Barter system:-
Exchange of goods is called Barter S called a C-C Economy i•e ystem and an Econom Commodity for Commodity Exchand om Econ ominated by Barter exchange is .
Definition of Money
Various types of definition of money are:
(i) Legal Definition of money:
According to law, “Money is what the law says it is”.
Money has legal tender power.
That is, it can be used to discharge debts. Legally money can be of two kinds:
(a) Legal Tender Money: It means money under the law of land.
The government issues an order stating what is money? and that becomes legal tender money. Currency (coins and notes) is legal tender money.
It is also called fiat money because it serves as money in the fiat or order of the government.
The legal tender status given by the government to money may be limited or unlimited.
(b) Non-legal Tender Money: It is optional and voluntary money which is generally accepted as money on the basis of trust that their issues commands.
For example, drab., cheques, bill of exchange, etc.
It is also called fiduciary money because it is accepted as money on trust.
(ii) Functional definition of money: Money is what money does.
It is based on the four functions of money. Anything which is generally accepted in payment of debt and as payments of goods and services should be included in money supply.
Alternatively if a good is generally used as medium of payments, it should be treated as money no matter what its legal status is.
It includes coins, notes and chequable deposits.
Representative Full-bodies Money
It is paper money.
It has no value as a commodity but it represents in circulation an amount of money with a commodity value equal to the equal value of money. its advantage is that it is portable (easy tocarry).
It is hundred percent backed up by metallic reserves and is fully redeemable in some precious metal.
It is equivalent to a circulating warehouse receipt for full-bodies coins or their equivalent in bullion.
The benefits of representative paper money is that it can be conveniently used in trade in which large sums of money are required.
Credit Money
Credit money refers to money whose value as money is greater than the commodity value of the material from which the money is made, e.g. token coins, currency notes, cheques etc. Since it is made of cheap metal or paper content.
Credit money is of various forms as shown below:
(i) Token coins: Token money (or coins) refers to money whose face value is much greater than its intrinsic value. All Indian coins like those of Rs.5,Rs.2,Rs.1, paise 50, paise 10 etc. are token coins since their Value as money is far above than the valuer the coins,
Meaning of Money Supply
This supply of money means the total stock of all forms of money ( paper money, coins demand deposits of banks) which are held by the public at any particular point Of time
Features of Money Supply
1. It includes ‘money held by public only’ and excludes any money held by the supplier of money (government of the country, central bank and commercial banks).
2. It is a ‘stock concept’, i.e. it is concerned with the volume of money held by public at a particular point of time.
3. In India there are four concepts of money supply M1 , M2 , M3 arid M4.
(i) M1 includes those assets which can be directly used for transaction.
It is also called transactions money.
The emphasis in the definition is on ‘directly used’.
It means that M1 is met by
(a) currency and
(b) chequable deposits
(c) other deposits
(a) Currency M = C + DD + OD
Currency includes coins and currency notes. Currency is also called fiat money.
Fiat money or currency is defined as the money which, under law, must be accepted for all.debts.
M1 includes only that currency which is held outside banks.
It means that currency held by banks is not included.
It also means that M, includes currency held only by the public.
(ii) M-2 = M, + savings deposits with Post Office Saving Banks.
(iii) M3 ,M, + Net time-deposits with Commercial Banks. (iv) M4 = M3 + Total deposits with post office saving
organization (excluding NSC) (This is still broader – broader than even M3).
Banking
A commercial bank is an institution which performs the functions of accepting deposits, granting loans and making investments, with the aim of earning profits.
Therefore, a financial institution can be a banking institution, only when it performs the functions of ac; opting deposits and advancing loans.
| Demand deposit | Time deposit |
| Demand deposit refers to those deposits witch are repayable by the banks on demand. | Fixed deposits refer to those deposits which are made for a fixed period of time. |
| They are chequeable deposits. | The are non- chequeable deposits. |
| Demand deposits do not carry any interest. | Fixed deposits carry interest which varies directly with the period of time. |
| The depositor can make any number of transactions for deposits or withdrawal of money. | Deposits generally makes only two transactions (i) deposit of money on maturity. |
Advancing of Loans
It gives loan and advances particularly to businessman and entrepreneurs and thereby earn interest.
This is. in fact, the main source of income of the bank.
A bank keeps certain portion of the deposits with itself as reserve and gives (lends) the balance to the borrowers as loans and advances in the following form.
(i) Cash Credit: An eligible borrower is first sanctioned a credit limit and within that limit he is allowed to withdraw a certain amount on a given security.
The withdrawing power depends upon the borrower’s current assets, the stock statement of which is submitted by him to the bank as the basis of security.
Interest is charged by the bank on the drawn or utilized portion of credit (loans).
(ii) Demand Loans: A loan which can be recalled on demand is called demand loan.
There is no stated maturity. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrow.
Security brokers whose credit needs fluctuate generally take such loans on personal security and financial assets.
(iii) Short-term Loans: Short-term loans are given against some security as personal loans to finance working capital or as priority sector advances.
The entire amount is repaid either in one installment or in a number of installments over the period of loan.
Central Bank
The central bank is the apex institution of monetary system of a country.
It is banker to the maintains other banks and to government.
It issues notes, controls money supply and credit, and maintain monetary stability.
Functions of Central Bank
1. Issuer of Currency
1. The central bank is given the sole monopoly of issuing currency in order to control over volume of currency and credit. These notes circulate throughout thesecure country as legal tender money.
