MONEY

 What is Money?
 What is Money?
 ‘Money is what money does’. F.A. Walker

 Money is a medium of exchange, a unit of

accounting, and a store of value.
Types of Money
[I] Fiat money and fiduciary money
[II] Full bodied money and credit money

Fiat money: Money which is issued by the authority of the

government.
E.G: Indian rupees and Coins issued by RBI and Government of India.

Fiduciary money: Money that is accepted due to trust between

people. E.g.: Cheque.

Full bodied money: Face value and commodity value are same.
Credit money: Face value is more than the commodity value.
 Functions of money

 Medium of exchange
 Store of value
 Deferred payment
 Unit of account
  Money Supply

 The money supply measures the total amount

of money in the economy at a particular time.

 It includes actual notes and coins and also any

deposits which can be quickly converted into
cash.
In India Reserve Bank of India uses four alternative
measures of money supply called M1, M2, M3 and M4.

M1 = C + DD + OD. Here C denotes currency (paper notes

and coins) held by public, DD stands for demand deposits in
banks and OD stands for other deposits in RBI.

[OD includes:
1] d.d deposits with RBI of the public financial institutions like
National Bank for Agricultural and Rural Development
Industrial Investment Bank of India Ltd.
Tourism Finance Corporation of India Ltd.
Risk Capital and Technology Finance Corporation Ltd.
Power Finance Corporation Ltd.
National Housing Bank.
2] d.d s deposits with RBI of foreign central banks and foreign governments.
3] d.d deposits of international financial institutions [IMF]
In India Reserve Bank of India uses four alternative
measures of money supply called M1, M2, M3 and M4.

M1 = C + DD + OD. Here C denotes currency (paper notes

and coins) held by public, DD stands for demand deposits in
banks and OD stands for other deposits in RBI.

M2 = M1 (detailed above) + saving deposits with Post

Office Saving Banks

M3= M1 + Net Time-deposits of Banks

M4 = M3 + Total deposits with Post Office Saving

Organisation (excluding National Saving Certificate)
CHAPTER -5

BANKING
 Bank: An institution which accepts deposits from the
public and gives loans to those who need it.

 Spread: Rate of interest charged by the banks for the

loans – Rate of interest paid by the banks for the
deposits they accept. [15- 5 here]

??? Interest
XII – E
Interest
HO 5%
BANK
15%
W

deposits Loan
So, this is the basic function of the
commercial banks.

WHAT??
1] Accepting deposits and
2] Advancing loans
1] Accepting deposits
Demand deposits
Savings deposits and
Fixed deposits

2] Advancing loans :
Against collateral
Credit or Money creation by commercial banks :

We know that Money Supply includes :

a. High powered money ( Money produced by

Central bank )
and
b. Demand deposits of the commercial banks
( also called bank money.)
 Credit / money multiplier:

 What is Money Multiplier?

 The money multiplier is the amount of money that
banks generate with each rupee of reserves.

 Reserves is the amount of deposits that the Reserve

Bank requires banks to hold and not lend.
Process of credit or Money creation by commercial
banks :
Lets assume that you deposited Rs 100 with the
bank.

Out of experience bank knows that, they need to

keep only 10% of it to meet the withdrawal
requirements.

So, bank will keep only Rs. 10/- with them to meet
the transaction requirements and will give the
rest of the money as loans.
The difference between actual reserve [which the
bank
The has at hand]
difference and actual
between the required
reservereserve[
[which Which
the
is needed
bank tohand]
has at meet and
the demand requirements
the required is
reserve[ Which
called ‘EXCESS
is needed RESERVE’.,
to meet the demand 100-10 = 90]
requirements is
called ‘EXCESS RESERVE’.

