The document discusses the limitations of the barter system, highlighting issues like the lack of a common unit of value and double coincidence of wants, which led to the evolution of money as a more efficient medium of exchange. It details the different forms of money, such as commodity, metallic, paper, and electronic money, and the functions of money in measuring value, storing wealth, and facilitating transactions. Additionally, it explains the role of central banks in regulating the monetary system, controlling credit, and managing the supply of money in the economy.

1. Unit – 2
Money & Banking
(6 Marks)

2. Introduction
• Exchange is of central significance in human life.
• An individual does not produce himself all that he
needs.
• For his existence, he depends upon many others
for the satisfaction of his wants.

3. Barter System of Exchange:
Meaning & Features
► Meaning of Barter System
• In the primitive stages of economic
development, human needs were very limited.
• The market transactions were limited to the
extent of mutual exchange of goods between
two or more individuals. This is barter.
• Barter means exchange of goods for goods.
Economic exchanges without intervention of
money are referred to as barter exchanges.
• The economy based on barter exchange is
called C-C economy.

4. Features of Barter System
• Barter system can be practical only if there is
“Double coincidence of wants” i.e., simultaneous
fulfillment of mutual wants of buyers and
sellers.
• If “double coincidence of wants” does not
exist, there will be huge ‘trading cost’.
• Trading costs refer to costs of engaging in
trade. They are –
(a) Search cost (b) Disutility of waiting
• With economic development, exchange
through barter became impractical.

5. Problems/ Drawbacks/ Difficulties of
Barter Exchange
(i) Lack of double coincidence of wants –
“Simultaneous fulfillment of mutual wants by buyers
and sellers is known as double coincidence of wants.”
In barter system there is lack of double coincidence of
wants.
Barter system can only work when both the persons
are ready to exchange each other's goods.

6. (ii) Lack of unit/ measure of value -
• In the absence of a common unit of measurement,
evaluation of goods and services is not possible.
• In the absence of common unit, proper accounting is
not possible.
• The value of each good would have to be expressed
in as many quantities as there are kinds and
qualities of other goods in the market.
(iii) Lack of divisibility – How to exchange goods of
unequal value? If a household wants to sell his cow
and get in exchange cloth equal to the value of half
of his cow, he cannot do so without killing his cow.
Thus, lack of divisibility of goods makes barter
exchange impossible.

7. (iv) Lack of store of value – In barter system,
it is difficult for the people to store wealth for future
use.
• The barter system does not provide for any
method of storing generalized purchasing power.
• It is difficult to store wealth in the form of goods
like cattle, wheat, potatoes etc.
• It involves costly storage, deterioration or
appreciation in the value of stored commodity.

8. (v) Lack of standard for deferred payments - Barter
system lacks a standard for deferred payments. It
creates problem in entering into contracts which
involves future payments because of lack of any
satisfactory unit.
• Borrowing and lending were difficult problems under
the barter system.
• As a result, future payments are to be stated in terms
of specific goods or services.

9. Evolution of Money
• Due to above limitations of the barter system, the
exchange process tends to be highly inefficient.
• It was to overcome these difficulties that money,
was invented by society due to increasing scale of
industrialization and commercialization.

10. Money evolved with time as follows:
(a) Commodity Money
Various types of commodities like
cows, seashells, leather etc. have
been used as medium of exchange.
(b) Metallic Money
Commodity money was replaced by
metallic money with growth of human
civilization. The mediums of exchange
were metals, particularly gold and silver.
(c) Paper Money
It was due to inconvenience in use
of gold and silver, that invention of
paper money facilitated huge
transactions requiring the use of money.
Paper money is regulated and controlled by RBI in India.

11. (d) Bank or Credit Money
Bank or credit money was invented
to make the transactions convenient
People started using credit money
like cheques, drafts etc.
(e) Plastic Money
It is in the form of debit and credit
cards which is used as medium of
exchange.
(f) e-Money
It is broadly defined as an
electronic store of monetary
value on a technical device that
may be widely used for making payments

12. Evolution of Money

13. Money: Meaning and Functions
► Meaning
In the words of Walker,
“Money is what money does.”.
Money is anything which is generally accepted
as a medium of exchange, a unit of value, a
store of value and means for standard of
deferred payments.
Money has overcome the limitations of barter
system.
Advantages of Money = Drawbacks of Barter

14. Functions of Money

15. (A) Primary/ Basic/ Original Functions
(i) Money is medium of exchange
▪ Money serves as a medium of exchange/payments.
▪ Money helps in buying and selling of goods and
services as it is commonly accepted measure of
value.
▪ Money has solved the problem of double
coincidence of wants.
▪ Money is also called, ‘a bearer of options’ or
‘generalised purchasing power’.
▪ Generalised purchasing power indicates the freedom
of choice that the use of money offers.

