The document discusses various aspects of money and banking, including the definitions, types, and functions of money, such as being a medium of exchange and store of value. It outlines the roles and operations of commercial banks and central banks like the Reserve Bank of India, including credit creation and regulation mechanisms such as cash reserve ratio and repo rates. Additionally, it explains inflation, its types, and the tools used for monetary policy and credit control within the banking system.

1. Money and
Banking
Presentation by Himaan Harish S
BSc Economics (Honours)
BASE University
12th ISC Economics Refresher course

2. Meaning
• Money, in simple terms, is a medium of exchange. It is instrumental in
the exchange of goods and/or services.
• Further, money is the most liquid assets among all our assets. It also has
general acceptability as a means of payment along with its liquid nature.
• Usually, a country’s Central Bank or Government creates and issues
money. Also called cash money, this is a legal tender and hence there is a
legal compulsion on citizens to accept it.

3. Kinds of Money
• The 4 different types of money as classified by economists are commercial
money, fiduciary money, fiat money, and commodity money.
• Commodity money
• Money whose value comes from a commodity of which it is made is known as
commodity money.
• Commercial money
• The portion of a currency which is made of book money – debt generated by
commercial banks is known as commercial bank money.
• Fiat money
• A government-issued currency that is not backed by a commodity such as gold
is known as Fiat Money
• Fiduciary money
• Payment on the basis of trust but not on the basis of any order of the
government is known as fiduciary money.

4. Functions of Money
• Primary functions of money
• The primary function of money includes money as a medium of exchange and money as a
measure of value.
(a) As a medium of exchange, it refers to a function of money in which money is considered a
mode of exchanging goods. This function of money solved the main problem of the barter system
which was a double coincidence of wants.
(b) As a measure of value, it refers to a function of money that helps in determining the value of
goods and services. Money is taken as the common denominator while measuring the value of
goods and services in monetary terms.

5. • Secondary functions of money
• The secondary function of money includes money as a store of value and money as a standard of
deferred payment.
(a) As a store of value, it refers to the function of money that helps individuals in storing their
wealth in the form of money. Therefore, money acts as an asset that sustains value over a period of
Time.
(b) As a standard of deferred payment, it refers to one of the most important functions of money.
Deferred payments refer to payments made on loans, salaries, pensions, insurance premiums,
interests, and rents. The necessary condition for deferred payment is that the amount of repaid money
should be the same as it was at the time of purchase of the good. Since all the goods and services can
be expressed in terms of money, it makes future payments easy and functional.

6. Contingent functions of money
(a) Distribution of national income: Money helps in the optimum distribution of national income
among
different factors of production by generating factor incomes like rent, interest, wage, and profit.
(b) Basis of credit creation: Credit creation by commercial banks is not possible without money money
as a store of value has encouraged savings by people in the form of demand deposits in the banks which
are used by commercial banks to create credit.
(c) Maximization of satisfaction: Money helps consumers and producers in maximizing their
satisfaction by measuring the value of everything in terms of money. A consumer derives maximum
satisfaction by equating the price (expressed in terms of money) of each commodity with its marginal
utility (satisfaction). Similarly, a producer maximizes his satisfaction (profit) by equating the marginal
productivity of a factor with a price of such factor.

7. (d) Increases productivity of assets: Money increases the
productivity of capital as it is the most liquid asset and can
be put to alternative uses. Due to liquidity of money, capital
can be easily transferred from less productive uses to more
productive uses.

