S.no GB) Particulars Pg.no. Remarks Introduction Barter System Evolution of Money | Types of Money Functions of Money Supply of Money _ = Seen om di. Measures of Money The Central Bank Commercial Bank Money Creation by _Commercial Banks Credit Control Measures2 The word "money" is believed to originate from a temple of Juno, on Capitoline, one of Rome's seven hills. In the ancient world Juno was often associated with money. Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. Money and banking are related to each other in many ways. In today’s progressive world, the banking sector has become the backbone of every economy worldwide just like blood is to the veins and unique because of its formation, staffing and extraordinary services rendered by the industry. Banking sector works in the best interest of the country and due to their contribution in the financial stability, banking is highly regulated in most of the countries. When the banking industry was born the primary job of banks was to mobilize money from individuals and lend most of the money to the companies. The biggest strength of an entity is the steadiness and banking sector has consistently performed better than others around the world over a few decades.Barter System Before money was invented, the primitive world’s trade was carried out according to the barter system of exchange. In the beginning of civilization, human needs were simple and limited. People used to exchange goods with each other to satisfy their wants. Barter Exchange refers to exchange of goods for goods. An economy, where there is a direct barter of goods and services, is called a ‘Barter Economy’ or ‘C-C Economy’ (where C stands for commodity). Barter System can work when there exists ‘Double Coincidence of Wants Drawbacks of Barter System 1.Lack of Common Measure of Value: The absence of a common unit of measurement to evaluate the goods for exchange makes proper accounting impossible. 2.Lack of Store of Value: In barter system, it was not possible to store things for future because many of the goods are perishable in nature. 3.Lack of standard for deferred payments: In barter system, it was not possible to make future payments or contractual payments.4 Evolution of Money Commodity money Metallic Money Paper Money Credit Money or Bank money | Plastic Money E-money§ Ci Tynes of Money 1. Commodity money: The different types of goods durable in nature ‘were commodity money used in ancient times. These types of commodity money lacked uniformity and were not usable in all societies. hey had more or less importance in different communities. There was difficulty in store measurement of value and transfer from one place to another place. 2. Metallic money: Money made up of metals is called metallic money. It was introduced to overcome the problems in the use of commodity money. There are two types of metallic money. They are: * Standard metallic money: It is metallic money made up of pure and superior metals like gold and silver. + Token money: It is metallic money made up of impure and inferior metals. 3. Paper money: Paper money is a country’s official, paper currency that is circulated for transaction-related purposes of goods and services. The printing of paper money is typically regulated by a country's central bank or treasury in order to keep the flow of funds in line with monetaryHi policy. Paper money tends to be updated with new versions that contain security features that seek to make it more difficult for counterfeiters to create illegal copies. 4. Credit money: Credit money is any future monetary claim against an individual that can be used to buy goods and services. There are many forms of credit money, such as IOUs, bonds and money market accounts. Virtually any form of financial instrument that cannot or is not meant to be repaid immediately is credit money. It is an instrument which is equivalent to money. 5. Plastic money Plastic money is a term that is used predominantly in reference to the hard- plastic cards we use every day in place of actual bank notes. They can come in many different forms such as cash cards, credit cards, debit cards, pre-paid cash cards and store cards. 6. E-money: Electronic money refers to money that exists in banking computer systems that may be used to facilitate electronic transactions. Although its value is backed by fiat currency and may, therefore, be exchanged into a physical, tangible form, electronic money is primarily used for electronic transactions due to the sheer convenience of this methodology.5 Functions of Money 1.A medium of Exchange: In an exchange economy, money plays an intermediary role. It makes the exchange system smooth and convenient. 2.A measure of Value: The value of a product or service is determined on the basis of the money needed for its possession. This helps in making the exchange a mutually profitable activity. 