16. (ii) Money as a Unit of Value/ Measure of Value
Money is a unit of account or it has a unit of value.
▪ It is a unit of account in terms of which the value of
all the goods and services is measured and
expressed.
▪ The value of each good or service is expressed as
its price.
▪ In other words, prices of all goods and services are
expressed in terms of money.
▪ This function makes possible of keeping business
accounts.

17. (B) Secondary Function
(i) Standard for deferred payments – Deferred
payments refer to those payments which are made
in future.
▪ Money as a standard of deferred payments has
facilitated market transactions of buying, selling,
borrowing etc.
▪ Money makes possible the credit transactions to
happen when payments are not to be made
immediately.

18. (ii) Store of value – Under barter system, storing of
value in terms of goods, was very difficult.
▪ Now with money, savings are done in terms of
money.
▪ Money occupies less space for storage in
comparison with goods.
▪ Money is an asset and can be stored in future.
▪ Money helps people to transfer their purchasing
power
(ii) Store of value – Under barter system, storing of
value in terms of goods, was very difficult.
▪ Now with money, savings are done in terms of
money.
▪ Money occupies less space for storage in
comparison with goods.
▪ Money is an asset and can be stored in future.
▪ Money helps people to transfer their purchasing
power from present use to future use.

20. Classification of Money
(a) Full Bodied Money – Full bodied money refers to
money in terms of coins whose commodity value
is equal to the money value as and when they are
issued.
(b) Credit Money – Credit money refers to that
money of which money value is more than the
commodity value.
(c) Fiat Money – Fiat money refers to that money
which is issued by order of the government. It
includes all notes and coins which the people in a
country are legally bound to accept as a medium
of exchange.
(d) Fiduciary Money – It is that money which is
accepted as a medium of exchange because of
the trust between the payer and the payee.

21. Supply of Money/ Money Supply
Supply of money refers to the total quantity or stock
of money available in the economy at particular
point of time. It includes stock of money in all forms
i.e. paper money, coins and demand deposits.
• Supply of money refers to the stock of money held
by those who demand money and not by those who
supply money.

22. Interesting Facts About Indian
Currency
• Only Re. 1 notes and coins in India are signed by the
Finance Secretary as they are printed by the Ministry
of Finance (Govt. of India). All other Indian currency
notes in India are printed by RBI.
• Currency notes from Rs.2 to Rs.2000 are printed and
issued by RBI.
• Rupees is Not made of paper! Your currency is
composed of cotton and cotton rag.

23. • Total 17 Languages appears out of which 15
languages appear in the language panel of
banknotes in addition to Hindi prominently displayed
in the centre of the note and English on the reverse
of the banknote.
• The current series of bank notes are called
Mahatma Gandhi Series. The Mahatma Gandhi
series of notes were introduced in 1996.
• Coins can be issued up to the denomination of Rs.
1000 as per Coinage Act, 2011.

24. • Have you ever noticed the different symbols below
the year. These symbols are actually specifying
where the originated.
• Indian Currency Notes are printed at Nasik, Dewas,
Salboni and Mysore.

25. In simple words,
“Bank is an institution which receives our
deposits and gives us loans.”
• According to Banking Companies Act, 1949
“Banking means the accepting (for the purpose
of lending or investments) of deposits of money
from the public, repayable on demand or
otherwise, and withdrawable by cheques, drafts,
order or otherwise”.
• To conclude two essential features of a bank are:-
(a) Acceptance of deposits
(b) Lending of funds
Banking

26. Central Bank: Meaning and Its
Features
Meaning
A Central Bank is an apex institution of a country
which operates, controls, directs and regulates
the monetary and the financial system of the
country. All the decisions related to the monetary
policies of a country are taken by Central Bank.
India's Central Bank is Reserve Bank of India
(RBI).

27. Features
▪ It is an apex bank and regulates money supply
and credit in the country.
▪ It does not deal with the public.
▪ It functions for the welfare of the economy.
▪ It has the exclusive right to issue currency
(notes).

