Basics of Money and Banking

Aug 12, 2024

Money and Banking

Introduction

  • This lecture is on money and banking.
  • Money is a small topic, but the points it covers are important.

Beginning of Money

  • There was no concept of money initially.
  • Initially, the barter system existed, where goods were exchanged.

Drawbacks of the Barter System

  1. Double Coincidence of Wants
    • I have what you need, but you don't have what I need.
  2. Measurement of Value
    • Earlier, people couldn't measure the value of goods.
  3. Storage for the Future
    • Items can't be kept safe for a long time.
  4. Standard of Deferred Payments
    • Difficult to make payments in installments or loans.

Definition of Money

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

Functions of Money

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

Money Supply

  • Money supply means the total quantity of money available with the public at a given time.
  • It is a stock concept.

Measures of Money Supply

  • Primarily 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 deposits from the public, lends money, and invests.
  • Commercial Bank: Deals with the public.
  • Central Bank (RBI): The bank of all banks.

Functions of a Central Bank

  1. Currency Authority
    • RBI holds the authority to issue all currency in India.
  2. Banker's Bank
    • All government transactions go through RBI.
  3. Controller of Money Supply
  4. Custodian of Foreign Exchange

Money Creation Process

  • Money Multiplier: Generation of multiple amounts of money from an initial deposit.
  • If the initial deposit is 1000 and LRR is 20%, it can grow up to 5000.
  • Banks hold back savings as per LRR and lend the remaining amount.

Formula for Money Multiplier

  • 1 / LRR

Differences Between Central and Commercial Banks

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

Conclusion

  • Knowledge of money and banking is crucial.
  • The role of RBI is to control the money supply and maintain economic stability.
  • This lecture clarifies the basics of money and banking.

Utilizing these notes will help students understand the key aspects of money and banking.