3.The Standard of Deferred Payments: Money plays an important role in lending and borrowing. Money is taken as a loan and repaid after a time-gap. 4.Store of Value: You can store the purchasing power of money and keep a part of it for future use —- monetary savings. You can use your current income for current consumption as well as _ future consumption through savings.Hi 8 Supply of Money The total stock of money circulating in an economy is the money supply. The circulating money involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets. Valuation and analysis of the money supply help the economist and policy makers to frame the policy or to alter the existing policy of increasing or reducing the supply of money. The valuation is important as it ultimately affects the business cycle and thereby affects the economy. Periodically, every country’s central bank publishes the money supply data based on the monetary aggregates set by them. In India, the Reserve Bank of India follows MO, M1, M2, M3 and M4 monetary aggregates. Sources of Money Supply: e Government (which Issues one-rupee notes and all other coins) e RBI (which issues paper currency) e Commercial banks (which create credit on the basis of demand deposits)9 Measures of Money 1.M,;=C+DD+0OD Here C denotes currency held by public, DD stands for demand deposits in banks and OD stands for other deposits in RBI. 2.M2 = M; (detailed above) + saving deposits with Post Office Saving Banks 3.M3= Mi; + Net Time-deposits of Banks 4.Ms = Mz + Total deposits with Post Office Saving Organisation (excluding NSC) Savings deposits of post offices are not a part of money supply because they do not serve as medium of exchange due to lack of cheque facility. Similarly, fixed deposits in commercial banks are not counted as money. Therefore, M; and M2 may be treated as measures of narrow money whereas M3; and M, as measures of broad money. In practice, M; is widely used as measure of money supply which is also called aggregate monetary resources of the society. All the above four measures represent different degrees of liquidity, with Ms being the most liquid and M4 is being the least liquid. It may be noted that liquidity means ability to convert an asset into money quickly and without loss of value.10 H The Central Bank The Reserve Bank of India (RBI) is India’s central bank, also known as the banker’s bank. The RBI controls monetary and other banking policies of the Indian government. The Reserve Bank of India (RBI) was established on April 1, 1935, in accordance with the Reserve Bank of India Act, 1934. The Reserve Bank is permanently situated in Mumbai since 1937. The Reserve Bank is fully owned and operated by the Government of India. The Reserve Bank’s operations are governed by a central board of directors, RBI is on the whole operated with a 21- member central board of directors appointed by the Government of India in accordance with the Reserve Bank of India Act. The Central board of directors comprise of: ¢ Official Directors - The governor who is appointed/nominated for a period of four years along with four Deputy Governors ¢ Non-Official Directors - Ten Directors from various fields and two government Official The primary objectives of RBI are to supervise and undertake initiatives for the financial sector consisting of commercial banks,11 Ci financial institutions and non-banking financiat companies (NBFCs). Some key initiatives are: « Restructuring bank inspections « Fortifying the role of statutory auditors in the banking system The Reserve Bank of India comes under the purview of the following Acts: « Reserve Bank of India Act, 1934 Public Debt Act, 1944 Government Securities Regulations, 2007 Banking Regulation Act, 1949 Foreign Exchange Management Act, 1999 Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 * Credit Information Companies(Regulation) Act, 2005 « Payment and Settlement Systems Act, 2007 Major Functions of RBI are: « Monetary Authority: Formulating and implementing the national monetary policy. Maintaining price stability across all sectors while also keeping the objective of growth. « Regulatory and Supervisory: Set parameters for banks and financial operations within which banking and financial systems function. Protect investors interest and provide economic and cost-effective banking to the public.12 Hi « Foreign Exchange Management: Oversees the Foreign Exchange Management Act, 1999. Facilitate external trade and development of foreign exchange market in India. « Currency Issuer: Issues, exchanges or destroys currency and not fit for circulation. Provides the public adequately with currency notes and coins and in good quality. * Developmental role: Promotes and performs promotional functions to support national banking and financial objectives. ¢ Chief Banker to all banks: Provides banking solutions to the central and the state governments and also acts as their banker. It maintains banking accounts of all scheduled banks. RBI Annually publishes Annual Report, Report on Trend and Progress of Banking in India, Lectures, Report on Currency and Finance, Handbook of Statistics on the Indian Economy, State Finances: A Study of Budgets, Statistical Tables Relating to Banks in India and Basic Statistical Returns.13 Ci Commercial Bank Commercial banks are the most important components of the whole banking system. A commercial bank is a profit-based financial institution that grants loans, accepts deposits, and offers other financial services, such as overdraft facilities and electronic transfer of funds. In other words, commercial banks are financial institutions that accept demand deposits from the general public, transfer funds from the bank to another, and earn profit. Commercial banks play a significant role in fulfilling the short-term and medium- term financial requirements of industries. They do not provide, long-term credit, so that liquidity of assets should be maintained. The funds of commercial banks belong to the general public and are withdrawn at a short notice; therefore, commercial banks prefer to provide credit for a short period of time backed by tangible and easily marketable securities. Commercial banks, while providing loans to businesses, consider various factors, such as nature and size of business, financial status and profitability of the business, and its ability to repay loans. Commercial banks mark significant importance in the economicA development of a country as well as serving the financial requirements of the general public. Commercial banks are of three types, which are as follows: « Public Sector Banks: