THEORY OF MONEY AND BANKING Unit : I
Unit: I Introduction to money Kinds functions and significance Demand for and supply of Money Monetary standards Gold standard Bimetallism and paper currency systems paper money money market 2
INTODUCTION TO MONEY Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts in a particular country or socio-economic context.... Legal tender, or narrow money (M0) is the cash money created by a Central Bank by minting coins and printing banknotes. 3
Kinds of Money Commodity Money It is the simplest kind of money which is used in barter system where the valuable resources fulfill the functions of money. The value of this kind of money comes from the value of resource used for the purpose Fiat Money The word fiat means the command of the sovereign. Fiat currency is the kind of money which don t have any intrinsic value and it can t converted into valuable resource 4
Money contd Fiduciary Money Today s monetary system is highly fiduciary. Whenever, any bank assures the customers to pay in different types of money and when the customer can sell the promise or transfer it to somebody else, it is called the fiduciary money. Commercial Bank Money Commercial Bank money or demand deposits are claims against financial institutions that can be used for the purchase of goods and services. A demand deposit account is an account from which funds can be withdrawn at any time by cheque or cash withdrawal without giving the bank or financial institution any prior notice 5
Functions and significance of Money THE MAIN FUNCTIONS OF MONEY ARE: It is a medium of exchange. It gives purchasing power to consumer to pay for goods and services. It is a unit of account. It is a unit measure of value. It is a standard of deferred payment. https://www.youtube.com/watch?v=ok2vtknszzy 6
Significance Money is of vital importance to an economy due to its static and dynamic roles. Its static role emerges from its static or traditional functions. In its dynamic role, money plays an important part in the life of every citizen and in the economic system as a whole 7
DEMAND AND SUPPLY OF MONEY DEMAND Demand for money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments. SUPPLY It includes all currency (notes and coins) in circulation, all checkable deposits held at banks (bank money), and all traveler's checks 8
DEMAND AND SUPPLY CURVE The demand and supply curve for money can be represented as above 9
MONETARY STANDARDS OF MONEY A monetary standard is a set of institutions and rules governing the supply of money in an economy. These rules and institutions collectively constrain the production of money. Through its constraints on money creation, the standard indirectly acts on prices. 10
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GOLD STANDARD- BIMETALLISM AND PAPER CURRENCY SYSTEM Gold standard: A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. Three types can be distinguished: specie, bullion, and exchange. Bimetallism: Under Bimetallism, both gold and silver coins are standard coins. A ratio is fixed by law between their values, and the ratio is maintained by the currency authority. Coins of each of the two metals are unlimited legal tender. 12
PAPER MONEY A banknote (often known as a bill, paper money, or simply a note) is a type of negotiable instrument known as a promissory note, made by a bank, payable to the bearer on demand A country's official, paper currency that is circulated for transaction related purposes. The printing of paper money is typically regulated by a country's central bank/treasury in order to keep the flow of money in line with monetary policy. Paper money tends to be updated with new versions that contain security features that seek to make it more difficult for counterfeiters to create illegal copies. 13
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FUNCTIONS OF THE MONEY MARKET Financing trade Financing industry Profitable investment Self-sufficiency of commercial bank Help to central bank 15
Functions of Money Market Financing trade The money market plays crucial role in financing domestic and international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. Financing industry They help industries secure short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc Profitable investment The Money Market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. 16
Functions Contd Self-sufficiency of commercial bank Developed money markets help the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. To help central bank Sensitive and integrated money markets help the central bank secure quick and widespread influence on the submarkets, thus facilitating effective policy implementation 17
Unit II commercial Banking classification of banks Functions Creation of credit Balance sheet Investment policies Bank assets Banking structure clearing houses 18
COMMERCIAL BANK Commercial Banks are like other financial institutions ( eg: money lenders, indigenous bankers, cooperative societies, agricultural and industrial credit institutions) which are in the business of lending and borrowing of money or credit 19
CLASSIFICATION OF BANKS 20