Excess reserve should be converted to income

earning asset.
[In our example, 100-10 = 90]
Example of money multiplier
Suppose banks keep a reserve ratio of 10%. (0.1)
So, if someone deposits $100, the bank will keep
$10 as reserves and lend out $90.
However, because $90 has been lent out – other
banks will see future deposits of $90.
Therefore, the process of lending out deposits can
start again.
Process of credit or Money creation by commercial
banks :
Lets assume that you deposited Rs 10,000 with
the bank.

Out of experience bank knows that, they need to

keep only 10% of it to meet the withdrawal
requirements.

So, bank will keep only Rs. 1000/- with them to

meet the transaction requirements and will give
the rest of the money as loans.
The difference between actual reserve [which the
bank has at hand] and the required reserve[ Which
is needed to meet the demand requirements is
called ‘EXCESS RESERVE’.

Excess reserve should be converted to income

earning asset.
So, bank will keep only Rs. 1000/- with them to
meet the transaction requirements and will give
the rest of the money as loans.

Liabilities RS Assets Rs.

1] D.d Deposits [ primary ] 10,000 1] Cash Reserve 10,000

2] Derived deposits 9,000 2] Loans 9,000

Total 19,000 Total 19,000

Now, the total demand deposit with the bank is

Rs. 19,000, and the bank need to keep only 10%
of it. Which means that bank can lend the rest.
So, bank will keep 10% of 9000 with them and rest will
be given as loans.
Liabilities RS Assets Rs.
1] D.d Deposits [ primary ] 10,000 1] Cash Reserve 10,000

2] Derived deposits 9,000 2] Loans 9,000

8,100 8,100
7,290 7,290

[ and so on till all excess

reserves are exhausted]
Total 1,00,000 Total 1,00,000
 Liabilities RS Assets Rs.
1] D.d Deposits [ primary ] 10,000 1] Cash Reserve 10,000

2] Derived deposits 9,000 2] Loans 9,000

8,100 8,100
7,290 7,290

[ and so on till all excess

reserves are exhausted]
Total 1,00,000 Total 1,00,000

The formula for estimating credit/ money creation by

the commercial banks:
= [1/Reserve requirements ] x Cash reserves
From our example: [1/ 10%] x Cash reserves
 Credit / money multiplier:

It is the reciprocal of reserve requirement of the

commercial banks as a percentage of their demand
deposits.
k = 1/ Reserve Requirement.
[ In our example RR was 10%]

Less the reserves to be held with the bank, more

credit can be created by the bank. i.e: THERE IS AN
INVERSE RELATIONSHIP BETWEEN CREDIT
CREATION ABILITY OF THE BANKS AND RR.
https://www.youtube.com/watch?v=JG5c8nhR3LE
 Money Multiplier : 1 / R.R

Money creation : Excess reserve x 1 / R.R

Or
Initial deposit x 1 / R.R

The formula to be used depends on the

situation. If money creation is from a primary
deposit, the first one. But if the credit
creation is from a central bank purchase of
bonds, then the second one.
Money creation : Excess reserve x 1 / R.R
Or
Initial deposit x 1 / R.R
The formula to be used depends on the situation. If money creation is from a primary
deposit, the first one. But if the credit creation is from a central bank purchase of
bonds, then the second one.
E.G: Find the amount of money that can be created:
1] If the primary deposit Rs.500, R.R is 20 %.
2] If the Central bank purchase bond for Rs.500 from a commercial bank, R.R is
20 %.
Case: 1
Since R.R is 20% Rs. 100 should be kept with the commercial bank. Only 400
will be available for money creation.

So: Money creation : Excess reserve x 1 / R.R Where Excess reserve =400
R.R = 20%.
400 x 1/20% = 400 x 1/.2

= 400 x 5 = 2000
 LEGAL RESERVE RATIO (L.R.R):

It is the ratio of deposits the

commercial banks should keep as a
reserve .
 L.R.R has two divisions

A) C.R.R: Minimum percentage of a commercial

banks total deposits to be kept with Central Bank.
The current CRR is 4% p.a
and

B) S.L.R : : Minimum percentage of a commercial

banks total deposits which banks are required to
keep with them ( To meet the daily business
needs).
 Liquid assets includes cash, gold, securities against
which the loan is raised.
 The current SLR is set at SLR is 18% p.a.
 Cash Deposit Ratio [ CDR]

 It is the ratio between money held by the people as

cash and money held by the people as demand
deposits.
 CDR = Cash in hand / Demand deposits

 It shows the liquidity preference of the consumers.

