Question: 2 explain briefly the money supply process, indicating the

importance of cash ratio. What are the implications for this process of
significant bad debts on loans?
Economists typically defines money as the widely accepted means of payment. Basically money
is anything that could be used to buy goods and services. Now it is clear from this definition that
currency i.e. paper bills and coins, they are definitely money. Most of your payments however
probably made by writing a cheque or using a debit card. Both of this transfer funds from your
bank accounts to seller bank accounts. Making payments through debit card or writing a cheque
is known as checking accounts. Checking accounts are also considered to be as Money. Now for
saving account it is a little bit tricky. Technically you can’t use the funds to buy goods and
services directly. But in practice it is just so easy to move funds from saving accounts to
checking accounts. Therefore we can also define saving accounts to be Money. For same
reasons we often define Money Market Mutual Funds to be money. The basic idea then is this we
count as money “Any asset that is widely used as means of payments for services and goods OR
any asset that can be easily converted into the widely used means of payment with loss in value.
So it is not written on stone that what exactly money is? There could be a Judgement Call. As a
result economists have defines several different measures of the supply of money. This Money
supply process is discussed below.

 What is Money Supply Process?

Money supply is the value of total available money i.e. cash or currency and other liquid
assets that is in circulation in the economy of the country at a certain point of time.
Money supply is also known as money stock. It includes roughly both the deposits that
can be easily used as easy as the cash and the cash itself and it tells us how much physical
currency and assets that can be liquidated easily, are existed in the economy of the
country at a certain particular point of time. This data is usually measured by the central
bank and the way it is measured may vary country to country.
Economists analyze the basic concept of the money supply and thus they develop certain
policies that revolves around it through controlling the inflation and the interest rate and
decreasing or increasing the amount of the money that flows in the economy. Also
private and public sectors are analyzed because money supply possibly affect the level of
prices, business cycle and inflation. For example, In US, for the money supply the most
important crucial factor is Federal Reserve policy
Today in most of the countries, central bank and other institutions are charged with
issuance of domestic currency. This charge is considered to be very important because
the money supply directly influence the inflation and the interest rates and ultimately the
aggregate of the output. If the monetary policy of the central bank is good, if it creates the
 right money’s amount, then the economy will hum and then it decreases the inflation and
the interest rate. And if monetary policy creates too quickly too much money, then there
will be the rapid increase in the prices and this will wipe out the savings of the people
until it converts the poorest into the nominal billionaire i.e. Zimbabwe is the example of
such situation. And if it creates money too little and too slowly, then it will wiping out
the debtors and prices will decreases and it became nearly impossible to earn profit from
the business. Therefore in order to avoid such issues, every individual must have to
understand that what is money supply process?
Money supply ultimately is determined by the four groups’ interaction: commercial
banks and other financial depositories, borrowers, depositors and the central bank itself.
Central bank is the part of the government but like every other bank the balance sheet of
the central bank consists of two parts: assets and liabilities. The asset side is same i.e.
consists of government securities. However the liabilities side is different. It consists of
reserves and currency in circulation. Government issues the coins and paper currency
through the combination of treasuries and central bank. Money supply that is available to
the people is influences by the bank regulators via requirements placed on the bank to
hold the reserves. It is the responsibility of the central bank to bring the money into the
banking system. The central bank have a direct control over the monetary base. It is also
known as the high powered money because money stock act as the base with which
bigger stocks of monetary assets are created.

 Effects of Money Supply Process on the Economy

Typically whenever the supply of money increases then it decreases the rate of interest,
which in return produces more investment and consumers will get more money, thus
spending stimulates. Consumers or businesses responds by increasing the production and
ordering more and more raw materials. The significant increase in the business activity
increases the demand for the labour. The opposite of this entire process can also occur if
the supply of the money decreases or when the growth rate starts declining.
Historically, whenever the money supply is going to be measured then it shows that the
relationship exits between the Money Supply and Price levels and inflation. However
these relationship become highly unstable since 2000 and thus reliability of these factors
are reducing that are used for monetary policy’s guide. The measures of money supply
are widely used. They are undoubtedly one of the large data collection of the economy
that is collected and reviewed by the Federal Reserve and economists.

