ECONOMICS [2281]

1. MONEY & BANKING
LEARNING OBJECTIVES:
THE FORMS, FUNCTIONS AND CHARACTERISTICS OF MONEY.
THE ROLE AND IMPORTANCE OF CENTRAL BANKS AND COMMERCIAL BANKS
FOR GOVERNMENT, PRODUCERS AND CONSUMERS.

2. • DEFINITION: Money is anything that is widely used and generally accepted within
a community as a means of exchange & for settling debts.
•
• FUNCTIONS OF MONEY
• A medium of exchange: Money is a medium of exchange in the sense that we all
agree to accept it in making transactions. It helps in buying & selling. It
overcomes the difficulties of barter.
• A measure of value: It helps to assess the value in exchange of good & services
(price).To compare the relative value of goods.
• A standard for deferred payments: It measures value for the future & acts as a
measuring rod for debts. It enables borrowing & lending.
• A store of value: It helps people to save for the future. It is the most liquid asset.

3. • WHAT FUNCTION IS PERFORMED BY MONEY IN THE
FOLLOWING CASES?
• A woman pays a bus fare of RS 15. (Medium of exchange)
• A man deposits RS 1000 in his account. (Store of value)
• A factory purchases equipment worth RS 100,000. (Medium of
exchange)
• A company prepares its annual Balance sheet. (Measure of
value)
• A businessman obtains a loan of RS 50,000 from a bank.
(Standard for deferred payment)
• A boy purchases an ice cream for RS 25. (Medium of exchange)

4. • CHARACTERISTICS OF MONEY - WHAT IS A ‘GOOD’
MONEY?
• Acceptability: Anything can be used as money as long as it is generally
accepted. Thus our present money is a token [symbol/evidence] money (as a
piece of paper it is worth much less than the face value printed on it).
• Durability: Coins & notes must be strong & durable so that they may act as a
store of value.
• Portability: Money should be easy to carry.
• Divisibility: It must be possible to divide money of a large value into smaller
values to make small purchases or to give change.
• Scarcity: If money is scarce will people value it as a commodity that can be
used in exchange.

5. • FINANCIAL INSTITUTIONS
• Business organisations that specialises in keeping money safe, helping customers
make payment, lending money, investing and exchanging money.
• The money market is made up of all those people/organisations that want money
and all the people/organisations willing and able to supply money.
•
• Banks - are financial intermediaries between customers who want to deposit
money and customers who want to borrow money. Banks earn profit for their
shareholders by:
• Making loans: they attract deposits and savings by paying their customers interest
on their money, or a share in their profits.
• Charging interest on loans.
• Charging fees for their services.
• Investing in shares in other companies: they use money deposited by customers to
buy and sell shares in other public limited companies on behalf of its shareholders.

6. COMMERCIAL BANKS & SERVICES
TYPES OF BANKS
• Commercial banks – offer services to the general public and to companies. Accept customers’ deposits
(historical function inherited from the forefathers of modern commercial banks {Goldsmith’s establishments}).
MAIN SERVICES:
• Accepting deposits Making/receiving payments Making loans Buying/selling shares for customers
• Providing insurance Operating pension funds Storing valuables Financial & tax planning
advice
Investment banks
• A bank that specializes in helping large business organization raise finance to fund their operations and
expansion, usually helping them to issue and sell stocks and shares on the market.
• They also provide advice on company mergers and takeovers.
Central banks manage the monetary system for a government.
Credit unions cooperatives and not-for-profit organizations owned by its members aiming to provide low-cost
loans (most banks are owned by investors).

7. Online banks operate entirely online – there are no physical branch locations to talk with a
teller or personal banker. They often offer competitive rates on savings accounts and
they’re likely to offer free checking.
Islamic banks- A bank that forbids interest charges and payments and therefore earn a
profit through the fees it charges customers for banking services.
Savings banks
• A bank that provides a safe and accessible place for people on low incomes to keep their
savings.
• By providing this service, they are able that the government can borrow.
• They offer similar services as commercial banks.
Other financial institutions:
• Finance houses, venture capitalists, pension funds, insurance companies, building
societies, investment & units trust.