 Higher the ratio, greater the liquidity preference.
 Repo Rate:
Repo rate is the rate at which the central bank of a
country (Reserve Bank of India in case of India) lends
money to commercial banks in the event of any
shortfall of funds. Repo rate is used by monetary
authorities to control inflation. [4.00%]
 Reverse Repo Rate:
When Reserve Bank of India faces a financial crunch,
they invite commercial banks and other financial
institutions to deposit their excess funds into RBI
treasury and offers them excellent interest rates.
 Reverse Repo Rate:

When banks have excess funds, they voluntarily

transfer it to RBI as their money is safe and secure
with them. Generally, Reverse Repo Rate [3.35%] is
always lesser than Repo Rate

The Reverse Repo Rate was lowered by the RBI to

6.00% on 7 February 2019, followed by another
reduction to 5.75% on 4 April, 2019.
The current Bank Rate is the
The current Repo Rate as
same as Marginal Standing
fixed by the RBI is 4% p.a.
Facility rate, i.e. 4.65%
CENTRAL BANK
 It is the principal banking and
monetary institution of a
country which has the
monopoly of note issue.
 Government of India has the sole right to issue coins in
India
 Functions of Central Bank:
1. Issuing notes: It is the exclusive right of
the Central Bank.
( so Central Bank is also known as the Bank
of issue).
This is called the currency authority function
of the central bank.
 2. Banker to the Government :
Central Bank acts as a banker, agent and
financial advisor to the government.

As an agent: RBI buys and sells securities on

behalf of the government.
As a banker: RBI manages the account of
the government.
As an advisor: RBI frames policies and
regulate money market.
 3. Banker’s Bank :
Central Bank is the apex of all banks in
the country. It holds C.R.R of the
commercial banks.
It changes CRR and SLR according to the
need of the economy.
 4. Supervision of the banks: Central
bank supervises the activities of the
commercial banks
( activities like Licensing , merger,
expansion etc).
Mention repo and reverse repo and clearing
house facility.
 5. Custodian of Foreign
Exchange :
The Central Bank maintains
foreign exchange reserves to
promote international trade and
stabilizes exchange rate.
 6. Lender of last resort:
If any commercial banks fails to
get financial accommodation from
anywhere, Central Bank gives loans
on eligible securities.
7. Stablisation measures:

RBI stablises the stock of money

using monetary policies.
8. CLEARING HOUSE FUNCTION:

EXPLAIN
9.Controller of Money supply and
credit:
RBI has two instruments for credit
control.

A) Quantitative Methods
(instruments)
and
B) Qualitative Methods (instruments)
A). Quantitative Methods (instruments)

It deals with controlling the quantity of money in

the economy.

THREE METHODS:
1] Policy rates : a] Bank rate and b] repo rate
2] Open market operations :
3] Policy ratios : CRR and SLR
1. Bank rate [long term] /repo rate policy:
It is the rate at which the central bank lends
loans to the commercial banks, against
securities.

If the bank rate is raised, commercial bank’s

ability to create money supply ( Bank money)
will reduce and vice versa.
1. Repo rate also known as the benchmark interest rate is the
rate at which the RBI lends money to the banks for a short term.
When the repo rate increases, borrowing from RBI becomes
more expensive.

2. If RBI wants to make it more expensive for the banks to borrow

money, it increases the repo rate similarly, if it wants to make it
cheaper for banks to borrow money it reduces the repo rate.
1.

Reverse Repo rate is the short term borrowing rate at

which RBI borrows money from banks.