29. Functions of Central Bank
1. Bank of Issuing Notes (Currency Authority)
• Bank of issue refers to a bank which has the legal
right to issue currency. In India, the Central Bank is
the sole authority for the issue of currency (except
one rupee notes and coins) in the country.
• It is the monetary liability of central bank to issue new
currency. Central government borrows money from
RBI to finance its deficit.
• All coins and one rupee notes are issued by
Ministry of Finance, Government of India, under
the Indian Coinage Act.

30. 2. Banker to the Government
(a) Carrying out all banking business of the government
(b) Agent to the Government
(c) Financial advisor
(d) Granting loans and advances
3. Supervision of Banks
(a) The Central Bank supervises, regulates and controls
the commercial banks.
(b) The regulation may be related to their licensing, branch
expansion, liquidity of assets management, amalgamation
and liquidation.
(c) It also includes periodic inspection of banks.

31. 4. Banker's Bank
(a) Custodian of cash reserves - Commercial
banks are required to keep a certain percentage of
their deposits with the central bank and in this way
the central bank is the ultimate holder of the cash
resources of commercial bank.
(b) Lender of last resort - Central bank is the
lender of last resort whenever banks are short of
funds they can take loans from the central banks.
(c) Clearing house function - Central banks acts as
a bank of central clearance, settlements and transfers.

32. 5. Lender of the Last Resort
The central bank lends to the commercial banks in times
of emergency. The commercial banks can borrow from
central bank against their eligible securities. It gives
financial loans to commercial banks against approved
securities.
• The rate at which central bank offers (short period)
loans to the commercial banks is called ‘Repo Rate’.
• The rate at which central bank offers (long period)
loans to the commercial banks is called ‘Bank Rate’.

33. 6. Clearing House Function
• Central bank performs the function of a clearing
house. Central Bank holds excess reserves of banks to
meet any clearing drains due to settlement with other
banks. The claims of one bank against other are
conveniently settled by simple transfers from and to
their accounts from these cash reserves.
• It avoids transfer of cash between the banks and
reduces requirement of cash.

34. 7. Custodian of Nation's Reserve of Foreign
Exchange
The Central Bank maintains the stability of exchange
rate fixed by the government. By the sale and purchase
of foreign currencies in the market, it maintains the
internal and external value of the currency.
• RBI issues currency on the basis of minimum
reserve system. Under this system, RBI maintains a
minimum reserve of Rs.200 crore in the form of
gold and foreign securities. Of this reserve, value
of the gold must be Rs.115 crore.

35. 8. Control of Credit and Money Supply
Controlling of the credit is the most important
function of the central bank through this function,
the central bank attempts to influence or control
the volume of bank credit and economic activity
in the country. Central bank can control
deflationary and inflationary situation in the
economy through various credit control measures
like qualitative and quantitative measures. During
inflation, the supply of money is restricted and
during deflation, the supply of money is liberalized.

36. Credit Control Measures/Measures
of Monetary Policy

37. I. Quantitative measures – Quantitative measures
are meant to regulate the overall level of credit in the
economy through commercial banks. Quantitative
measures are also known as general or indirect
measures of credit control.
(a) Bank rate/Discount Rate – It is the minimum rate
at which the central bank of a country gives credit to the
commercial banks against approved securities to meet
their long term needs.
Inflation → Bank Rate Deflation → Bank Rate
(b) Repo Rate – It is the minimum rate at which the
central bank of a country gives credit to the commercial
banks against approved securities to meet their short term
needs.
Inflation → Repo Rate Deflation → Repo Rate

38. (c) Reverse Repo Rate – When the commercial banks
have surplus funds they can deposit the same with the
central bank and earn interest. The rate of interest paid
by the central bank on such deposits is called reverse
repo rate.
Inflation → Reverse Repo Rate
Deflation → Reverse Repo Rate
(d) Cash Reserve Ratio – It is the minimum
percentage of deposits of commercial banks (net
demand and time liabilities) which is kept with RBI.
Inflation → Cash Reserve Ratio
Deflation → Cash Reserve Ratio

39. (e) Statutory liquidity ratio (SLR) – It is the
percentage of deposits of commercial banks (net
demand and time liabilities) which every bank is
required to maintain with itself in the form of
designated liquid assets.
Inflation → Statutory Liquidity Ratio
Deflation → Statutory Liquidity Ratio
(f) Open Market operations - It refers to buying and
selling of Govt. securities and bonds in the open
market (public and commercial bank) by the central
bank.
Inflation → Selling of Securities
Deflation → Buying of Securities