Classification of Banks Scheduled Banks: The banks which have been included in the Second Schedule of Reserve Bank of India Act, 193 are the Scheduled Banks. These include: Public Sector Banks: These can be further classified into Nationalized Banks and Non Nationalized banks. These are the banks which are owned and controlled by the government. In these the majority of stake is held by the government. Their main aim is to provide service to the public. Private Sector Banks: These are the banks which are owned and controlled by the private individuals. So their main aim is to earn profit like any other businessman does. These include ICICI Bank, HDFC Bank, Axis Bank, Yes Bank, etc 21
Contd. Foreign Banks: These are the banks which are owned and controlled by the foreign companies. Non-Scheduled Banks: The banks which have not been included in the Second Schedule of Reserve Bank of India Act, 193 are the Non-Scheduled Banks. Example include EXIM Bank, etc. 22
FUNCTIONS OF COMMERCIAL BANKS 23
PRIMARY FUNCTIONS (A) Demand Deposits: (i) Accepting Deposits : The owners of these deposits are allowed to withdraw money anytime by simply writing a check. These deposits are the part of money supply as they are used as a means for the payment of goods and services as well as debts. Receiving these deposits is the main function of commercial banks. (B) Time Deposits: Refer to deposits that are for certain period of time. Banks pay higher interest on rime deposits. These deposits can be withdrawn only after a specific time period is completed by providing a written notice to the bank. 24
Contd. C) Advancing Loans: The public deposits are used by commercial banks for the purpose of granting loans to individuals and businesses. Commercial banks grant loans in the form of overdraft, cash credit, and discounting bills of exchange. Secondary Functions: The secondary functions can be classified under three heads, namely, agency functions, general utility function. 25
Contd. ii) Collecting Income: Constitute another major function of commercial banks. Commercial banks collect dividends, pension, salaries, rents, and interests on investments on behalf of their customers. A credit voucher is sent to customers for information when any income is collected by the bank. (iii) Paying Expenses: Implies that commercial banks make the payments of various obligations of customers, such as telephone bills, insurance premium, school fees, and rents. Similar to credit voucher, a debit voucher is sent to customers for information when expenses are paid by the bank 26
Contd. 2) General Utility Functions: (i) Providing Locker Facilities: Implies that commercial banks provide locker facilities to its customers for safe keeping of jewellery, shares, debentures, and other valuable items. This minimizes the risk of loss. 27
Contd. ii) Issuing Traveler s Cheques: Implies that banks issue traveler s cheques to individuals for traveling outside the country. Traveler s checks are the safe and easy way to protect money while traveling. (iii) Dealing in Foreign Exchange: Implies that commercial banks help in providing foreign exchange to businessmen dealing in exports and imports. However, commercial banks need to take the permission of the central bank for dealing in foreign exchange. (iv) Transferring Funds: Refers to transferring of funds from one bank to another. Funds are transferred by means of draft, telephonic transfer, and electronic transfer. - 28
CREDIT CREATION Credit creation means that on the basis of primary deposits commercial banks make loans and expand the money supply. It results in multiple expansion of banks demand deposits. Process of Credit creation The existence of a number of banks, A, B, C etc., each with different sets of depositors. Every bank has to keep 20% of cash reserves, according to law. Suppose, a person deposits Rs. 100 cash in Bank A. As a result, the deposits of bank A increase by Rs. 100 and cash also increases by Rs. 100. 29
EXAMPLE 30
BALANCE SHEET Balance Sheet is the financial statement of a company which includes assets, liabilities, equity capital, total debt, etc. at a point in time. Balance sheet includes assets on one side, and liabilities on the other. both heads (liabilities & assets) should tally (Assets = Liabilities + Equity). 31
INVESTMENT POLICY An investment policy is any government regulation or law that encourages or discourages foreign investment in the local economy, e.g. currency exchange limits. Investment policy statement An investment policy statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance and liquidity requirements are included in an IPS. 32
BANK ASSETS Banks have general assets and liabilities just like individuals. There are asset accounts that make money for the bank. For example, cash, government securities, and interest-earning loan accounts are all a part of a bank's assets. A bank can have different types of assets, including physical assets, such as equipment and land; loans, including interest from consumer and business loans; reserves, or holdings of deposits of the central bank and vault cash; and investments, or securities. 33
