposit is an interest/profit earning deposit with a

specified maturity date.
Are Credit and Debit Cards
Money?
Credit card use represents loans which
must be repaid. They represent the use
of someone else's money.
Debit cards give access to checkable
deposits which are already part of the
money supply.
Fractional Banking

 On an average day, very few people came to

redeem their gold receipts.
 Some goldsmiths began lending out some of
the stored gold, issuing additional receipts
instead of gold, and earning interest.
 This was the beginning of “fractional reserve
banking*.”
* A banking arrangement that
allows banks to hold reserves
equal to only a fraction of their
deposit liabilities.
Bank Reserves

• Reserves - The sum of bank deposits at

Bangladesh Bank and vault cash.
• Required Reserve Ratio (r) - A percentage of
each taka deposited that must be held as
reserve.
• Required Reserves - The minimum amount of
reserves a bank must hold against its
checkable deposits as mandated by
Bangladesh Bank.
• Excess Reserves - Any reserves held beyond
the required amount. The difference between
(total) reserves and required reserves.
 Reserve Ratios in Bangladesh

Statutory Liquidity Requirement (SLR): The

term used by Bangladesh Bank for reserve.

Cash Reserve Requirement (CRR): CRR is a

part of SLR that must be held in cash.
Reserve Ratios in Bangladesh

 For interest based banks: Currently SLR is

18.5% of which CRR is 5.5%. That means
each commercial bank has to keep at least
18.5% percent of its total collected deposits as
reserves. Say Bank Z collects 100 crore taka
from its depositors then Bank Z has to keep
18.5 crore taka as reserves. Out of this 19.5
crore taka, at least 5.5 crore taka has to be
kept in cash (CRR) with Bangladesh Bank and
the commercial bank will not earn any interest
on this amount. The rest 13% can be kept as
government securities which provides interest.
Reserve Ratios in Bangladesh

For interest free (Islamic) banks:

SLR: 5.5%
CRR: 5.5%
Bank Reserves

• Reserves = SLR + Vault cash

• Required reserves = r x Checkable
deposits
• Excess reserves = Reserves - Required
reserves
 The Banking System Creates
Checkable Deposits (Money)

The required
reserve ratio is 10
percent.
Assume that there
is no cash leakage
and that excess
reserves are fully
lent out; that is,
banks hold zero
excess reserves.
Simple Deposit Multiplier

• Maximum change in checkable deposits = (1/r ) x

ΔR where r = the required reserve ratio and ΔR =
the change in reserves resulting from the original
injection of funds.
• In the previous example:
• Maximum change in checkable deposits =
• = (1 / 0.10) x Tk.1,000
• = 10 x Tk.1,000
• = Tk.10,000
• In the equation, the reciprocal of the required
reserve ratio(1/r ) is known as the simple deposit
multiplier