📘 Chapter 3: Money and Banking (Detailed Notes)

1. Money: Meaning & Functions

• Definition (Prof. Crowther): Money is anything that is generally accepted as a medium of exchange and at the same time acts as a measure and store of value.

Functions of Money:

1. Medium of Exchange.

2. Measure of Value.

3. Store of Value.

4. Standard of Deferred Payments.

2. Types of Money

• Commodity Money: Gold, silver.

• Fiat Money: Legal tender by govt. order (notes & coins).

• Fiduciary Money: Accepted on trust (cheques, drafts).

• Bank Money / Credit Money: Demand deposits, electronic money.

3. Money Supply in India

• Measured by RBI in terms of M1, M2, M3, M4.

• M1: Currency with public + Demand deposits + Other deposits.

• M3 (Broad Money): M1 + Time deposits with banks.

• M3 is most commonly used.

4. Banking System

(a) Commercial Banks

• Primary functions: Accept deposits, give loans.

• Credit Creation Process:

  • Banks keep a fraction as reserve (CRR), lend the rest.

  • Loans given → deposited again → cycle continues.

  • Creates multiple expansion of credit.

(b) Central Bank (RBI in India)

• Established in 1935, nationalised in 1949.

Functions of RBI:

1. Issue of currency.

2. Monetary policy implementation.

3. Supervision of commercial banks.

4. Control of credit.

5. Foreign exchange management.

5. Monetary Policy Tools

(a) Quantitative (General) Instruments

• CRR (Cash Reserve Ratio): % of deposits kept with RBI.

• SLR (Statutory Liquidity Ratio): % of deposits kept in liquid assets.

• Repo Rate & Reverse Repo Rate: Short-term lending/borrowing between RBI & banks.

• Open Market Operations: Buying/selling govt. securities.

(b) Qualitative (Selective) Instruments

• Credit rationing.

• Margin requirements.

• Directives to control credit flow to priority sectors.

6. Credit Control

• During inflation: RBI raises CRR, SLR, repo → reduces money supply.

• During deflation: RBI lowers rates → increases money supply.

7. Importance of Money & Banking

• Money removes barter system problems.

• Banking system mobilises savings and promotes investment.

• Central Bank ensures economic stability by controlling inflation/deflation.

• Essential for growth and development of economy.