The document discusses money supply and its components. It explains that money supply consists of currency in circulation, current account balances, money market funds, savings deposits, and short-term deposits. It also describes how commercial banks can create new deposits and credits by lending out most of the money deposited with them, while keeping reserve requirements. This process of banks lending deposits expands the total money supply in the banking system. The central bank regulates the money supply and acts as the main regulatory body in the financial system.

1. GR Advisory & Training – Banking Basics Program
MONEY SUPPLY
Money is an important ingredient of the world of business and trade. Its importance is due to the fact that
 It serves as a medium of exchange - used for payment of all goods and services.
 It serves as an accounting unit - as it is used for payment of goods and services, it is also a good yardstick
for comparing the value of goods and service. It therefore serves as a unit of account - a common
denominator that it is used to value goods and services.
 It is used as a store of value - money when saved provides purchasing power at a later date.
Money is therefore an important cog in the wheel that makes trade and business go around and therefore has
demand. It is supplied and controlled by the government of that country. Like all other goods, the value of money (as
reflected in the interest rate) is determined by its supply and demand.
The money that is supplied is called fiat money - money that has little or no intrinsic value (unlike the old days when
gold, silver, etc. were used, which had intrinsic value). Thus a dollar bill or a rupee note is just a piece of paper.
Deposits are essentially accounting numbers. Coins may have some intrinsic value as metal, but is less than the
value they depict. These get accepted by people as money because people believe that it will give them the
purchasing power (to purchase goods and services) it represents, and can be used for settlement of debt. People’s
belief in turn stems from the confidence in their government and their system of governance.
Thus money supply is nothing but all the fiat money that the government injects into a country which takes form of
currency plus deposits with banks plus deposits with other institutions and so on.
The components of a country’s money supply are:
M1 Made up of money people have available to spend now as  Currency in circulation
medium of exchange  Current account balances
M2 M1 + types of money being held as store of wealth for  Money market funds
possible spending later  Savings deposits
 Short-term deposits
M3 M2 + time deposits with banks
Therefore, all current, savings and deposit accounts with banks contribute to the country’s money supply.
Another important function that distinguishes banking institutions with others is that, they can create deposits and
credits, whereas others cannot.
Banks are supposed to lend deposits that they receive. But, at the same time, they cannot lend the entire amount of
deposits they receive. They are required to keep certain percentage of deposit as reserve in the form of cash. This
reserve is precautionary to ensure that at any point in time, if depositors want cash, the bank is able to meet the
obligation without any problem. This requirement varies from country to country and is governed by the finance
department of the government. This percentage plays an important factor in controlling the money supply and credit
in the economy. Let’s understand how.
Anupam, say, gets a cheque for Rs.100000 as a share of his ancestral property and deposits the amount in his bank
A. The bank A gets a deposit of Rs.100000 and puts aside, say 10% as reserve requirement and the remaining
Rs.90000 is lent to Badri, who had applied for a loan to purchase a computer. A 10% reserve indicates that the bank
A estimates that at any point in time not more than 10% of the deposits may be withdrawn by way of cash. Badri

2. GR Advisory & Training – Banking Basics Program
takes a pay order for Rs.90000 and hands it over to the computer dealer. The dealer maintains his account with bank
B and deposits the amount with his bank. Bank B’s deposit is now increased by Rs.90000 and therefore the bank can
lend up to Rs.81000, after keeping Rs.9,000 as its reserve, to someone else who approaches them.
Bank A
Deposits 1,00,000 Loans 90,000
Reserve 10,000
Bank B
Deposits 90,000 Loans 81,000
Reserve 9,000
The above process goes on. With the initial amount of Rs.100,000 we mentioned in the example, the deposits and
the credit gets expanded in the banking system viz. 1,00,000 + 90,000 + 81,000 + …. and so on, from the initial
deposit of Rs,100000.
Of course, there are limitations to this process. The bank may not lend the full 90% of the deposit. All the loan
payments may not be deposited in the banking system. The non-banking organizations can lend only out of the
resources put at their disposal by their customers.
The main regulatory body in the financial system is the Central Bank of each country, which we shall see in greater
detail in a later section.