8. Supply of Money
Reserve Money (M0): Other names include High-Powered Money, Financial Base, Base Money,
etc. M0 is calculated as follows: Money in circulation + Bankers' deposits + Other deposits with RBI.
It is the economic foundation's currency.
Narrow Money (M1): M1 equals money in circulation plus demand deposits in the banking
system (current and savings accounts) plus additional deposits with the RBI.
Narrow Money (M2): Post Office Savings, Bank Savings Deposits added to M1 equals M2.
Broad Money (M3): M3 equals M1 plus time deposits made with banks.
Broad Money (M4): M4 is equal to M3 plus any deposits made at post office savings banks.
M4 = M3 + Total Deposits with Post Office
As the total deposits with the post office are negligible there is not much difference between M3
and M4

9. Inflation
Inflation is referred to as the
situation when the price level of
goods and services rise, which leads
to decrease in the purchasing power
in the economy or in other words
decreases the buying power of the
money.

10. Demand pull and cost push inflation
Demand pull inflation
• Inflation that occurs due to an increase in
aggregate demand is referred to as
demand-pull inflation.
Increase in Aggregate demand.
Rise in aggregate demand
• The beginning of price inflation
• Monetary factors and real factors
• Occurs in most economies of the world.
Cost-push inflation
• Inflation that results from a decline in aggregate
supply due to external factors is referred to as
cost-push inflation.
• In cost-push inflation the aggregate demand
remains the same.
• Rise in price of inputs like raw materials, labor,
etc.
• The idea that inflation is difficult to stop, once it
has started
• Caused by business groups of society who
respond to rise in costs of the product
• Cost push inflation is not that relevant in current
times.

11. Banks

12. Functions of commercial banks
• A commercial bank is a kind of financial institution that carries all the operations
related to the deposit and withdrawal of money for the general public, providing loans
for investment, and other such activities. These banks are profit-making institutions
and do business only to make a profit.
• A) Primary functions
Accepts deposits: The bank takes deposits in the form of savings, current, and
fixed deposits. The surplus balances collected from the firm and individuals are lent to
the temporary requirements of the commercial transactions.
Provides loans and advances: Another critical function of this bank is to offer loans
and advances to entrepreneurs and business people, and collect interest. For every bank,
it is the primary source of making profits. In this process, a bank retains a small number
of deposits as a reserve and offers (lends) the remaining amount to the borrowers in
demand loans, overdrafts, cash credit, short-run loans, and more such banks.
Credit cash: When a customer is provided with credit or a loan, they are not provided
with liquid cash. First, a bank account is opened for the customer and then the money is
transferred to the account. This process allows the bank to create money.

13. • Secondary functions
• Discounting bills of exchange: It is a written agreement
acknowledging the amount of money to be paid against the goods
purchased at a given point in time in the future. The amount can also be
cleared before the quoted time through a discounting method of a
commercial bank.
Overdraft facility: It is an advance given to a customer by keeping the
current account to overdraw up to the given limit.
Purchasing and selling securities: The bank offers you the facility of
selling and buying the securities.
Locker facilities: A bank provides locker facilities to the customers to
keep their valuables or documents safely. The banks charge a minimum of
an annual fee for this service.
Paying and gathering the credit: It uses different instruments like

14. Credit creation process
• The process of credit creation is considered one of the most important functions performed by a commercial
bank.
The central bank of a country is responsible for ensuring the supply of money in the economy by circulating the
currency. It also ensures that for fulfilling all the transactions, there should be an appropriate currency in the
system.
This process cannot be implemented by the central bank alone. For this, they require the help of commercial
banks and their reserves.
Commercial banks perform the function of credit creation in an economy. Therefore, the money that is created
by commercial banks is known as credit money.
This is achieved by commercial banks in the form of purchasing securities and providing loans. Commercial
banks facilitate the loans by utilizing the deposits that are obtained from the public.
There are restrictions on the amount of money that can provide credits from the total deposits that a bank
obtains from the public.
As per the rule, commercial banks need to maintain a certain portion of the public deposits as reserves with the
central bank that will be used for meeting the immediate cash requirements of the depositors.

