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Money and banking

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Money and banking
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Money and banking

  1. 1. Money and Banking Chapter -6
  2. 2. Evolution of money • Commodity money , metallic money, paper money, bank money • Barter system • Bank money • Plastic money • E-money
  3. 3. Barter – meaning and its inconveniences • Direct exchange of goods without use of money is called barter exchange • Economic exchanges without the medium of money are referred to as barter exchange • C.C.Economy • Commodity for commodity exchange
  4. 4. Inconveniences of Barter exchange • Lack of double coincidence of wants • Lack of common measures of value • Lack of standard of deferred payment • Difficulty in storing wealth • Lack of divisibility
  6. 6. Meaning of Money • Anything which is generally accepted by the people in exchange of goods and services or in repayment of debts • Money is anything that is commonly accepted as a medium of exchange
  7. 7. Functions of Money ‘ Money is a matter of functions four A medium, a measure , a standard , a store.’ • To facilitate the exchange of goods and services and help in carrying out trade smoothly
  8. 8. Functions of money Functions of money Primary functions Medium of exchange Measures of value Secondary functions Standard of deferred payment Store of value
  9. 9. Legal and Functional definition of money
  10. 10. Legal defnation • Legal tender money : money that has a legal sanction by the government behind it, is called legal tender or legal tender money 1. Limited legal tender : it is the money which can be accepted only up to a certain maximum limit fixed by law. 2. Unlimited legal tender : it is the money for which there is no limit to the quantity of money offered in a payment at a time. • Non legal tender money : it refers to that form of money whose acceptance is optional
  11. 11. Functional definition of money • It is defined in terms of its function. Accordingly, money is that which money does • It is based on the four functins of money – a medium , a measure , a standard, a store
  12. 12. Classification of money • Standard and Token coins • Credit money • Fiat money • Fiduciary money- Is the money which is accepted as money on the basis of trust that the issuer commands • Standard coins refers to those coins whose face value is equal to tis intrinsic value • Token money refers to money whose face value is much greater then its intrinsic value Standard and token money • Credit money refers to money whose intrinsic value is less than its face value Credit money • Fiat money is that money which is issued by the order of the govt, to act as money Fiat money Fiat money fa
  13. 13. Liquidity Trap • It is a situation of very low rate of interest where people expect the interest rate to rise in future and consequently bond prices to fall.
  14. 14. Monetary system in India • Indian monetary system is ‘paper currency standard’ • Again ‘paper currency standard’ is also known as ‘managed currency standard’ • In India RBI issues all paper notes expect one rupee note and coins • For note issue India follows the Minimum Reserve system.
  15. 15. Money supply –meaning , components and sources
  16. 16. Meaning of money supply • The supply of money means the total stock of money in circulation held by public at any point of time. • The total stock of money in circulation on a specific day is the money supply of a country
  17. 17. Components of Money supply 1. Currency 2. Demand deposits
  18. 18. Sources of Money supply 1. Government 2. RBI 3. Commercial banks
  19. 19. What is ideal supply of Money
  20. 20. Impact of change in Money supply 1. If there is too much supply of money, people ill have too much purchasing power and demand more and more of goods and services. In case goods and services are not available in the market in sufficient quantity, prices will shoot up. The economy will fall n vicious circle of inflation. 2. If there is too little supply of money, it means people will have too less purchasing power. People will demand less and less of goods and services. A persistent fall in demand will cause depression leading to vicious circle of deflation.
  21. 21. Alternative mesures of money supply (money stock) 1. M1= C+DD+OD 2. M2 = M1 + saving deposits with post offices saving banks 3. M3= M1 + Net time deposits of Banks 4. M4 = M3 + total deposits with post office saving organization(excluding NSE)
  22. 22. High powered money and money multiplier • High powered money , the total liability of the monetary authority of the country, RBI, is called the monetary base or high powered money. • It consists of 1. Currency 2. Vault cash of commercial banks 3. Deposits held by government and commercial banks with RBI
  23. 23. Commercial Bank • A commercial bank is a financial institution which performs the functions of accepting deposits from the public and giving loans for investment with the aim of earning profit.
  24. 24. Function of Commercial Bank •Acceptance of deposits 1.Demand deposits 2.Time deposits
  25. 25. Function of Commercial Bank • Advancing loans • Discounting bills of exchange • Overdraft facility
  26. 26. Function of Commercial Bank • Agency function 1. Transfer of funds 2. Collection of funds 3. Payments of various items 4. Collection of dividend
  27. 27. Function of Commercial Bank • Performance General Utility services 1. Traveler's cheques 2. Locker facility 3. Underwriting securities issued by government, public or private bodies 4. Purchases and sale of foreign exchange • Money creation
  28. 28. Credit creation by commercial bank • Credit creation by commercial banks is determined by two factors 1. Primary deposits new deposit in cash by the people. Indirectly primary deposits reflect savings of the people in the banks . 1. LRR( legal Reserve Ratio) minimum ratio of deposits which is legally compulsory for the commercial bank to keep as cash or in liquid form
  29. 29. Credit creation by commercial bank • When banks receives cash deposit from the public, it keeps a fraction of deposits as cash reserve and uses the reaming amount for giving loan. • In the process of giving loans, banks are able to create money(credit)through secondary deposits (demand deposits, are deposits which arise on account of loan given by the bank) • RBI produces money while commercial banks increases the supply of money by creating credit which is also treated as money creation.
  30. 30. Process of money (credit) creation • A man, say Madan, deposits ₹2,000 with a bank and the LRR is 10% • Bank is required to keep only the minimum required ₹ 200 as LRR • Now bank is free to lend the reaming amount ₹1800 • The bank lends ₹1800 to , say Vinod , • Actually not given in cash but only demand deposit account is opened in his name and the loan amount is credited to his account. • Again 10% of Vinod deposit is kept by the bank as LRR and remain amount will be given as loan • The process of credit creation goes on till derivative deposit (demand deposit) becomes 0
  31. 31. Total credit creation = initial deposit x 1/LRR
  32. 32. Money multiplier • It is multiple by which total deposits increases due to initial deposit • More the number of deposit and the amount of loan therein, more will be investment, in the economy leads to rise in national income through multiplier effect .
  33. 33. Central Bank • The central bank is the apex institution of monetary and banking system of a country. • In India the Central Bank is known as Reserve Bank of India which was established in 1935
  34. 34. Function of a Central Bank • Issue of Currency/Bank of issue • Banker to Government • Banker’s bank and supervisor 1. It is the custodian of their cash reserves. 2. It is lender of last resort 3. It acts as clearing house
  35. 35. Function of a Central Bank • Controller of credit and money supply • Exchange control • Lender of last resort • Custodian of foreign exchange • Clearing house function • Collection and publication of data
  36. 36. Comparison between Central Bank and Commercial Bank Central Bank Commercial Bank It is the apex bank in the money market of a country It is merely a unit in the banking structure of the country Its primary aim is general public welfare Its primary aim is to make profit It has the monopoly/absolute right to issue currency notes A commercial bank is statutorily denied this function It cannot deal with the public It directly deals with the public ad business firms It acts as a banker to the government It has no such responsibility towards the state It decides its monetary policy to realize economic stability and full employment in country It plays a supplementary role and is quite often regulated by the central bank It is custodian of nation’s Gold and Foreign Exchange Reserves It does not perform such function
  37. 37. Thank you