BANK ASSETS.. Contd Physical assets include the building and land (if the bank owns it), furniture, and equipment. Loans, such as mortgages, are an important asset for banks because they generate revenue from the interest that the customer pays on the loan. Examples of interest loans include consumer loans, such as home loans, personal loans, automobile loans, and credit card loans, and examples of business loans include real estate development loans and capital investment loans. 34
BANKING STRUCTURE 35
CLEARING HOUSE A clearing house is an intermediary between buyers and sellers of financial instruments. Further, it is an agency or separate corporation of a futures exchange responsible for settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery, and reporting trading data. Clearing houses act as third parties to all futures and options contracts, as buyers to every clearing member seller, and as sellers to every clearing member buyer https://www.youtube.com/watch?v=ibhsnln76dc 36
Unit III Central Banking Evolution Definition concepts Functions qualitative methods of credit control 37
CENTRAL BANKING The last 25 years have been an eventful time for central banking. The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. It was originally constituted with a capital of Rs.5 cores. The entire share capital was contributed privately with the exception of the nominal value of Rs 2.2 lakh subscribed by the central bank. After independence, the reserve bank of India was nationalized. 38
EVOLUTION OF CENTRAL BANKING Reserve bank of India is central bank of India and regulates all the banks of India Warren Hastings felt that there is need of centralized bank in the country. It all started in late 18th century when first time in the history India. His recommendation didn't reach at a thoughtful conclusion of creating a central body to regulate the banking in India. Later when demand of central bank increased in the 20th century and Lord Keynes also recommended setting up a central bank. Reserve bank started its function from April 1 1935 under the Reserve bank of India Act 1934 39
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CENTRAL BANK A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low and prevent inflation. 41
FUNCTIONS OF CENTRAL BANK Monopoly Power of Note Issue Bankers Bank Banker to the Government Lender of the Last Resort Controller of Money Supply and Credit Custodian of Foreign Exchange Reserves Clearing House https://www.youtube.com/watch?v=rlyqk_qbt3i 42
Monopoly Power of Note Issue: The central bank is the bank of issue. It has the monopoly of note issue. Notes issued by it circulate as legal tender money. It has its issue department which issues notes commercial banks. and coins to Coins are manufactured in the government mint but they are put into circulation through the central bank. 43
Banker s Bank There are a number of commercial banks in a country. There should be some agency to regulate and supervise their proper functioning. Being the apex bank, the central bank (RBI) acts as the banker to other banks. In this sense, it bears the same relationship with commercial banks as the latter maintains with the general public. It gives advice to banks on good/sound banking practice. A central bank usually discusses government policy with them and reports back to the government. Thus, a central bank closely monitors the activity of commercial banks 44
Banker to Government The Reserve Bank of India acts as a banker, agent and a financial advisor to the Central Government and all the State Governments (except that of Jammu and Kashmir). As a banker, it carries out all banking business of the government. 1. It maintains a current account for keeping their cash balances. 2. It accepts receipts and makes payments for the government and carries out exchange, remittance and other banking operations. 3. It also gives loans and advances to the government for temporary periods. The government borrows money by selling treasury bills to the Central Bank. 45
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Lender of last resort: When commercial banks fail to meet their financial requirements from other sources, they approach the central bank to give loans and advances as lender of the last resort. Central bank assists these banks through discounting of approved securities and bills of exchange. 47
Controller of Money Supply and Credit: Due to economic fluctuations, the Central Bank, i.e. RBI controls the money supply and credit in the best interests of the economy. As RBI has the sole monopoly in currency issue, it can control credit and supply of money. 48
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Custodian of Foreign Exchange Reserves With the aim of facilitating foreign trade and payment and promoting orderly development and maintenance of foreign exchange market, a central bank acts as the manager of foreign exchange. The central bank acts as the sole custodian of gold and foreign currencies for the purpose of issuing notes and for correcting an adverse balance of payments situation. 50
Clearing House As central bank holds the cash reserves of all the commercial banks, it becomes easier and more convenient for it to act as their clearing house. All commercial banks have their accounts with the central bank. Therefore, the central bank can easily settle claims of various commercial banks against each other, by making debit and credit entries in their accounts. 51