15. Limitations of credit creation process
Cash amount present in the bank
The higher the number of deposits made by the public, the higher credit creation
from commercial banks can be seen. However, there is a certain limit on the
amount of cash that can be held by the banks at a time.
This limit is determined by the central bank, as the central bank may contract or
expand this limit by selling or purchasing securities.
Cash reserve ratio or CRR
It refers to the amount of money in the form of reserve that needs to be kept with
the central banks by the commercial banks. This amount is used for meeting the
cash requirements of the users. Any fall in the CRR will lead to more credit
creation.

16. Excess reserve
This takes place when a country faces recession, at that time the banks find it
conducive in maintaining reserves in place of lending that leads to less credit
creation
Prevalent business conditions
If an economy is witnessing a depression, then the businesses will not be seeking
credit that leads to contraction of credit creation. Whereas, if a nation is
prospering, then the businesses will seek new funds in the form of credit from
the banks that would lead to credit creation.

17. Central Bank : Reserve Bank of India (RBI)

18. Functions of the Central Bank
The functions of a central bank can be discussed as follows:
1. Currency regulator or bank of issue
2. Bank to the government
3. Custodian of Cash reserves
4. Custodian of International Currency
5. Lender of last resort
6. Clearing house for transfer and settlement
7. Controller of credit
8. Protecting depositors’ interests

19. • Custodian of Cash reserves: It is a practice of the commercial banks of a country to
keep a part of their cash balances in the form of deposits with the central bank.
Commercial banks can draw that balance when the requirement for cash is high and
pay back the same when there is less requirement for cash.
• It is for this reason that the central bank is regarded as the banker’s bank. The central
bank also plays an important role in the credit creation policy of commercial banks.
• Custodian of International currency: An important function of the central bank is to
maintain a minimum balance of foreign currency. The purpose of maintaining such a
balance is to manage sudden or emergency requirements of foreign reserves and also
to overcome any adverse deficits of the balance of payments.
• Lender of last resort: The central bank acts as a lender of last resort by providing
money to its member banks in times of cash crunch. It performs this function by
providing loans against securities, treasury bills and also by rediscounting bills.

20. • Clearing house for transfer and settlement: Central bank acts as a
clearing house of the commercial banks and helps in the settling of
• mutual indebtedness of the commercial banks. In a clearing house, the
representatives of different banks meet and settle the interbank
payments.
• Controller of credit: Central banks also function as the controller of
credit in the economy. It happens that commercial banks create a lot of
credit in the economy which increases inflation. The central bank
controls the way credit creation by commercial banks is done by
engaging in open market operations.
• market operations or bringing about a change in the CRR to control the
process of credit creation by commercial banks.
• Protecting depositors’ interests: Central bank also needs to keep an
eye on the functioning of the commercial banks in order to protect the
interests of depositors.

21. Regulatory role of the Central Bank - RBI
• The RBI, as a regulator, supervises the entire financial system. Thus, it restores public trust, protects interest rates, and
provides positive banking alternatives.
• Here is a breakdown of the role of RBI as a regulator in maintaining the country’s financial stability:
• Reserve Bank of India provides the license to the banks
• After this license, they have the authority to regulate their bank in India
• Foreign banks also have to take permission from the RBI to establish their branch in India
• RBI provides approval to the different operations like policy formulation, implementation of Prudential Norms, Basel – II
and III frameworks, validation of quantitative models on Credit, and so forth
• So, all the banks running currently in India must have permission from RBI first to modify their operational process
• RBI also decides the salary packages of Whole-Time Directors and Part-Time Chairpersons of Private Sector Banks and
Chief Executive Officers of Foreign Banks operating in India
• RBI also handles all the issues of Indian banks. Issues related to the liquidation of banking companies, customer service
policy issues, Anti-Money Laundering, Combating Financing of Terrorism, and so forth
• It handles all types of issues and provides appropriate guidance to resolve them

22. • the function of the RBI as a regulator of the money market is to regulate and
manage the country’s foreign exchange.
• It is in charge of the country’s currency and gold reserves.
• The foreign exchange rate reflects the demand for and supply of foreign
exchange resulting from trade and capital transactions on any given day.
• RBI works as a regulator of the money market. It also regulates the Financial
Markets Department (FMD). It also checks and regulates all the functions
which are done under the foreign exchange market. It facilitates this foreign
regulation by selling and buying foreign currency, which helps in reducing the
volatility during the time of excess demand for foreign currency in the market.

