Unit-1

Money

Meaning of Money
Money (money supply)anything that is
generally accepted in payment for goods
or services or in the repayment of debts.
Money supply is the total amount of
money available in the economy.
Wealththe total collection of pieces of
property that serve to store value
Incomeflow
of time

of

earnings

per

unit

What serves as money

For a money, we need it
Divisible
Identical (uniform)
Storable and durable
Compact (easy to carry): high value per
unit of volume or weight

What serves as money?

Coin & Notes

What serves as money

First paper money, 11th century in

China
Bank notes carried a guarantee that
it could be traded at any time for
coinage

Functions of Money
Medium
of
Exchangepromotes
economic
efficiency by minimizing the time spent in exchanging
goods
and services. A good medium of exchange
Must be easily standardized
Must be widely accepted
Must be divisible
Must be easy to carry
Must not deteriorate quickly
Unit of Accountused to measure value in
the economy: assets, goods, services.
Store of Valueused to save purchasing power;
allows intertemporal substitution of income
most liquid of all assets but High inflation
diminishes its store of value function.
6

Evolution of the Payments

System
Commodity Money: Gold, Silver, other precious
metals, certain stones, etc.
Representative money that is backed 100 % by
precious metals (bank notes)
Checks
Electronic Payments: EFTs, wire transfers.
E-money: Debit cards (POS), etc.

Section 22 of RBI Act

In terms of Section 22 of RBI is the sole
authority for issue of currency in India
including one rupee coins/notes.
One rupee coins/notes are issued by the
Government of India but put into
circulation through RBI.
RBI took over the function of issue of
notes from GOI from April 1, 1935.
Actual notes were issued by RBI only in
January 1938 and until then Bank was
issuing currency notes of Government of
India.

What is a Currency Note?

Currency Note is the same
banknote pertaining to our
Nation Indian Currency Note
is called Indian Rupee (INR)

Notes issued by RBI

At present, banknotes in India are issued in the
denomination of Rs.10, Rs.20, Rs.50, Rs.100,
Rs.500, Rs.1000.
Banknotes issued by RBI in the denominations
of Rs.2 and Rs.5 has been discontinued and
replaced fully with coins.
Bank can also issue notes in the denomination
of Rs.5000 and Rs.10000
Notes
of
higher
denominations
of
Rs.1000,Rs.5000 and Rs.10000 issued earlier
(before
1946
and
1954)
have
been
demonetized in 1978 and are no longer in

Rupee coins and Small coins

Rupee coins and Small coins are
issued by Government of India
through RBI.
Rupee coins are Re.1, Rs.2,Rs.5 and
Rs.10 and Small coins are issued in
the denominations of Ps.25 and
Ps.50. The highest denomination of
coin that can be issued by GOI is
Rs.1000 as per Section 6 of Coinage
Act, 1906.

Printing of Notes and Minting of

Coins
Notes are printed by Government of India at its
printing presses at Nashik and Dewas and at the
presses of Bharatiya Reserve Bank Note Mudran
Private Ltd. (BRBNMPL) at Mysore and Salboni.
Coins are minted at the four Government Mints at
Mumbai, Kolkata, Noida and Hyderabad.
Presses are required to produce around 12,000
million pieces of notes per annum to maintain clean
notes in circulation.
The average life of a note in circulation varies from 1
year to 2 years.
The cost of production of banknote is reimbursed by
the Bank to the Press and the cost of production of
coins is borne by GOI itself.
The design, form and material of the bank notes are
recommended by Central Board of Directors of RBI

Issue of Notes and Coins

The issue of fresh notes and coins is
conducted by RBI in the Issue Department.
These fresh notes are stocked at the
Currency Chest of RBI and other agencies.
The currency chest is provided to a branch
of public sector bank or to a Government
Treasury, which has opted to function as
an agent of RBI.
Thus we have as on June 2007 a wide net
work of 4,301 currency chests and 4,027
small coin depots apart from 18 Issue
Offices, a sub-office at Lucknow and a
currency chest at Kochi of Reserve Bank of
India.

