MONEY

BARTER SYSTEM
 Money act as a Medium of exchange.
i.e. Money is commonly accepted as a medium of exchange
 Functions of money

Primary Secondary

Medium of Standard of
Exchange Deferred Payment

Common measure
of value Store of Value
Primary functions:- Primary function include the most important function of money which it must perform in every
country these are:

i) Medium of exchange:- Money as a medium of exchange means that it can be used to make payments for all
transaction of goods and services. It is the most essential function of money. Money has the quality of general
acceptability. So all exchange take place in term of money.

ii) Measure of value (Common unit of value) :- Money as a measure of value means that money works as a
common denomination in which values of all goods and service are expressed.

Secondary functions:- These refer to functions of money which are supplementary to the primary functions these
function are derived from primary functions and therefore they are also known as Derivative functions

i) Standard of Deferred payments:- Money as a standard of deferred payments means that money act as a
standard for payments which are to be made in future. Every day millions of transaction take place in which
payments are not made immediately. Money encourage such transactions and helps in capital formation and
economic development of the economy.
ii) Store of value (Assets function of money) :- Money as a store value means that money can be used to transfer
purchasing power from present to future. It provides security to individuals to meet contingencies,
unpredictable emergencies and to pay future debts. Under barter system it was difficult to use goods as a store
of wealth due to perishable nature of some goods and high cost of storage.
 MONEY SUPPLY
Supply of money is a stock concept.
Money supply does not include
(i) Stock of money held by the government
(ii) Stock of money held by the Banking System of a country.
They are considered suppliers of money. Money supply includes
(i) Individuals
(ii) Business firms
 Components or measurement money supply

M1 = CC + DD + OD with RBI
It does not include
(a) deposits of the Indian government of the country with RBI.
(b) deposits of the Commercial Bank of India with RBI.
M1 is also known as Transaction money
It is Most Liquid.
M1 = CC + DD + OD with RBI
Note: (i) CC : Currency in cash i.e. Paper notes & coins.
(ii) DD : Demand deposits i.e. deposits of public with Commercial Banks which can be withdrawn by issuing
a cheque. It must be noted that here we only include net demand deposits. It means inter bank deposits
are excluded. Interbank deposits are those deposits held by one bank of behalf of other bank.

(iii) OD: Other deposits with RBI. It includes:

(a) Deposits held by RBI on behalf of Foreign Banks and Foreign government.
(b) Demand deposits of international financial institutions like international monetary fund (IMF) and
World Bank.
(c) Demand deposit of financial institutions like NABARD (National Bank for Agriculture and Rural
Development)
NABARD established on 12 July 1982
 BANKING
A bank is an organization which keeps money safely for its customers; You can take money out, save,
borrow or exchange money at a bank

BANKS ARE OF TWO TYPES

1.) COMMERCIAL BANK
2.) CENTRAL BANK
 Meaning of Commercial Bank
A commercial bank is a kind of financial institution that carries all the operations related to deposit
and withdrawal of money for the general public, providing loans for Consumption, investment, and
other such activities.
These banks are profit-making institutions and do business only to make a profit.
E.g. HDFC Bank. , SBI, ICICI etc.
LRR: Legal Reserve Ratios
 Credit Creation by Commercial Bank
Commercial bank is an important source of money supply in the economy, which contribute to money supply
by creating credit in terms of demand deposit. Suppose a new deposit of ₹1000 is made by a depositor into
bank and Bank Legal Reserve Ratio is 10%
Bank will keep legal Reserve Ratio of ₹100 (10% of ₹1000) and lend the balance money of ₹900 to the
borrower by crediting as chequeable deposits (I round of credit creation).
The borrower will use the amount to pay its creditors which ultimately will be deposited in another bank and
bank keeps ₹90 (10% of ₹900) as legal Reserve Ratio and lends the balance ₹810 to borrower. (II Round of
Credit Creation). This process will continue till amount become zero and make the money 10 times the initial
deposits i.e. ₹10,000.