2. The Reserve bank uses this tool when it feels there is too much
money floating in the banking system.

3. An increase in the reverse repo rate means that the banks will
get a higher rate of interest from RBI. As a result, banks prefer to
lend their money to RBI which is always safe instead of lending it
others (people, companies etc) which is always risky.
 2. Open Market Operations:

It is the buying and selling of

government securities in the open
market.

 When money supply is more, RBI

will sell securities, so money with
the public and bank will be reduced
and vice versa.
 3. Legal Reserve Requirements:
The commercial banks are obliged to keep a
portion of their reserve known as L.R.R
L.R.R is divided in to :
a). C.R.R : Which is to be kept with Central bank.
and
b). S.L.R : Which the banks can keep with them
for business.
 To reduce money supply the central
bank will increase the C.R.R. and
S.L.R and vice versa

 Thus Reserve Bank controls the

credit creation capacity of the
commercial banks.
 B. Qualitative Methods
(instruments)

It deals with the uses for which the credit is

used.
1] Margin requirements.
2] Moral Suasion.
3] Rationing of credit.
4] Direct Action.
1. Margin Requirements:
Margin is the difference between the
amount of loans and the price of the security.

By altering margin requirements, the central bank

can control the credit creation.
Eg. If Margin requirements imposed by central bank
is 40%,loan can be given only 60% of the value
of security.

Usually margin requirements will be kept high for

speculative trading.
 2. Moral Suasion:

This means persuasion or pressure the

central bank exerts on the commercial
banks to follow its policy.
3. Rationing of credit:
It is the fixing of the credit quotas for different
business activities.
To check flow of credit for speculative activities/
particular activity.

4. Direct Action:
Central Banks take direct action against those
banks which do not comply with its directives.
 Definition of 'Marginal Standing Facility'

Definition: Marginal standing facility (MSF) is a window for

banks to borrow from the Reserve Bank of India in an
emergency situation when inter-bank liquidity dries up
completely.

Description: Banks borrow from the central bank by pledging

government securities at a rate higher than the repo rate under
liquidity adjustment facility in short.

The MSF rate is pegged 100 basis points or a percentage point

above the repo rate. Under MSF, banks can borrow funds up to
one percentage of their net demand and time liabilities (NDTL).
 The Marginal Standing Facility (MSF) Scheme is
operational on the lines of the existing Liquidity
Adjustment Facility – Repo Scheme (LAF – Repo) i.e.
commercial banks can borrow money from RBI

 . The basic difference between Repo and MSF

scheme is that in MSF banks can use the securities
under SLR to get loans from RBI and hence MSF rate
is 1% more than repo rate.
Bank Rate: Rate charged by RBI on commercial banks
for long terms borrowings.

Repo Rate(Repurchasing Rate): Rate charged by RBI

on banks for short term loans/ borrowings.

Here the banks keep the Govt-Securities with RBI and

repurchase them again. When they repurchase banks
have to pay more, which is nothing but rate charged by
RBI.
Instruments of credit control/ Monetary policy

Quantitative Qualitative

Margin
Bank rate 2 policy requirements
rates of
Repo rate RBI Rationing of credit

CRR 2 policy
ratios
Moral Suasion
of RBI
SLR

OMO
THANK YOU
 Credit / money multiplier:

 What is Money Multiplier?

 The money multiplier is the amount of money that
banks generate with each dollar of reserves.
Reserves is the amount of deposits that the Federal
Reserve requires banks to hold and not lend.
 Different measures of money supply.
 M1 [narrow money]: include coins and notes in
circulation and other money equivalents that are
easily convertible into cash [ Demand deposits].
 M2 = M1 + short-term time deposits in banks and
24-hour money market funds.
 M3 = M2 plus longer-term time deposits and money
market funds with more than 24-hour maturity.
 M4 = M3 plus other deposits.
 The term broad money is used to describe M2, M3 or
M4, depending on the local practice.