Clean Note Policy

Ensuring adequate availability of good quality banknotes and

coins is one of the core functions of RBI.
Towards this various measures were initiated by RBI viz.
speedier disposal of soiled banknotes, discontinuance of the
practice of stapling of note packets, supply of adequate
quantity of fresh notes to banks and mopping up of soiled
and
mutilated
notes,
particularly
notes
of
lower
denominations from circulation, regular removal of soiled
banknotes from the currency chests and acceleration in
mechanized processing of the notes at the offices of the RBI
as also at Currency Chests by installing CVPS and SBS. Thus,
there has been marked improvement in the quality of
banknotes in circulation.
Reserve Bank of India has been continuously making efforts
to make good quality banknotes available to the members of
public. To help RBI and banking system, the members of
public are requested to ensure the following:
Not to staple the banknotes
Not to write / put rubber stamp or any other mark on the
banknotes

Notes and Coins in circulation Data

as on March 2007 (source: Annual
Report- 2007)

As on March 2007 - 38,831 million pieces in all

denominations of banknotes valued at Rs.4,96,138 crores
are in circulation.
In volume terms, Rs.100 denomination notes had the
largest share (34% of the total pieces in circulation) and in
terms of value Rs.500 denomination notes had the largest
share (45% of the total value of banknotes in circulation).
Rupee Coins and small coins to the extent of 90,357 million
pieces valued at Rs.8,021 crores are in circulation.
In view of the reported mellting of Rs.2 cupro nickel coins
due to rising metal prices, the GOI in consultation with the
RBI decided to mint all denominations coins in ferritic
stainless steel (FSS).
The volume of banknotes supplied to the public during
2006-07 is to the tune of 11,472 million pieces valued at
Rs.1,84,561/- crores

Capital Formation
The act of increasing the stock of capital in the
economy is given the name of Capital Formation.
Capital formation means a situation where the
society does not consume whole of its current
income but directs a part of it for making capital
goods
like
instruments,
machines,
plants,
equipments, transport facilities, finished & semifinished good.
In words of Singer Capital formation consists of
both tangible goods like plants, tools and machinery
and intangible goods like high standard of education,
health, scientific tradition and research.

Process of Capital Formation

Generate Savings

Mobilize Saving

Investment

CREATION OF SAVINGS
Savings are done by individuals or
households. They save by not spending
all their incomes on consumer goods.
When individuals or households save.
They release resources for the
production of consumer goods.
Workers, natural resources, materials
etc thus released are made available
for the production of capital goods.

Types of Domestic Saving

SAVINGS

HOUSEHOLD

FINANCIAL
SAVINGS

PHYSICAL
ASSETS

POSSESSION OF
CURRENCY

MACHINERIES

INVESTMENT IN
SHARES &
DEBENTURE

STOCKS

GOVT
SECURITIES

LIFE
INSURANCE

PROVIDENT
FUNDS

PRIVATE SECTOR

PUBLIC LTD CO
(NON GOVT,
NON FINANCIAL CO)

NET PROFIT
(FINANCIAL STATEMENT)

PUBLIC SECTOR

ADMINISTRATIVE
DEPT

ENTERPRISES

NET PROFIT
(FINANCIAL STATEMENT)

Will to save
Apart from the power to save, the total amount
of savings depends upon the will to save.
Various
personal,
family
and
national
considerations induce the people to save.
People save in order to provide against old age
and unforeseen emergencies.
Some people desire to save a large sum to start
a new business or to expand the existing
business.
Also, people want to make provision for
education, marriage etc.

MOBILIZATION OF SAVINGS
Savings of the households must be
mobilized and transferred to businessmen
or entrepreneurs who require them for
investment.
In the capital market, funds are supplied
by the individual investors ( who may buy
securities or shares issued by companies),
banks,
investment
trusts,
insurance
companies,
finance
companies,
governments etc.

INVESTMENT OF SAVINGS IN REAL

CAPITAL.
For savings to result in capital formation, they
must be invested .
In order that the investment of savings should
take place, there must be a good number of
honest and dynamic entrepreneurs in the
country who are able to take risks and bear
uncertainty of production.
Investment will be made by entrepreneurs only
if there is sufficient inducement to invest.
Inducement to invest depends on the marginal
efficiency of capital ( ie the prospective rate of
profit) & rate of interest.