8. TYPES OF ACCOUNTS
Savings Account Fixed Deposit Account Current Account
1.
Suitable for those who wishes to
save small sums of money.
Suitable for those who have extra money
to be set aside to earn interest.
Useful for businesses who needs
safe method to make and receive
payments.
2. Opened with minimum deposit. Opened with large deposit. Opened with large deposit.
3. Earns low interest. Earns high interest. Earns no interest.
4. No need to pay bank charges. No need to pay bank charges.
Has to pay charges if deposit falls
below certain amount.
5.
Money can be deposited and
withdrawn any time.
Amount of deposit remains fixed. Cannot
be withdrawn.
Money can be deposited and
withdrawn any time.
6.
Certain limit of withdrawing
money.
Money cannot be withdrawn until a
specific period expires.
No Limit of withdrawing money.
7. - - - - - - - - - - - Certificate of deposit. - - - - - - - - - - -

9. TYPES OF LOANS
• An overdraft (short term loan) allows a bank’s customer to overdraw their account
by an agreed amount. It provides a short term loan with interest charged.
• A personal loan must be repaid with interest over a fixed period of time.
• A commercial loan is a loan to a business which is repayable with interest over a
fixed period of time.
• A mortgage is a (long-term loan) secured against a property.
• Granting loan to customers remains main profit activity of commercial banks but are
strictly controlled by the central bank.
METHODS OF PAYMENT
• Cash.
• Cheque: written promise to pay cash/transfer money into the account of someone
else.
• Direct Debit - Payment of varying amounts at irregular intervals.

10. PLASTIC MONEY
• Plastic money is a term that is used predominantly in reference to the hard plastic cards we use every day
in place of actual bank notes. (bank cards, credit cards, debit cards, smart cards, etc. )
Cash Cards - A card allowing the withdrawal of money directly from your bank via an Authorised Teller
Machine (ATM) but it will not allow the holder to purchase anything directly with it.
Credit Cards - This card will permit the card holder to withdraw cash from an ATM, and a credit card will
allow the user to purchase goods and services directly like a debit card, but unlike a Cash Card the
money is basically a high interest loan to the card holder, although the card holder can avoid any interest
charges by paying the balance off in full each month. It allows the card holder up to a month or longer to
pay for the purchases (interest may be payable).
• Debit Cards - This type of card will directly debit money from your bank account, and can directly be used
to purchase goods and services. While there is no official credit facility with debit cards per se, as it is
linked to the bank account the limit is the limit of what is in the account, for instance if an overdraft facility
is available then the limit will be the extent of the overdraft.
• Smart card: Plastic card similar to debit/credit card with embedded microprocessor chip, electronic
memory, and a battery. Used for information storage and management and authentication.

11. COMMERCIAL BANKS & SERVICES
• 1-To accept customer’s deposits: This is the historical function inherited from the forefathers of
our modern commercial banks (Goldsmith’s establishments).
• 2-To grant loans to customers: This is the main profit making activity of commercial banks. They
usually grant overdrafts (short-term) as well as (long-term) loans e.g. mortgage. They should be
ready to lend money in order to maximise profit but are strictly controlled by the central banks.
• 3-Advice to customers on investment & stock exchange transaction: Precious advice can be
given to customers willing to invest in company shares or Government securities.
• 4-Credit Card Facility: People can use a credit card to make payment and receive a bill from the
credit card company.
• 5-Other services: vault safe facility to store precious documents & jewel, etc. .Traveller’s
cheques, pension funds, advice in filling income tax returns, writing a will (executorships &
trusteeship service)

