Money _ Banking

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                  Chapter 8: Money and Banking
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Praveen Baldua’s Smart Notes                    ECONOMICS                                                CA‐CPT

                                           CHAPTER 8 ‐ UNIT 1

   •    In layman terms, Money is an instrument we use to pay for things.
   •    Traditionally following items used as money: Clay, Cowry shells, Tortoise shells, Cattle, Slaves, Rice,
        Wool, Salt, Porcelain, Stone, Gold, Iron, Brass, Silver, Paper & Leather etc.
   •    Thus any items can be termed as money if they satisfy following function:
          a)    Served as medium of exchange.
          b)    Served as a common measure of value
           c)   Served as a store of values
   •    Hence there are two types of MONEY

               Pure Money                                            Near Money
        Cash & Demand deposits                             Bands, Govt. securities, Time
                                                          deposits, Equity share (financial asset)
   •    So, Money is what money does.

       In a static sense (Traditional Economics)           In a dynamic sense (Modern Economics)
       •As a medium of exchange                        •Direct economic trends
       •Common measure (Denominator) of value.         •Encouragement of divisions of labour.
       •Standard deferred (future debts) payment       •Smooth transformation of savings in to investment.
       •Store of value                                            ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

          As per RBI -1979                                 As per (Redefined money stock)
M1 (Narrow money):                         M1=
Currency notes & Coins + Demand            Currency + Demand deposits + Other deposits with RBI
M2 =                                       M2=
M1 + Post office saving deposits.          M1+ Time liabilities portion of saving deposits issued by banks +
                                           Term deposits maturing within a year excluding FCNR (B) deposit.
M3 (Broad money) =                         M3=
M1 + Time deposits with banks              M2+ Term deposits with banks with maturity over one year + Call/
                                           term borrowing of the banking system
M4=                                                              -------------------------------
M1+ Total post office deposits
Note: The difference between M1 & M3                              ---------------------------------
is Time deposits with Bank

Prepared by: Praveen Baldua                                   Page 1
Praveen Baldua’s Smart Notes                          ECONOMICS                                             CA‐CPT

                                             CHAPTER 8 ‐ UNIT 2
                                           COMMERCIAL BANKING
   •        Commercial Banks act as a bridge between the user of capital & those who save money.

 1)          Received deposits through:
          a)    Demand deposits i.e. saving A/c. & Current A/c. (Low or Nil interest for Current A/c.)
          b)    Time deposits i.e. fixed deposit (Highest int. rate)

 2)         Lending of money through:
   •        Cash credit, Overdrafts, Loans & Advances or Discounts of bills etc.

 3)         Agency service i.e. collection of bills, Cheque, Dividends, Interest, Premium, Acts as a trustee etc.

 4)          General Service i.e.
          a)    Issue of LIC, Travelers’ cheques, drafts etc.
          b)    Safety of valuables vaults.
          c)    Under wring of shares, long term Loans etc.

   •        At the time of independence India had only 645 banks & 4800 branches.
   •        Nationalization of banks:
            i. In 1969 14 banks were nationalised.
            ii. In 1980 6 more banks were nationalised.
      •     But at present there are 19 nationalised Banks (Because two banks were merged in 1993).
      •     Objectives of Nationalisation:
            i. Removal of control by few.
            ii. Provision for credit to priority sector.
            iii. Giving professional bent to management.
            iv. Encouragement of new class of entrepreneurs
            v. Provision of adequate training to bank staff.

