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Money and Banking

THE MEANING OF MONEY


Money is the set of assets in an economy that people regularly use to buy goods and services from other people.

Money
Money is anything that is generally accepted in exchange for goods or services. Commodities have several disadvantages when used as money, the most important of which is that they deteriorate easily after a few trades. Precious metal coins have been used for money, partly because of their durability.

The Nature of Money


Barter versus Monetary Exchange
A barter system (with no money) --- inefficient. Money greases the wheels of exchange and thus, makes the whole economy more productive.

The Nature of Money


The functions of money:
Medium of exchange Unit of account Store of value

Money = whatever serves as the medium of exchange

Currency
Currency consists of coins and/or paper that some institution or government has created to be used in the trading of goods and services and the payment of debts. Currency in the form of metal coins is still used as money throughout the world today. The disadvantage of metal currency is that it is bulky.

Currency
Certain types of metals traditionally used in coins, like gold and silver, are not available in sufficient quantities to meet our demands for a monetary instrument. For these reasons, metal coins have for centuries been supplemented by paper currency, often in the form of bank notes.

Currency
Coins and paper money have been officially declared to be money to be acceptable for the settlement of debts incurred in financial transactions. In effect, the government says, We declare these instruments to be money, and citizens are expected to accept them as a medium of exchange.

Demand Deposits And Other Checkable Deposits


Demand deposits are deposits in banks that can be withdrawn on demand, by simply writing a check. It is a monetary instrument that has become "generally accepted" in exchange over the years and has now, by custom and tradition, become money.

INDIAN FINANCIAL SYSTEM


The Indian financial system providers of financial services are the following: Central Bank Banks Financial Institutions Money and Capital Markets

THE BANKING SYSTEM


The Banking Regulation Act of India1949.
BANK: accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheques, draft, order or otherwise.

THE BANKING SYSTEM


Accepting Deposits Lending Money

MONEY SUPPLY: THE


COMPONENTS OF MONEY SUPPLY
Governed by Central Bank. Concept of money supply : The sum of currency with the public and demand deposits with the banking system. This is called as 'narrow money' and represented as M1.

The Components of Money Supply


The Report of the Second Working Group in 1970, M1=Currency in circulation* + Demand Deposits with the Banking System + Other Deposits with the RBI M2 =M1 + Post Office Savings Bank Deposits M3=M1 + Time Deposits with the Banking System M4=M3 + Total Post Office Deposits (excluding National Savings Certificates) (*Currency in circulation = Currency with the public + Currency with the commercial banks) Broad Money (M3)

The Balance sheet of the RBI


The Balance Sheet RBI includes that the dated securities of the Central Government include marketable securities, special securities, special non-interest bearing securities, and gold bonds.

Liabilities A. Monetary Liabilities (ML) A1. Notes in circulation A2. Other Deposits: a.Deposits of quasigovernment and other financial institutions b.Balances in the accounts of foreign Central Banks and governments c.Accounts of international agencies such as the IMF, etc. A3. Deposits of Banks (Reserves)

Assets Financial Assets (FA) A. Credit to Government A1. RBI credit to the Center a.Loans and Advances from the RBI to the Center b.RBI holdings of Treasury Bills, dated securities and rupee coins and small coins A2. RBI credit to the State Governments: Loans and advances to the State Governments

Liabilities B. Non-monetary Liabilities (NML) B1. Capital Account: (Net Worth) a.Paid-up Capital b.Statutory Reserve c.Contingency Reserve, etc. B2. Government Deposits B3. IMF a/c No.1 (Since 1948) B4. Miscellaneous NMLs e.g. Bills Payable, RBI Employees Pension Fund, Cooperative Guarantee/Provident Funds (since 1964), Compulsory Deposit Scheme Balance, etc.

Assets B. Credit to the Commercial Sector B1. Shares/bonds of financial institutions B2. Ordinary debentures of the co-operative sector B3. Debentures of co-operative land mortgage banks B4. Loans to financial institutions B5. Internal bills purchased and discounted

Liabilities

Assets C. RBI's Gross Claims on Banks C1. Refinance of RBI to the banks C2. Fixed investments in commercial banks' shares/bonds/debentures, e.g. Holding of shares of the SBI D. Net Foreign Assets D1. Gold coin and bullion D2. Eligible foreign securities D3. Balances held abroad netted for balances in IMF Account No.1 minus India's quota subscription in rupees Other Assets (OA) A. Physical Assets B. Others

High Powered Money


The RBI money together with the Government money constitutes the monetary base which is known as High Powered Money. i.e. High Powered Money (H) = Monetary liabilities of the RBI + Government money (GM) = Currency with the public (C) + Reserves (R) + Other Deposits with the RBI Reserves (R) = Vault Cash + Banks Deposits with the RBI

Money Multiplier
The money multiplier approach is based on the following equation Ms = m.H Where m is the money multiplier and Ms is the broad money (M3) . M3 is the sum of currency held by the public (C), demand deposits with the commercial banks (DD) and the time deposits with the banks (TD). or, M3 = C + DD + TD

Money Multiplier
Money multiplier m = M3/H = (C+DD+TD)/(C+R) where R = (DD + TD) r or r= Reserve Ratio=R/(DD+TD) and Dividing the numerator and denominator by DD we have:

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