2. Note-issuing is governed by Minimum Reserve System. It has to keep a reserve in the form of gold and foreign securities as per statutory rules against the notes issued by it
3. RBI issues all currency notes in India from Rs.2 and above and Rs.1 note and small coins are issued by govt mints.
4. Central government of a country is usually authorized to borrow money from the central bank.
When central government expenditure exceeds government revenue and govt. is unable to reduce its expenditure, then it borrows from RBI.
This done by selling security bills to RBI which creates new currency notes for tile purpose. This is called monetization of budget deficit or deficit financing.
5. There are two reasons for giving the monopoly power of note issue is given to the central bank.
(i) It brings about uniformity in note circulation.
(ii) It gives a central bank some direct control over ‘money supply’.
2 Banker Agent and Advisor to Government
Banker
A central, bank conducts the banking accounts of government departments. It accepts their deposits and undertakes inter-bank transfers.
It also gives loans to the government.
Agent
A central bank also provides various services as ‘lie government.
It manages public debit
It undertakes patent of interest on this debt, and ,all sorts of other services relating to Public debt.
Advisor
Central Bank acts as the adviser to the government it after examining the situation in the market advice the government what kind of fiscal policy should he followed.
Banker’s Bank and Supervisor
1.Custodian of Cash Reserve: The central bank is a reservoir of the cash reserves of commercial banks. Commercial banks maintain a certain proportion (Cash Reserve Ratio, i.e. CRR)
2. Lender of the Last Resort: When commercial banks fail to meet their financial requirements from other sources, they can approach the central bank which gives loans and advances as lender of the last resort.
The rate, at which the central bank advances loans to commercial banks, is known as bank rate.
Central bank assists these banks through discounting of approved securities and bills of exchange.
The direct lending to commercial banks by central bank is referred to as the ‘lender of the last resort function of a central bank
3. Bank of central clearance
A bank may recourse chequing claims of another bank so in this cash central bank acts as a clearing house.
Central bank holds cash recourse of all bank so it become easy and convey for central hank to act as a clearing house.
All commercial bank have their account with central bank so central Bank ran easily settle their claims against another bank by making entries of debit and credit
Custodian of Foreign Exchange Reserve
I. The, central bank acts as the custodian of the country’s stock of gold and key currencies like currencies Dollars, British pounds and other prominent currencies.
2. All foreign exchange transactions are routed through the central bank.
It means, all payments in foreign exchange are made by this bank and all earnings in foreign exchange transaction are to be deposited in the market.
3. Central Bank is responsible for keeping the external value of country’s currency stable.
In case of any fluctuations, the central bank, in order to minimize them, may have to buy or foreign currency in the market.
The purpose of maintaining cash reserves was 2 fold
1) to maintain confidence in domestic currency
2) To meet emergency requirement of foreign exchang
Bank Rate Policy
1. Bank rate refers to the rate at which the central bank lends money to commercial banks as the lender of the last resort.
The bank rate is announced by the central bank at regular intervals in response to the needs of money market.
2. Bank rate and Rate of interest: Bank rate is the rate at which the central bank lends to commercial banks bank lend to their customers.
Bank rate and rate of interest directly related.
If there is an increase in the bank rate, then commercial banks more for the financial accommodation by the central bank.
As a result they would rise the rate of interest.
3. Central Bank tries to control credit by making changes in the-bank rate.
An increase in bank rate raises the cost of credit (rate of interest) and credit becomes expensive.
The demand for credit decreases. Similarly, a decrease in bank rate lowers down the cost of credit and credit becomes cheap.
A reduction in interest rates motivation tines to borrow money from banks to undertake investment.
This is turn increase the volume of credit in the economy.
Open Market Operations
1. Open market operations refers to sale and purchase of securities (mainly government securities) in the open market by the central bank.
2. The sale of government securities to banks will have the effect ()t- reducing, their reserves.
When the bank gives the central bank’s ability to give credit and therefore decrease the money supply in the economy
3. When the central bank buys securities from the banks, it gives the banks a cheque drawn on itself in payment for the securities.
When the cheque clears the central bank increase, the reserves of the bank by a particular amount.
This directly increases the bank’s ability to give credit and thus increase the money supply.
Varying Reserve Requirements
Banks are obliged to maintain reserves with the central bank on two accounts (a) the Cash Reserve Ratio or CRR (b) SLR or Statutory liquidity ratio.
1. CRR: Under CRR the banks are required to deposit with the central bank a monetary and credit and credit control. An increase in the CRR has the effect of reducing the banks excess reserves and thus curtail their ability to give credit. Similary the CRR decress the supply in the economy.
2. SLR: The SLR requires the banks to maintain a specified percentage of their net total demand and time liabilities in the form of designated liquid assets which may be
(a) excess reserves
(b) unencumbered (are not acting as security for loans from central bank) government and other approved securities (securities whose repayment is guarantee by the government)
(c) current account balances with other banks.
Difference between Central Bank and Commercial Bank:
| Central bank | Commercial bank |
| It is the apex bank in the money market of a country. | It is merely a unit in the banking structure of the country. |
| Its primary aim is general public welfare. | Its primary aim is to make profit. |
| It has the sole monopoly right to issue currency notes. | A commercial bank is statutorily denier function of issuing notes. |
| It cannot deal with the public. | It directly deals with the public and business firms. |
| It acts as a banker to the government. | It has no such responsibility towards tile state. |
| It decides its monetary policy to realize economic stability and full employment in the country. | It plays a supplementary role and is quite often regulated by the Central bank. |
| It is custodian of Nation’s Gold and foreign exchange reserve. | It does not perform such function. |
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