Refer to a type of commercial banks that are nationalized by the government of a country. In public sector banks, the major stake is held by the government. In India, public sector banks operate under the guidelines of Reserve Bank of India (RBI), which is the central bank. Private Sector Banks: Refer to a kind of commercial banks in which major part of share capital is held by private businesses and individuals. These banks are registered as companies with limited liability. « Foreign Banks: Refer to commercial banks that are headquartered in a foreign country, but operate branches in different countries. In India, since financial reforms of 1991, there is a rapid increase in the number of foreign banks. Functions of Commercial Banks: (i) Accepting Deposits: Implies that commercial banks are mainly dependent on public deposits. There are two types of deposits, which are discussed as follows: « Demand Deposits ¢ Time Deposits15 The process of money creation by the commercial banks starts as soon as people deposit money in their respective bank accounts. After receiving the deposits, as per the central bank guidelines, the commercial banks maintain a portion of total deposits in form of cash reserves. The remaining portion left after maintaining cash reserves of the total deposits is then lend by the commercial bank to the general public in form of credit, loans and advances. Now assuming that all transactions in the economy are routed through the commercial banks, then the money borrowed by the borrowers again comes back to the banks in form of deposits. The commercial banks again keep a portion of the deposits as reserves and lend the rest. The deposit of money by the people in the banks and the subsequent lending of loans by the commercial banks is a never-ending process. It is due to this continuous process that the commercial banks are able to create credit money a multiple time of the initial deposits. Suppose, initially the public deposited Rs. 10,000 with the banks. Assuming the Legal Reserve Ratio to be 20%, the banks keep Rs. 2,000 as minimum cash reserves and lend the balance amount of Rs. 8,000 (Rs. 10,000 — Rs. 2,000) in form of loans and advances to the general public. Now, if all the HiCi », Credit Control Measures Quantitative or General Methods 1.Bank Rate Policy: The bank rate is the rate at which the Central Bank of a country is prepared to re-discount the first-class securities. As the Central Bank is only the lender of the last resort the bank rate is normally higher than the market rate. 2.Open Market Operations: This method of credit control is used in two senses: narrow sense and broad sense. In narrow sense—the Central Bank starts the ]@erchase and sale of Government securities in the money market but in the Broad Sense—the Central Bank purchases and sale not only Government securities but also of other proper and eligible securities like bills and securities of private concerns. 3.Variable Cash Reserve Ratio: Under this system the Central Bank controls credit by changing the Cash Reserves Ratio. For example—If the Commercial Banks have excessive cash reserves on the basis of which they are creating too much of credit which is harmful for the larger interest of the economy. So, it will raise the cash reserve ratio which the Commercial Banks are required to maintain with the Central Bank. Similarly, when the Central17 A Bank desires that the Commercial Banks should increase the volume of credit in order to bring about an economic revival in the country. The Central Bank will lower down the Cash Reserve ratio with a view to expand the cash reserves of the Commercial Banks. Qualitative or Selective Method of Credit Control -Rationing of Credit: Under this method the credit is rationed by limiting the amount available to each applicant. The Central Bank puts restrictions on demands for accommodations made upon it during times of monetary stringency. In this the Central Bank discourages the granting of loans to stock exchanges by refusing to re-discount the papers of the bank which have extended liberal loans to the speculators. This is an important method of credit control and this policy has been adopted by a number of countries. 2.Direct Action: Under this method if the Commercial Banks do not follow the policy of the Central Bank, then the Central Bank has the only recourse to direct action. This method can be used to enforce both quantitatively and qualitatively credit controls by the Central Banks. This method is not used in isolation; it is used as a supplement to other methods of credit control. This method can be successful only when the Central Bank is powerful enough and has cordial relations with the Commercial Banks. _3.Moral Persuasion: This method is frequently adopted by the Central Bank to exercise control 18 over the Commercial Banks, Under this method Central Bank gives advice, then request and persuasion to the Commercial Banks to co- operate with the Central Bank is implementing its credit policies. If the Commercial Banks do not follow or do not abide by the advice or request of the Central Bank no gross action is taken against them. 4.Method of Publicity: In modern times, Central Bank in order to make their policies successful, take the course of the medium of publicity. A policy can be effectively successful only when an effective public opinion is created in its favour. 5.Regulation of Consumer’s Credit: Under this method consumers are given credit in a little quantity and this period is fixed for 18 months; consequently, credit creation expanded within the limit. This method was originally adopted by the U.S.A. as a protective and defensive measure, there after it has been used and adopted by various other countries.