Importance of Capital Formation

Increase productivity of various sectors: capital

formation increases the stock of material and human
capital. The productivity in agriculture, manufacturing
and mineral sector etc increases.
Increase in National Income: Capital formation
helps in raising national output which in turn raises the
rate and level of national income.
Increase employment: The increased investment in
various sectors of the economy leads to increase
employment opportunities in a country.
Break the vicious circle of poverty: it helps in
breaking the vicious circle of poverty in the LDCs.
Expansion of market: Capital formation makes it
possible to produce the goods on large scale. As the
good of one industry will be the inputs of other and so

Importance of Capital
Formation:
Control Inflation: Capital formation increases the supply of goods
in the country. It thus helps in controlling inflation and bringing
stability in the economy in the long-run.
Self-Sufficiency: A country engaged in capital formation will be
able to produce a variety of goods and make the country selfsufficient. This will reduce a countrys dependence on foreign
countries.
Correct Balance of Trade: Capital formation helps in building
import-substitution industries. The reduced demand of the foreign
goods helps in solving the problems of adverse balance of trade.
Proper Utilization of Natural Resources: The adequate volume
of capital formation makes it possible to utilize the natural resources
of a country to the maximum extent and thus increase the rate of
economic growth rapidly at a higher rate.
Technological Progress: Technological progress requires higher
rate of capital formation. The technological improvements helps in
getting more output from the same resources.
Building up of infrastructure: The building up of sound
infrastructure like road, railways, communication system, power etc is

Sources of Capital
Formation

There are two sources of capital formation

A. Domestic Sources:
a. Voluntary savings by household and
business sectors
b. Involuntary
saving
by
transferring
resources from consumers and producers to
government through taxation.
c. Government borrowing
d. Use of idle resources
e. Deficit financing
B. External Sources:
a. Foreign Aid
b. Restrictions of imports
c. Direct Foreign Investment

Voluntary and Forced

savings
Savings may either voluntary or
forced.
Voluntary savings are those savings
which people do of their own free
will.
Taxes by the government represent
forces savings.

Deficit financing
Deficit financing i.e newly created
money is another source of capital
formation. By issuing more notes and
exchanging them with the productive
resources, the government can build
real capital.
The method of deficit financing as a
source of development finance is
dangerous because it often leads to
inflationary
pressures
in
the
economy.

DISGUISED UNEMPLOYMENT
For example, surplus agricultural workers
can be transferred from agricultural sector
to
non
agricultural
sector
without
diminishing
agricultural
output.
The
objective is to mobilize these unproductive
workers and employ them on various
capital creating projects, such as roads,
canals, building on schools, flood relief
activities.
In this way, the hitherto unemployed labor
can be utilized productively and turned
into capital.

Foreign capital
Capital formation in a country can also
take place with the help of foreign capital,
ie foreign savings. Foreign capital can take
the form of
(a) direct private investment by foreigners,
(b) loans or grants by foreign govts,
(c) loans by international agencies like
world bank
India is receiving a good amount of foreign
capital from abroad for investment and
capital formation under Five- Year Plans

Causes of Low Capital Formation

The following are the causes of low capital formation in LDCs:
Vicious Circle of poverty: The low capital formation in LDCs is
attributed to vicious circle of poverty which operates in LDCs. It
is because of VCP the incomes, savings, investment and
productivity of the people remains limited and obstructed.

Population explosion <higher birth rate: In case of poor

countries not only the volume of population is very high but the
rate of growth of population is also significantly greater. In such
situation all of the incomes have to be devoted to the rising
number of children and nothing is left to be allocated for
savings.
International Demonstration Effect: According to Prof.
Nurkse the biggest obstacle in the way of capital formation in
LDCs is the existence of International Demonstration Effect. It
means that the people of LDCs have the desire to attain that
standard of living which has been
attained by Developed
Countries (DCs); their consumption pattern must be similar to
those of DCs and their educational systems must be like those of

Causes of Low capital formation. continued

Lack of proper infrastructure: In case of LDCs, there is an

acute shortage of infrastructure facilities like power, transport,
communication etc. thus in the presence of inadequate infrastructure the domestic as well as foreign investors are not
prepared to invest. With this the stock of capital and capital
formation remains low.

