Fiduciary or paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. Monetary policy guides the Central Bank’s supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income.

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2. DepositoryInstitutions
Depository institutions are financial intermediaries that accept deposits from
individuals and institutions and make loans.
Their primary source of funding is the deposits of savers.
They accept your money and typically pay interest over time
While holding your money, they lend it out to other people and generate more
interest than they pay you.

3. Lending has risks, because of information asymmetry between the lender and
the borrower.
 Borrowers know a lot more about their ability and willing to pay than lenders do,
which is why it is risky for people to lend out money directly to others.
 Depository institutions mitigate this risk by assessing the creditworthiness of
borrowers, Monitoring the borrowers after the loan, and Collecting on delinquent
accounts.
They also convert the short-time deposits that most savers prefer to the long-
term loans that businesses desire.

4. Depository institutions also provides a convenient payment system through
check, electronic funds transfer, or by credit or debit card; which eliminates the
need to have large amount of cash on hand, which is very risky in fact.
They also provides foreign exchange services.
They also provide exporters and importers with services, such as letters
of credit, that facilitate international trade.

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oAre highly regulated because
1. They mobilize a significant amount of household and business deposits
2. They are used as vehicles for executing monetary policy.
oDIs are exposed to Risk
 Credit Risk- Default by borrower or by issuer of security.
 Regulatory Risk-Adverse impact of regulations on earnings.
 Funding (interest rate) risk-Caused by interest rate changes when DIs borrow long(short)
and lend short(long)

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Regulation
 By the central bank
 Areas of regulation include,
Setting interest rate
Permissible activities for DIs
Capital requirements

7. TypesofDepositoryInstitutions
Depositary institutions are further subcategorized depending on the markets they serve,
their primary sources of funding, type of ownership, how they are regulated, and the
geographic extent of their market.
There are different types of depository institutions and the following are the
major one:
Commercial Banks
Microfinance Institutions (MFIs)
Saving Banks
Credit unions

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9. CommercialBanks
Commercial Banks are a type of financial institution that accepts deposits, provides loans,
and offers financial products and services
Generally they are stock corporations whose principal obligation is to make a profit for
their shareholders.
Commercial banks are the most diverse and the largest, both in assets and in geographic extent,
among all depository institutions.
It covers a much wider geographic area with many branches, many ATM machines at convenient
locations throughout their area and usually have assets in the hundreds of billions of dollars.

10. These financial intermediaries raise funds primarily by issuing
Checkable deposits (Deposits on which checks can be written),
Savings deposits (Deposits that are payable on demand but do not allow their owner to write checks), and
Time deposits (Deposits with fixed terms to maturity).
They then use these funds to make commercial, consumer, and mortgage loans and to
buy government, municipal or corporate securities and bonds.
A commercial bank primarily earns money by charging interest on loans to customers.
They also give interest to depositors but pays out less than it charges for loans.

11. Functions of Commercial Banks

12. AgencyFunctions
Commercial banks may serve as agents by collecting and paying checks,
dividends, and bills of exchange for their customers.
They could also pay rent, insurance premiums, trade securities on behalf of
their customers.
Banks can also act as trustees and executors of the estate on behalf of their
customers for a nominal fee.

13. TakingDeposits
 Initially, banks used to charge customers a fee to accept deposits; however as
the banking system has evolved and become more profitable, banks pay a small
interest to the depositors who keep money with them.
Currently it is the major assets of commercial banks

14. AdvancingLoans
Banks earn most of their income from providing loans to businesses and
individuals.
After conducting a thorough review of the applicant, a bank will likely offer a
short-term, medium-term or long term loan.
This review is done to maintain long-term liquidity.

15. CreditCreation
After a loan has been approved, the bank will provide an account from which
the customer can draw funds.
By doing so, instead of giving actual cash, the bank is increasing the amount of
money in circulation in the economy.
This process increases credit.

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17. MicrofinanceInstitution
Microfinance institutions are organizations that provide loans to low-
income clients, including micro-companies and the self-employed, who
traditionally lack access to mainstream sources of finance from Banking
Institutions.
The goal of microfinance is to ultimately give impoverished people an
opportunity to become self-sufficient.

18. The loans are typically for small amounts, targeting poor borrowers and usually
for a short term (a year or less).
The loans are not secured by collateral assets as would be the case
for Banking Institutions .
The first organization to receive attention was the Grameen Bank, which
was started in 1976 by Muhammad Yunus in Bangladesh.