CREDIT CONTROL RBI controls money as well as bank credit. By controlling credit it works to stabilize prices and rates for credit exchange 52
Unit IV Foreign Exchange Mechanism Exchange Market Exchange control 53
FOREIGN EXCHANGE MECHANISM The foreign exchange market is the market in which participants are able to buy, sell, exchange and speculate on currencies. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The forex market is considered the largest financial market in the world. https://www.youtube.com/watch?v=unviex1p2ie 54
CHARACTERISTICS Highly Liquid Open 24 Hours a Day, 5 Days a Week Leverage 55
Highly Liquid The forex market has enticed retail currency traders from all over the world because of its benefits. One of the benefits of trading currencies is its massive trading volume, which covers the largest asset class globally. This means that currency traders are provided with high liquidity. In the forex market, as one major forex market closes, one in another part of the world opens. Unlike stocks, the forex market operates 24 hours daily except on weekends. Traders find this as one of the most compelling reasons to choose forex, since it provides convenient opportunities for those who are in school or work during regular work days and hours. 56
Leverage The leverage given in the forex market is one of the highest forms of leverage that traders and investors can use. Simply put, leverage is a loan given to an investor by his broker. With this loan, investors are able to enhance profits and gains by increasing traders and investors control over the currencies they are trading. 57
EXCHANGE MARKET Foreign exchange market The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-thecounter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market. 58
MARKET SIZE AND LIQUIDITY The foreign exchange market is the most liquid financial market in the world. Traders include governments and central banks, commercial banks, other institutional investors and financial institutions, currency speculators, other commercial corporations, and individuals. 59
Exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country s currency in relation to another currency. 60
Foreign exchange controls Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents. Common foreign exchange controls include: Banning the use of foreign currency within the country Restricting currency exchange to government-approved exchangers Fixed exchange rates Restrictions on the amount of currency that may be imported or exported 61
Unit V Indian Banking system Indian banking Reserve Bank of India Organization Management Functions NABARD State Bank of India Exchange Banks Commercial Banks Indigenous Banks Co-operative Banks. 62
INDIAN BANKING SYSTEM The banking system of the country is the base of the economy and economic development of the country Its is the most leading part of the financial sector of the country The banking system in the country has three primary functions : 1. Operations of payment system 2. Depositor and protector of people s savings 3. Issue loans to individual and companies 63
RESERVE BANK OF INDIA The Reserve Bank of India (RBI) was established on 1 st 1935 April Its is called as the supreme monetary authority or the central banking authority RBI is aware of operating the currency and credit system of the country to its advantages 64
FUNCTIONS OF RBI Monetary authority RBI acts as regular and supervisor of financial system Foreign exchange control Currency issuance Government s banker Banker to bank 65
NABARD NATIONAL BANK FOR AGRICULTURAL INSTITUTION IN INDIA (NABARD) is an apex development financial institution in India. In July 1982 the NABARD act was set up under the chairmanship of Mr.Sivaraman known as CRAFICARD, the committee recommended the setting up of separate apex bank called NABARD NABARD is an apex development financial institution in headquartered at Mumbai with branches all over India India, https://www.youtube.com/watch?v=huowswrhyvy 66
FUNCTIONS OF NABARD Its acts as an apex body for meeting the credit needs of all types of agricultural and rural development It has the responsibility of inspecting co-operative banks and RBI It maintain a research and development fund to promote research in agricultural and rural 67
STATE BANK OF INDIA State bank of India (SBI) is an Indian multinational, public sector banking and financial services company Its is a government owned corporation with its headquarters in Mumbai & Maharashtra 68
EXCHANGE BANKS The operating of the exchange bank had remained a closed book for long, because until the passing of the banking company act 1949 These banks published no separate balance sheet for their Indian business As these bank have a network of branches all over the world 69
INDIGENIOUS BANKERS Indigenious bankers are private firms or individual who operate as bank and as such both receive deposit and give loans. They are also financial intermediaries They are distinguished from professional money lender whose primary business is not banking money lending 70