Fundamentals of Money and Banking

Aug 12, 2024

Money and Banking

Introduction

  • This lecture is about money and banking.
  • Money is a small topic, but the marks from it are important.

Beginning of Money

  • Initially, money had no meaning.
  • At first, there was a barter system where goods were exchanged.

Limitations of the Barter System

  1. Double Coincidence of Wants
    • What I need is with you, but what you need is not with me.
  2. Measurement of Value
    • People could not measure goods before.
  3. Storage for Future
    • Goods cannot be stored safely for a long time.
  4. Standard of Deferred Payments
    • Difficult to make payments in loans or installments.

Definition of Money

  • Money is what is generally accepted as a medium of exchange.

Functions of Money

  1. Medium of Exchange
    • Money is used in buying and selling.
  2. Measure of Value
    • Goods can be measured in terms of money.
  3. Store of Value
    • Money can be stored for future use.
  4. Standard of Deferred Payments
    • Standard for repaying loans.

Money Supply

  • Money supply refers to the total amount of money available with the public at a given time.
  • It is a stock concept.

Measures of Money Supply

  • Mainly four measures: M1, M2, M3, M4.
  • M1: Most liquid money.
  • M2: M1 + savings deposits.
  • M3: M1 + time deposits.
  • M4: M3 + post office deposits.

Money Creation

  • A bank is a financial institution that accepts money from the public, provides loans, and invests.
  • Commercial Banks: Deal with the public.
  • Central Bank (RBI): Bank of all banks.

Functions of the Central Bank

  1. Currency Authority
    • RBI has the right to issue all currency in India.
  2. Government's Bank
    • All government transactions occur through RBI.
  3. Controller of Money Supply
  4. Custodian of Foreign Exchange

Money Creation Process

  • Money Multiplier: Generating multiple amounts of money from a single initial deposit.
  • If the initial deposit is 1000 and LRR is 20%, it can grow up to 5000.
  • Banks keep a reserve according to LRR and lend the remaining amount.

Formula of Money Multiplier

  • 1 / LRR

Difference between Central and Commercial Banks

  • Central Bank: One, in public interest.
  • Commercial Banks: Many, for profit.

Conclusion

  • Knowledge of money and banking is important.
  • The role of RBI is to control money supply and maintain economic stability.
  • This lecture elucidates the fundamentals of money and banking.

Using these notes will help students understand the important aspects of money and banking.