2.4, 2.5 & 2.6]
   2.4]        Nationalisation of              2.5]      Progress CB after           2.6]    Short comings of CB in
            commercial bank                           Nationalisation                            India.
1) Private ownership of commercial         1) Expansion of branches.               • The expansion of branch in
bank & Concentration of economic           • In 2008 no of branches increased      numerical terms is insufficient
power:                                     to 76,885                               because In rural area 41% of bank
• All major banks were controlled          • Population per bank office has        branches serve more than 70%
by one or more business houses to          reduced to around 15000 in 2008         population.
use the resource for personal
2) Urban – bias:                           • In June 2008, 41% of total bank •         Regional imbalances are there.
• Only 5000 banks serves to                branches established in rural areas.
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Praveen Baldua’s Smart Notes                    ECONOMICS                                             CA‐CPT
around 5.6 lakhs village in India.      • Deposit mobilesation in 2008 is
• Five major cities (Ahemdabad,         3197000 crores (almost 80% of NI)
Bombay, Calcutta, Delhi & Madras)       • Maharashtra account for 1/5th of
together had 1/7th share in the         deposits.
numbers        of    bank      office   • Delhi, UP, WB, TN & Karnataka &
& 50% share of bank deposits &          AP together account for 65% of
credits.                                aggregate deposits.
3) Neglect of agricultural sector &     • Bank lending increased to 2362000   • The gross non perform assets
often priority sector:                  crores in June 2008                   (NPAS) has been increased up to
• Agriculture accounted for only        • At present (March 08) 44% of the    51000 crores in 2006‐07
2.2% of total advance.                  commercial bank credit has been       • NPAs as a % of gross advance is
• Others sectors such as exports,       accounted for Agriculture, SSI,       2.5% in 2006‐07.
SSI etc. were completely neglected.     Small retail trade etc.               • To reduce NPAs follows measure
                                                                              are taken by RBI
                                                                              1) Corporate debt restructuring.
                                                                              2) Debt recovery through Lok‐
                                                                              adalats, Civil courts & Debt
                                                                              recovery tribunals.

4) Speculative activities:
• Private banks provide loans to                                              • Absolute profit is increasing but
Hoarders & Black marketers at a                                               profitability ratio is decreasing due
high interest rate.                                                           to:
                                                ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐     a) Law interest on Govt.
                                                                              b) Low interest loans to priority
                                                                              c) Increase in overheads.
                                                                              d) Rapid branch expansions.
                                                                              e) Lack of competition.
                                                                              f) In creasy expenditure due to
                                                                              overstaffing & expansion of
                                                                              g) High incidence of NPAs

                                        • Bank finance the schemes which • Quality of service rendered by
         ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐        promote enter partnership i.e. IRDP, commercial banks has been
                                        TRYSEM,JRY,NRY etc.                  deteriorates overtime.

Prepared by: Praveen Baldua                                 Page 3
Praveen Baldua’s Smart Notes                  ECONOMICS                                             CA‐CPT

                                     CHAPTER 8 ‐ UNIT 3
                                 THE RESERVE BANK OF INDIA

   •   Central Bank (RBI) is the apex Bank, performs in the national economic interest.
   •   In other words he is responsible for economic stability & assisting the growth of economy.

3.0] FUNCTIONS OF CENTRAL               3.2] ROLE OF RBI                     3.3] FUNCTION OF RBI
1. Regulation of currency in                                       1. Issue of Currency: RBI has sole authority
accordance with the requirement                ‐‐‐‐‐‐‐             to issue currency other than 1 rupee coins
of business & the general public.                                  & notes & subsidiary coins.
2. Performance of Agency & It acts as an advisor to the            2. Banker to the Govt.:
Banking service for the state     Govt. in the economic &          • RBI handles all banking operation on
                                  Financial policies.              behalf of state & central Govt. (i.e. many
                                                                   • It also sells Treasury bills on behalf or CG
                                                                   & SG as well as given advance to CG & SG
                                                                   for 90 Days.
                                                                   • Govt. act as an advisor for framing
3.                                It acts as a Friend,             3. Bankers Bank:
• It grants collateral advances o Philosopher & Guide to           It is called Bankers Bank because.
commercial Bank, Bill brokers & Commercial Bank.                   • RBI has full power to control & supervise
dealers.                                                           commercial banks und RBI Act 1934 &
• Custody of Cash reserve of the                                   Banks regulation Act 1949.
Commercial Bank.                                                   • RBI provides loans & advance in the form
                                                                   of bill discounts etc.
                                                                   • All banks have to maintain certain
                                                                   minimum cash reserve ratio with RBI
                                                                   against demand & time deposits.
4. The custodian of Nations                                        4. Custodian of Foreign exchange reserve :
reserves  of    International                                      • RBI has to maintain the external value of
Currency.                                      ‐‐‐‐‐‐‐             rupees.
                                                                   • Hence wherever foreign exchange is
                                                                   inadequate it borrows from IMF.
5. Control of credit as per the RBI has to keep Inflationary       5. Controller of credit’s:
monetary policy adopted by the trends under control & the          Controlling credit operations is a Principal
state.                          provide credits at cheap           function of a central bank by using
                                rates to priority sector.          Qualitative & Quantitative methods of
                                                                   credit control.
                                                                   6. Promotional Functions:
             ‐‐‐‐‐‐‐                           ‐‐‐‐‐‐‐             RBI also performs a variety of
                                                                   developmental functions for this NABARD,
                                                                   SIDBI & EXIM BANK has developed.