Inflation: In UDCs, inflation is a very common phenomenon.

Because of persistent rise in general price level, the real
incomes of the people decrease restricting their saving
potentials.
Unproductive expenditures: In case of LDCs, the lavish
expenditures are made on unproductive fields both by
individuals as well as by governments. The individuals waste
their precious savings by spending them on traditions, customs
and litigations etc. while government make expenditures on
unproductive fields for example political purposes. Consequently
a little surplus is available for capital formation.
Unequal income distribution: in UDCs, the distribution of

Causes of Low capital formation. continued

Tax system: in UDCs, the tax structure is also responsible

for low capital formation. In these countries the indirect
taxes are imposed in a greater amount rather direct taxes.
This situation also discourages the saving potential of the
people. In this situation, the poor and middle class of the
UDCs hardly contributes to savings and capital formation.
On the other hand, the businessmen and industrialists are
always found hectic regarding tax evasion.

Problems of Money Markets: Money market is in infancy

in the less developed countries which
is not fully
contributing to capital formation.

Measures to Increase Capital Formation

The effective measures to increase capital formation in a
developing country are:
1.Saving drives: Savings of both types, voluntary and
involuntary can greatly help in capital formation.
2.Setting up financial institutions: The setting up of financial
institutions in urban and rural areas can greatly help the people to
deposit their savings in financial institutions rather than keeping
them in homes. The small and larger amounts of saving so
collected helps in raising funds for development.
3.Public Borrowing: Public borrowing is an effective method of
capital formation. Government raises loans through sale of bonds
and saving certificates etc.
4.Development of Capital Markets: Government can divert
resources from unproductive channels by strengthening the
capital market in the country. The establishment of stock
exchanges etc can go a long way in capital formation.
5.Privatization of financial institutions: The privatization of
financial institutions can also attract savings both at the gross and

Measures to Increase Capital

Formation:
5. Utilization of disguised unemployed workers: If the
disguised unemployed workers are employed on various
projects like irrigation, roads etc they can be a fruitful sources
of capital formation.
7. Foreign Aid: if the capital is not adequate for meeting the
development requirements of the country, then to bridge the
savings-investment gap, the country has to reply on foreign aid
for economic development.
8. Restrictions on Luxury Imports: another source of capital
formation is the imposition of restrictions on luxury imports.
The foreign exchange thus saved could be used for capital
formation.
9. Foreign Earning through exports of physical goods: The
foreign earning through boosting the exports of physical goods
to the other parts of the world can be utilized for capital
formation.
10.Foreign Remittance: Foreign remittance refers to the

ROLE OF BANKS AND FINANCIAL

INSTITUTIONS IN ECONOMY

Development banks
Development banks are the institutions engaged in
the promotion and development of industry,
agriculture and other key sectors.
In the words of A.G. Kheradjou "A development
bank is like a living organism that reacts to the
social-economic environment and Its success
depends on reacting most aptly to that
environment".
D.M. Mithani states that. "A development bank may
be defined as a financial institution concerned with
providing all types of financial assistance (medium
as well as long-term) to business units.

Features of a development bank

A development bank does not accept deposits from the public
like commercial banks and other financial institutions who
entirely depend upon saving mobilization.
It is a specialized financial institution which provides medium
term and long-term lending facilities.
It is a multipurpose financial institution. Besides providing
financial help it undertakes promotional activities also. It helps
an enterprises from planning to operational level.
It provides financial assistance to both private as well as public
sector institutions.
The role of a development bank is of gap filler., When assistance
from other sources is not sufficient then this channel helps. It
does not compete with normal channels of finance.
Development banks primarily aim to accelerate the rate of
growth. It helps industrialization specific and economic
development in general
The objective of these banks is to serve public interest rather
than earning profits. Development banks react to the socioeconomic needs of development.