 How Money Supply is Measured

There are various types of money in the money supply process that are classified
generally as “Ms” i.e. MB, M0, M1, M2 and M3. They differ from each other on the
 bases of size and type of the account. All of these classifications are not widely used.
Each county however may use different classifications. The supply of money reflects that
each type of money have different liquidity potential in the economy. In Ireland, in order
to measure the supply of money, M1, M2 and M3 are used for calculating the money
supply of the economy
M0 and M1 are also known as narrow money that consists of the most liquid liabilities.
For example overnight deposits and currency and overnight deposits that can be easily
converted into the cash. M2, the intermediate money includes the M1 plus short-term
time deposits (whose maturity period is less than two years or having a notice period of
less than three month) and certain funds of money market. M3, the broad money includes
M2 plus long term deposits whose maturity time is up to two years, repurchase
agreements, shares of the the money market and paper of the money market.
The data of the money supply is collected, recorded and published by the central bank or
government of the country periodically. In Ireland the data of M1, M2 and M3 is
recorded and published every quarterly i.e. after every 3 months and this data can be
found online so easily.

 Importance of Cash Ratio in Money Supply Process:

Cash ratio or reserve ratio are the important part of operational framework of the central
bank’s monetary policy that is used to regulate the inflation’s level, liquidity and money
supply in the county. Cash ratio (ratio of cash to total liabilities that specified an amount
a bank will hold) determines how much credit a bank will create from the deposits. It also
explains the profitability of the bank. The bank is considered to be less profitable if the
cash ratios are higher because the higher the ratio of cash, the smaller will be the amount
of cash that is available for the banks for investing and lending. However high securities
will be achieved if cash ratios are higher.
Whenever we talk about the cash ratio or reserve ratio then what ever deposits comes in
the bank then they will split into two reserves:

1- Required Reserves: Required reserves is the compulsory percentage of the money

that should be hold by the banks for daily transactions

2- Excess Reserves: After required reserves we have excess reserves. So whatever

money is left it goes in excess reserves.
So if the bank want to give a loan to other parties or do some investments then they
can use excess reserves. But in excess reserves it is the condition that bank should
have to invest a certain amount of money in the assets that are most liquid in nature
because if bank is going to face the problems like bankruptcy or shortage of money or
 insolvency then bank can immediately sell those liquid assets and save themselves
from insolvency.
During the time of inflation, attempts are made in order to reduce the level of flow of
money supply in the economy. For this the central bank increases the cash ratios in
order to decrease the amount of loanable funds that are available with the banks. This
in return reduces the investment and lowering down the money supply in the
economy. This scenario impacted the growth of the economy negatively. However
this helps us also to bring down the inflation in the economy.
On the other hand whenever central banks needs to inject the funds into the system, it
decreases the cash ratio. The decrease in the cash ratio will increases the amount of
the funds that can be loan out with the bank. Thus the bank can grant the large
number of loans to industry and businesses for the purpose of different investments.
Also it boost up the overall money supply in the economy and this at the end
increases the rate of growth of the economy.

 The Implications For Money Supply Process Of Significant Bad Debts

On Loans:
All the banks always want that in their balance sheet there should not have any amount
that is recorded as “Bad Debts”. Bad debts is the share of a loan or loan’s portfolio that
is considered to be “Uncollectable” by the lender. It creates a negative and a very bad
impression about the bank’s loan portfolios (they are the primary assets and the main
source of their revenue in future) in the public’s eyes. Toxic Loans (these are the loans
that have a very little chance of being collected with the interest) reflects the financial
performances of the bank very poorly and harmfully affects the bank’s prestige.
Therefore bank write-off these toxic loans as the reputation of the bank is very badly
damaged by them. Banks made all possible efforts to recover the dues of the loans before
they completely written off the bad debts amount from the accounts’ books. After making
all the exhausting efforts to recover the dues of the loan, if the auditor or branch
managers thinks that the chances of the recovery of the loan dues are very remote and
doubtful, then auditors are highly recommended to make a suitable debt’s provisions.
After sometime if the branch still finds out that the chances for the recovery of the loans
are almost zero or nil then the bank finally write off the loan amount.

 How to Prevent Or Limit the Bad-debts on Loans:

In the banking system, there is a certain restrictions on the bank that they can’t
lend the entire amount of deposits as a loan. In the recession people wants to be
save instead of borrowing the loan from banks. Also banks don’t want to lend the
money because they feels that individuals or firms during recession may more
 expected to default. Thus in recession the banks ultimately ends up with the
highest rate of the cash ratio or reserve ratio. And when such type of ratios are
implemented then obliviously government will not going to take a risk and will
not going to spend on risk taking projects and will not going to grant a loan to
everyone easily. Because if the money is going to be defaulted after investing in
any business or granting a loan. Then it become a bad-debts for the bank. Central
bank should have to control such ratios in order to avoid bad debts. Then
obviously commercial banks also do secure investments or grant loans. The more
commercial banks do secure investments, the more it will reduce the chances of
bad debts.

References:
https://cleartax.in/s/cash-reserve-ratio-crr