19. Microfinance also offer additional services such as checking and savings accounts as well
as micro-insurance products, and some even provide financial and business education.
Like conventional lenders, microfinanciers must charge interest on loans, and they
institute specific repayment plans with payments due at regular intervals.
Some lenders require loan recipients to set aside a part of their income in a savings
account, which can be used as insurance if the customer defaults.
If the borrower repays the loan successfully, then they have just accrued extra savings.

20. Because many applicants cannot offer collateral, microlenders often pool borrowers
together as a buffer.
After receiving loans, recipients repay their debts together.
Because the success of the program depends on everyone's contributions, this creates a
form of peer pressure that can help to ensure repayment.
Interestingly, although these borrowers often qualify as very poor, repayment amounts
on microloans are often actually higher than the average repayment rate on more
conventional forms of financing.

21. Benefits of Microfinance
The World Bank estimates that more than 500 million people have directly or indirectly benefited
from microfinance-related operations.
In addition, entrepreneurs who create successful businesses, in turn, create jobs, trade, and overall economic
improvement within a community.
Criticisms of Microfinance
As microfinance interest rates are generally higher than conventional banks, critics have charged that these
operations are making money off of the poor.
Those micro finance institutions charges higher interest rates that may create a debt trap for low-
income borrowers.
Additionally, some have argued that the individual microloans are not enough money to provide a
realistic path to independence.

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23. Savings Banks
Saving bank are financial institutions that mainly focuses on mortgages and other kinds
of consumer loan
The original function of savings banks was limited to savings.
They originated in Europe during the 18th century with the aim of providing access to
savings products to all levels in the population.
But now, savings banks invest in government and corporate debt, and in additions they
issue mortgages.

24. Now a days the functions of saving bank is almost similar with that of
commercial banks.
But still saving banks concentrate on non-commercial loan unlike commercial
banks that concentrate on commercial loan.
So, the main functions of saving banks are:
To accept customers’ deposits in exchange for interest payments.
They offer insurance products, credit, and savings accounts and specialize in
retail banking.

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26. Creditunions
 Credit unions are nonprofit depository institutions that are financial cooperatives owned by people
belonging to a particular group, such as the employees of a particular company, a union, or a
religious group, or who live in a specific area such as a county, and they are governed by a board of
volunteers.
 Credit unions are seek to encourage savings and make excess funds within a community available
at low cost to their members.
 Credit unions' financial powers have expanded to include almost anything a bank can do, including
making home loans, issuing credit cards, and even making some commercial loans.
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27. Membership in a credit union is not open to the general public, but is restricted
to people who share the common bond of the group that created the credit
union.
Credit unions are exempt from federal taxation and sometimes receive
subsidies, in the form of free space or supplies, from their sponsoring
organizations.
They acquire funds from deposits called shares and primarily make consumer
loans.

28.  The profits earned are either paid to the members as dividends or reinvested
into the organization.
 The members of the credit unions are the ones that own accounts in the
institution; hence, the depositors are also partial owners and receive dividends.
 Because they are nonprofits institutions, (they pay no federal or state
tax); and owned by their customers, they charge lower loan rates and pay
higher interest rates on savings.

29. 1. Serves as a link between public companies and investors/ shareholders
A depository functions as a connecting link between the public companies that issue financial
securities, and the investors or shareholders.
The securities are issued by agents associated with depositories, who are known as depository
participants.
The agents are responsible for transferring the securities from the depositories to the investors.
A depository participant can be a bank, an institution, or a brokerage.
Functionsofadepository

30. 2. Eliminates risk related to owning physical financial securities
A depository allows traders and investors to hold securities in dematerialized form; thus,
eliminating the risk related to holding physical financial securities.
The buyers and sellers now do not need to check whether the securities have been
transferred successfully without any loss or theft.
The depository system reduces such risks by allowing the securities to be held and
transferred in electronic form.

31. 3. Allows the provision of loans or mortgages to interested parties
A depository holds the securities of customers and gives them back
when the customers want.
The customers receive interest on the deposits, while the depository
earns even more interest by lending the deposits to other people or
businesses in the form of loans or mortgages.

32. 4. Reduced paperwork and accelerates the process of transferring securities
When a trade occurs, a depository transfers the ownership of securities
from the account of one investor to another.
It helps in reducing the paperwork associated with the finalization of a
trade and accelerates the process of transfer of securities.

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