OBJECTIVES OF DEVELOPMENT
BANKS
Lay Foundations for
Industrialization
Meet Capital Needs
Need for Promotional Activities
Help Small and Medium Sectors

FUNCTIONS OF DEVELOPMENT
BANKS

Financial Gap Fillers

Undertake Entrepreneurial Role
Commercial Banking Business
Joint Finance
Refinance Facility
Credit Guarantee
Underwriting of Securities

LENDING PROCEDURES OF
DEVELOPMENT BANKS
OPERATIONAL ACTIVITIES
Project Appraisal and Eligibility of Applicant
(I) Guidelines for assistance to industries issued by the government or others concerned from time to
time
(ii) Guidelines issued by the bank
(iii) Policy decisions of the Board of Directors of the bank.

Technical Appraisal
Feasibility and suitability of technical process in Indian conditions.
Location, of the project in relation to the availability of raw materials, power:
water. labour, fuel, transport, communication facilities and market for finished
products.
The scale of operations and its suitability for the planned project.
The technical soundness of the projects.
Sources of purchasing plant and machinery and the reputation of suppliers. etc.
Arrangement for the disposal of factory affluent and use of bye products, if any.
The estimated cost of the project and probable selling price of the product.
The programme for completing the project.
The sources of supplying various inputs and marketing arrangements.
Details of any technical collaboration and its practical aspects. The technical
appraisal determines the suitability of the project.

 Economic Viability: The economic

appraisal will consider the national and
industrial priorities of the project export
potential, product employment potential
and study of market.
Assessing Commercial Aspects: The
examination of commercial aspects
relates to the arrangements for the
purchase of raw materials and sale of
finished products. If the concern has
some arrangement for sale then the
position of the party should be assessed.

 Financial Feasibility
The financial feasibility of a new and an existing concern
will be assessed differently. The assessment for a new
concern will involve:
The needs for fixed assets, working capital and preliminary
expenses will be estimated to find out its needs.
The financing plans will be studied in relation to capital
structure, promoters' contribution, debt-equity ratio.
Projected cash flow statements both during the
construction and operation periods
Projected profitability and the like dividend in near future.

Managerial Competence
National Contribution
Loan Sanction
Loan Disbursement
Follow up

DEVELOPMENT BANKING IN
INDIA

Industrial Finance Corporation

of India (IFCI)
18 State Financial Corporations
(SFC's)
National Industrial
Development Corporation
(NIDC)
The Industrial Credit and
Investment Corporation of India
(ICICI)
Refinance Corporation for
Industry Ltd. (RCI)
Industrial Development Bank of
India (IDBI)
State Industrial Development
Corporations (SIDC's)
The State Small Industries
Development Corporations
(SSIDC's)
The Unit Trust of India (UTI)

Industrial Reconstruction
Corporation of India Ltd. (RCI)'
Export-Import Bank of India
(Exim Bank)
National' Bank for Agriculture
and Rural Development
(NABARD)
Film Finance Corporation,
Tea Plantation Finance
Scheme,
Shipping Development Fund,
Newspaper Finance
Corporation,
Handloom Finance
Corporation,
Housing Development Finance
Corporation

PROMOTIONAL ROLE OF
DEVELOPMENT BANKS IN INDIA
Surveys of Backward Areas
Inter-Institutional Groups
Establishing Technical
Consultancy Organizations
Entrepreneurial Development
Programmes
Technological Improvements

Banking and FI in Economic Development

The financial system interacts with real economic activity

through its various functions by which it facilitates
economic exchange
First, the financial system facilitates trade of goods and
services.
Second, it increases saving mobilization by an improvement
of the savers confidence .
Third, it plays an important role in mobilizing funds and
transforming them into assets that can better meet the
need s of investors either by direct, market-based
financing or by indirect, bank -based finance.
Fourth, financial institutions play an important role in
easing the tension between savers
preference for
liquidity and entrepreneurs need for long -term finance.
Fifth, financial system plays an important role in creating
a pricing information mechanism.
Sixth, the financial system can enhance efficiency in the
corporate sector b y monitoring management and exerting
corporate control (Stiglitz, 198 5). Saver s cannot

Role of development banks in

financial system