12. CREDIT CREATION (History)
• Started at Goldsmith establishments. Merchants & travelers were often attached & robbed of their gold
coins. They decided to keep Gold coins to the Goldsmith & travel with gold certificate. Gradually gold
certificate became generally accepted.
• The Goldsmith realized that the bulk of gold coins were immobilized in their safe. The idea of lending
money started to germinate. Borrowers preferred borrowing Gold certificate rather than gold coins.
Numbers of gold certificates were several times greater in circulation than the gold coins. The Goldsmith
alone knew this.
• The money supply expanded so fast that members of public started doubting the Goldsmith (confidence
crisis).The majority of the certificate owners returned to the goldsmith to claim their gold. The goldsmith
could not convert the entire gold certificate into gold coins. The crowds usually beat the goldsmith &
break their bench. The word bankrupt originated from this.
• Our modern banks create credit in the same way as the Goldsmith. Bank notes have replaced gold coins
& cheques have replaced the gold certificates. For safety purposes or to earn interest, people keep their
liquid money in banks rather that to keep it at home.
• Banks usually keep a Cash reserve of 10% in order to meet normal demand for cash. This is known as
the cash ratio. Thus if a customer deposit RS 100, the commercial bank can lend as much as RS 900.
• There is another ratio observed by commercial banks known as the liquidity ratio which is about 28% of
total deposit. At any time an unexpected demand for cash might crop up. Hence apart from the 10% kept
as cash in drawer, another 18% may be kept as near cash or near money which is known as money at
call.

13. Credit creation rest on the important condition:
Public confidence in commercial banks.
Unwillingness of people to keep liquid money at home
Total amount of deposits = ( (1/cash ratio) * cash deposit) – (e.g. 1/10%*Rs100 = R1000)

14. THE CENTRAL BANK
• BRITAIN- Bank of England, West Germany -Bundesbank: Mauritius –Bank of Mauritius.(dept of the ministry of
finance) USA: Federal Reserve bank (12: New York –main)
• The central bank is controlled by the government and it controls all the other commercial banks in the country.
FUNCTIONS OF CENTRAL BANKS
• 1-Sole right of note issue: It has the monopoly of controlling the issue of bank notes and minting of coins collectively
known as M1 (UK: 1-Thomas de larue & co ltd. 2-Bradbury Wilkinson)
• The governor of the bank decides on the number of notes and their value to be put on the market. The central bank
also withdraws from circulation old and used up banks notes.
• 2-It is the government’s bank: It looks after the money received by the government e.g. tax revenues, and managing
its payments, e.g. its spending on hospitals, school etc….
• 3-It stores the nation’s gold & foreign currency reserves: These reserves are used to influence the value of a
country’s currency against other countries’ currencies.
• 4-It acts the banker’s bank: It supervises the banking system, deciding who can be a bank and how banks should
behave. Commercial banks keep deposits of their own money at the central bank.
• 5-A lender of last resort: It will lend money to the banking system to prevent banks from going bankrupt if they run
out of money.
• 6-It governs the government monetary policy: It fixes the interest rate and control the volume of credit created by
commercial banks.

15. MONETARY POLICY
• Monetary policy is the process by which the monetary authority of a country controls the supply of
money, often targeting a rate of interest for the purpose of promoting economic growth and
stability. The official goals usually include relatively stable prices and low unemployment.
• It is referred to as either being expansionary or contractionary. An expansionary policy increases
the total supply of money in the economy more rapidly than usual, and contractionary policy
expands the money supply more slowly than usual or even shrinks it.
• Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering
interest rates in the hope that easy credit will entice businesses into expanding. Contractionary
policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of
asset values.
• A policy is referred to as contractionary if it reduces the size of the money supply or increases it
only slowly, or if it raises the interest rate. An expansionary policy increases the size of the money
supply more rapidly, or decreases the interest rate. Furthermore, monetary policies are described
as follows: accommodative, if the interest rate set by the central monetary authority is intended to
create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or
tight if intended to reduce inflation.