23. Statutory Liquidity ratio

24. • SLR is the minimum percentage of deposits that a commercial bank has
to maintain in the form of liquid cash, gold or other securities. It is
basically the reserve requirement that banks are expected to keep
before offering credit to customers. The SLR is fixed by the RBI and is a
form of control over credit growth in India.
• The government uses the SLR to regulate inflation and fuel growth.
Increasing the SLR will control inflation in the economy while
decreasing the statutory liquidity rate will cause growth in the economy.
The SLR was prescribed by Section 24 (2A) of Banking Regulation Act,
1949.

25. Cash Reserve Ratio
• Cash Reserve Ratio or CRR is the minimum amount as specified by the
Central Bank, to be maintained by the Commercial banks of the public
deposits with the Central Bank.

26. Repo Rate
• Repo rate is the rate at which the central bank of a country (Reserve Bank of
India in case of India) lends money to commercial banks in the event of any
shortfall of funds. Repo rate is used by monetary authorities to control
inflation.
• In the event of inflation, central banks increase repo rate as this acts as a
disincentive for banks to borrow from the central bank. This ultimately reduces
the money supply in the economy and thus helps in arresting inflation.
• The central bank takes the contrary position in the event of a fall in inflationary
pressures. Repo and reverse repo rates form a part of the liquidity adjustment
facility.

27. Reverse Repo Rate
• Reverse Repo Rate is defined as the rate at which the Reserve Bank of
India (RBI) borrows money from banks for the short term. It is an
important monetary policy tool employed by the RBI to maintain
liquidity and check inflation in the economy. The Reverse Repo Rate
helps the RBI get money from the banks when it needs. In return, the
RBI offers attractive interest rates to them. The banks also voluntarily
park excess funds with the central bank as it provides them with an
opportunity to earn higher interest on surplus money. The Reverse Repo
Rate is decided by the Monetary Policy Committee (MPC), headed by the
RBI Governor.

28. Open Market Operations
• Open market operations are carried out by the central bank in association with commercial
banks. For conducting such operations, there is no involvement of the public.
• Government bonds are mostly bought by commercial banks, financial institutions high-net-
worth individuals, and large business corporations. All these entities maintain accounts with the
bank, and whenever these entities purchase bonds, the amount gets transferred to the central
bank.
• Thus, it can be said that open market operations have an impact on the deposits and reserves of
the bank and also plays a role in their ability to provide credit. When a central bank wants to
reduce the availability of money to the public, it will sell government bonds and securities with
the help of commercial banks.
• This step reduces the money supply in the economy and restricts banks to offer credit to
individuals. It impacts both the supply and demand of credit.

29. Qualitative methods of credit control
• Qualitative Methods of credit control refers to the monetary policy by the central bank which includes those
instruments that focus on the selected sectors of the economy to control and regulate the money supply. It
includes:
• A. Margin Requirement:
• Margin requirement refers to the difference between the current value of the security offered for the loan
(called collateral) and the value of the loan granted. It is a qualitative method of credit control adopted by the
central bank in order to stabilize the economy from inflation or deflation.
• B. Rationing of Credit:
• Rationing of credit refers to the fixation of credit quotas for different business activities which is introduced
when the flow of credit is to be checked particularly for speculative activities in the economy.
• Moral Suasion:
• Moral suasion refers to the persuasion and pressure which the central bank exerts on the member banks in
order to follow its directives. These are generally not ignored by the member banks as it comes directly from
the upper authority. The banks are advised to restrict the flow of credit during inflation and be liberal in
lending during deflation.