Prepared by: Praveen Baldua                               Page 4
Praveen Baldua’s Smart Notes                     ECONOMICS                                              CA‐CPT
                    CENTRAL BANK                                             COMMERCIAL BANK
1) Its objectives are not to make profit.                    Its is a profit making Institution.
2) Central bank deals with governments, Central &            Commercial bank deals with only Public.
    State banks & others financial institute.
3) Central bank ensures other banks conduct their            Commercial bank ensures mobilize saving &
    business with Safety, Security & In pursuance with       channelise them in to proper use.
    economic & Social development.
4) Its main source of Income is                              Its main source of income is :
  a) Reserve against note issue & interest.                  Interst on Loans & Advances grants to public.
  b) Interest on advance& loans grant to state govt. &
  other financial institution & commercial banks.
5) It does not allow interest on deposits.                   It allows interest on deposit.

          A main objective of monetary policy in India is:
       1)    To maintain price stability
       2)     To ensure adequate credit for economic growth
       3)    To encourage credit flow in to desire, neglected & priority sectors.
       4)    To Strengthing the banking system.

   •      There are two types of monetary policy i.e.
       1)    Quantitative or General Measures are used to influence Total volume of credit in the economy.
       2)    Qualitative or selective measures are used to influence Specific or particular use of credit (not total

I] Quantitative measures or General measures
       METHOD                                                  EXPLANATION
BANK RATE POLICY           • It is traditional weapon of credit control.
                           • Bank rate is a rate at which central bank discounts bill of commercial banks.
                           • During Inflation Bank rate ↑
                             During Deflation Bank rate ↓
                           • At present Bank rate is 6%
OPEN MARKET                • OMO means direct purchase & Sales of securities & bill in the market by central
OPERATIONS (OMO)           bank.
                           • During Inflation Sell the securities in the market.
                           • During Deflation Buy securities from the market
VARIABLE RESERVE           • There are two types of reserve i.e.
REQUIREMENT                  1)      Cash reserve Ratio: It is that portion of total deposit which commercial bank
                                     keeps with (Central Bank)
                             2)      Statutory liquidity Ratio: It is that portion of total deposits which commercial
                                     bank keep with himself in the form of cash gold or approved Govt securities.
                           • During Inflation Reserve Ratios ↑
                           • During Deflation Reserve Ratio ↓
                           • At present CRR is 5% & SLR is 24%.
REPO RATE & REVERSE        • Repo rate is a rate at which our banks borrow rupees from RBI against approved
RATE                       securities to fulfill short term gap.

Prepared by: Praveen Baldua                                   Page 5
Praveen Baldua’s Smart Notes                 ECONOMICS                                          CA‐CPT
                        • At present Repo rate is 4.75%
                        • Reverse repo rate is a rate at which RBI borrow money from banks.
                        • At present reverse repo rate is 3.25%
                                       SITUATION                        REPO RATE        REVERSE REPO
                          DURING INFLATION
                                                                            ↑                 ↑
                          DURING DEFLATION
                                                                            ↓                 ↓

II] Qualitative or Selective measures.
         METHOD                                              EXPLANATION
Securing loan regulation by   • During Inflation margin requirement is ↑
fixation     of      margin   • During Deflation      margin requirement is ↓
requirements.                 •This method is also useful to check inflation in certain sensitive spots.
Consumer credit regulation    • Consumer credit consists of down payments & No. of installments.
                                Situation           Down payment No of Installment.
                                During Inflation
                                                        ↑                   ↓
                                During Deflation
                                                        ↓                   ↑
Issue of Directives           • Directives are oral or written statements appeals or warnings to crub
                              individual credit by central bank to commercial banks.
Rationing of credit.          • This method is used to regulate the purpose for which credit is granted.
Moral suasion                 • It is a psychological means of controlling credit.
                              •It is purely informal & milder method
                              • Under this method central bank persuade or request to commercial bank to co‐
                              operate with general monetary policy (i.e. not to finance speculative or non
                              essential activities)
Direct Action.                • Some time central Bank takes action against commercial bank like.
                              a) Refuse to rediscount their papers.
                              b) Refuse to give excess credit
                              c) Or charge panel rate of Interest over & above bank rate.

     *****************BEST OF LUCK*****************

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