Deposit multiplier (or) Money multiplier Credit Creation Deposits Loans LRR
= 1/LRR = 1/10 % = 10 times
Initial Deposit 1000 900 100
As seen in the table, banks are able to
create total deposits of ₹10,000 with the Round I 900 810 90
nitial deposits of just ₹1000. It means total
deposits become 10 times of the initial Round II 810 729 81
deposit. This 10 times is value of
Money Multiplier. All Other Round -- -- --

Total 10000 9000 1000

 Central bank

It is an apex bank that controls the entire banking system of a country.

It is the sole agency of note issuing in a country. In India it is Reserve Bank, in England; Bank of
England, in America; Federal Reserve System.
RBI was established in April 1, 1935 under RBI Act passed in 1934
 Functions of central Bank

Issuing Authority of Currency Notes

Banker of the Government

“Bankers Bank” & “Supervisory Bank”

Lender of the Last Resort

Custodian of Foreign Exchange Reserve

Clearing house function

Control of Credit
(i) Issuing Authority of Currency Notes: Central Bank of a country has the exclusive right of issuing notes. In
20th century, the Central Bank was known as Bank of Issue. Central Bank is the sole agency of issuing
currency notes which is legal tender. However one rupee coin and notes are issued by Ministry of Finance.

(ii) Banker of the Government: Central Bank is a banker, agent and financial advisor to the government As a
banker to the government it manages accounts of the government As an agent to the government, it buys
and sells securities on the behalf of the government It helps the government in framing policies to regulate
the Money Market. As a financial advisor, the Central Bank advises the government from time to time on
economic financial and monetary matters. RBI also offers loans to the government against some securities.
In situation of deficit government budget, the government often seeks loans from the Central Bank. This is
called Deficit financing

(iii) “Bankers Bank” & “Supervisory Bank”: The Central Bank the banker’s bank and also plays a supervisory
role. As a Banker’s Bank, it has almost the same relation with other banks in the country as a Commercial
banks has with it’s customers. It accepts deposits from the Commercial Banks and offered them loans. The
rate at which Central Bank offers loans to the Commercial Bank is called ‘Repo rate’. The rate at which
commercial banks are allowed to park their surplus fund with RBI is called “Reverse Repo Rate”. As a
Supervisor, Central Bank Regulate and Controls the Commercial Banks. RBI continuously exercised
inspection on Commercial Banks. RBI gives license to Commercial Banks. Central Bank ensure that
Commercial Banks maintains Cash Reserve Ratio & Statutory Liquidity Ratio in proper way. Otherwise RBI
charge interest and penalty
(iv) Lender of the Last Resort: As we know, commercial bank create liabilities (demand deposits) many times
more than their cash reserves. However, there may be occasions when a bank suffers crises of finance. In
such a situation the Central Bank acts as a lender of last resort. Central Bank helps Commercial Banks in
critical situation.

(v) Custodian of Foreign Exchange Reserve: Central Bank is the custodian of nation’s foreign exchange
reserve. The Central Bank not only maintain foreign exchange reserve but also exercises managed floating
to ensure stability of exchange rate in the international money market. Managed floating refers to the sales
and purchase of foreign exchange with a view to achieving stability of exchange rate for the domestic
currency.

(vi) Clearing house function: Central Bank acts as a clearing house for transfer and settlement of mutual
claims of Commercial Banks. Since the Central Bank hold reserves of Commercial Banks. It transfer funds
from one Bank to other banks to facilitate clearing of cheques.

(vii) Control of Credit: The most important function of the Central Bank is to control supply of money in the
economy. It implies increase or decrease in the supply of money by regulating the ‘Creating of Credit’ by
the Commercial Banks. The Central Bank needs to control the supply of money to cope with the situation of
inflation and deflation. During inflation, supply of money is restricted and during deflation, supply of money
is liberalised
Credit Control By Central Bank/ RBI
MONETARY POLICY
 B. Monetary Policy by RBI
1. Quantitative Measures.
2. Qualitative Measures

INSTRUMEMTS OF QUANTITATIVE & QUALITATIVE MEASURES

Quantitative Measures Instruments Qualitative Measures Instruments

Banks Rate and Repo Rate Marginal Requirement
CRR + SLR = LRR
Open market operations.
Reverse Repo Rate
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