40. II. Qualitative Measures – Qualitative credit aims at
controlling specific types of credit. These are also
known as selective or direct measures of credit
control.
(a) Imposing Margin requirements – A margin is the
difference between the market value of security
offered against by the borrower against the loan and
the amount of the loan granted.
Inflation – Margin is Increased
Deflation – Margin is Decreased
(b) Rationing of credit - It refers to fixation of credit
quotas for different business activities.
Inflation – Rationing Starts
Deflation – Rationing Stops

41. (c) Moral Pressure and Direct Action – It is a
combination of persuasion and pressure that the
central bank applies to other banks in order to get
them fall in line with its policy.
Inflation – Credit Costlier
Deflation – Credit Cheaper
Measures Inflation Deflation
1. Bank Rate
2. Repo Rate
3. Reverse Repo Rate
4. Cash Reserve Ratio
5. Statutory Liquidity Ratio
6. Open Market Operations
7. Margin Requirements
8. Rationing of Credit
9. Moral Pressure & Direct
Action
Increases
Increases
Increases
Increases
Increases
Selling
Increases
Starts
Credit is made
Costlier
Decreases
Decreases
Decreases
Decreases
Decreases
Buying
Decreases
Stops
Credit is made
Cheaper

42. Money Creation by the Commercial
Bank (Credit Creation)
• Currency creation is done by the central bank of a
country, and demand deposits are created by the
commercial banks.
• Commercial banks create money in the form of
credit to the borrowers. Therefore, money creation
by the commercial banks is also called ‘credit
creation’ by the commercial banks.
• Credit creation by commercial banks depends upon
two facts:
(a) Amount of Primary/Initial Deposits
(b) Amount of LRR (LRR = CRR + SLR)

43. • Money creation or credit creation is the process of
expansion of credit through derivative deposits.
• The credit or deposits created by commercial banks
are called derivative deposits.
• A bank cannot lend more than primary deposits.
Total Money Creation = Primary Deposits x 1/ LRR
• Let us suppose that every bank has to keep a cash
reserve of 20% against its total deposits and its
primary deposit is Rs.1,000.
• Minimum reserve requirement or legal reserve ratio
(LRR) is assumed to be 20%.
• Total money creation will be: Rs.5,000.
(Primary deposit x 1/LRR)

44. Working of Money Creation by Commercial Banks
• So in every round 80% of derivative deposits go in
creation of credit and 20% go to reserves. The
• The process continues till the primary deposits of
Rs.1,000 is completely exhausted.
Round Deposits Legal
Reserves
Loans
1st Round
2nd Round
3rd Round
4th Round
……..
1000
800
640
512
……..
5000
200
160
128
102.4
…….
1000
800
640
512
409.6
…….
4000

45. Difference b/w Central Bank and
Commercial Bank
Basis Central Bank Commercial Bank
1. Position
2. Number
3. Ownership
4. Dealing
5. Motive
6. Credit
7. Currency
Authority
8. Status
Apex institution
Only one central
bank in a country.
Government of India.
Doesn’t deal with
public.
Public Welfare.
Controls Credit.
Sole authority to
print and issue
currency notes.
Banker to the Govt.
A part of central bank.
Large number of
commercial banks.
Private or Public Sector
owned.
Directly deals with
public.
Profit Maximisation.
Creates Credit.
No such authority.
No such responsibility.

46. An Extra Mile
I. Why do People Hold Cash Balances?
Cash balances refer to the amount of money, public
intends to maintain for certain motives. The amount
depends on determinants affecting these motives:
(a) Transaction Motive Dm (T) = f(Y)
(b) Precautionary Motive Dm (P) = f(Y)
(c) Speculative Motive Dm (S) = f(Y)
II. Money Multiplier/Deposit Multiplier (m)
Money multiplier measures how many times the total
deposit would be of the initial/primary deposits, which is
determined by LRR.
m = 1
LRR

47. III. Monetary System in India
India at present follows the ‘Paper Currency
Standard ’ because here standard currency is made
of paper currency. This standard is also referred to
as ‘Managed Currency Standard’ because any
amount of notes can be issued with the minimum
back up of gold.
• Coins in India are limited legal tender.
• Paper notes in India are unlimited legal tender.

48. Presented by –
Ritvik Tolumbia