11.

3MEANING OF MONEY
According to Robertson, Money is anything that is generally acceptable as a medium of exchange, measure
of values, slore of value and defered payments.

Aecording R. P. Kent, Money is a commodity which is used to denote anything which is widely accepted in
payments of goods or in the discharge of other business.
According to Keynes, Money is that by delivery of which debt contracts and price contracts are discharged
and in the shape of which a store of general purchasing power.
According to Walker, "Money is what money does".
Asuitable de finition of money must emphasis not only the important functions of money but also its basic
characteristics.
Imost suitable.
namely general acceptability. Looking from this criterion we find that Crowther's definition is the
According to Crowher, money is anything that is genrally acceptable as ameans of exchange and that at ythe
same lime, acts as a measure and store of value.

11.4 FUNCTIONS OF MONEY

Money performs several important functions. It serves as a medium of exchange, a unit of account, a store
of value and a standard off deferred payments.
Prof. Kinley has classified the functions of money into three groups (i) Primary function (ii) Secondary function
(iii) Contingent function.
(i) Primary Functions
The two primary functions of money are to act as a medium of exchange and as a unit of value.
(e) Money as a Medium of Exchange : The most important function of money is that it serves as amedium
of exchange or means of payments. For most purchases or sales money is the accepted as medium through which
the buyer pays the seller.
(b) Money as a Unit of Value : The second important function of money is that it can act as a common
measure or standard of value or the unit of goods and services. In measuring distance, the meter or foot is the
unit of account. Similarly. in measuring value in exchange money serves as the unit of account. By reducing the
value of all goods and services to a single unit of account the process of exchange is enormously simplified. Money
thus becomes a common denominator. Economists call this aspect of money as its unit of account function.
(iü) Secondary Functions
Tiere are three secondary functions of money :
(a) Money as a Standard of Deferred Paynents: Money also serves as standard of debt or deferred
payments. It is customary to mcasure the debts or the promises of future payments in terms of money rather than
in commodity or services. The reason being that money is expressible in definite and standardised units and its
value remains slable over time.
(b) Money as a Store of Value : Money is a store of value. This means that it is way to store wealth. It iS
true that the wealth can be stored even the form of other assets but its holding in the form of money is better
than all the other alternative forms of wealth. The reason being that money has more liquidity than
any other form fu
of assets. Liquidity means the ability of an asset to be exchanged for some thing else of value without
delay. Thus
money is very connected way to store wealth for use whenever it is needed. is
bu
2
283

(c) Transfer uf lalue : [he thrd secondars functon of money relatcs lo its ser ing as a medtim
ranster of value. it helps us to transler salue from one person to another or Ironi on plave to another. oney
can effcct such transfer value from one person to another. Money can effect such transters easily. quickly and
efficiently.
(iii) Contingent Functions
In addition to the primary and secondary functions money also performs certain contingent functions. These
are

(a) equalisation of marginal utilities of spending.

(b) distribution of social income.
(C) basis of credit system, and
(d) liquidity and uniformity of wealth.

11.5 CLASSIFICATION OF MONEY

Different economists have classified money in different wavs. We shall discuss some of the important forms
money.
Money can be classified on the basis of following two criteria.
Monetary System Criterion
(1) Actual Money and Money of Account : Actual money is that money which actually
currently in practice in a country. Actual money is the medium of exchange of goods and services circulates and is
For example. in a country.
India, the coins and paper notes of various
denominations are actual money
Money of account is that in which debts and prices and general
form of money in terms of which the accounts of a country ar: kept purchasing power are expressed. It is that
and transactions are made.
(2) Commodity Money and Representative Money :
or representative money. Commodity money is made of
Actual money may be either commodity money
certain metal and its face value is equal to its intrinsic
value. It is also referred to as full bodied money.
value.
Commodity money is both a medium of exchange and store of
Representative money means those notes which are freely convertible into full-bodied mnoney. It may
either of cheap metal or convertible paper money. This money is not a be made
because it commands little intrinsic value. good medium for storing purchasing power
Metallic Money and Paper Money: This classifications of
money is made. Money made of some metal is called metallic money depends upon the material of which
money and that of paper is known as paper
money.
Metallic money is further classified under two sub heads:
() Standard Money. It is full-bodied money and
its face value and intr1nsic value are equal.
(i) Token Money. It is that unit of
currency the face value ot which is higher than its
rupee is a token money. intrnsic value. Our
Paper money can be classified under tive heads:
I. Representative Paper Money. Representative paper money
full-bodied coins or their is in etleet a circulating warehouse receipt for
equivalent in bullion. It
i_ fully backed by gold coins or gold is also known as representative tull-bodied money
bullion held by he treasury. They because it
are tully convertible into gold coins or
bullion.
 12.1 MEANING OF COMMERCIAL [Link]
function is generall, accepting chequeable
They are unique as financial intermediaries in that their main
transferred bv means of cheques fron
deposits. A deposit with a commercial bank serves as money as it can be
one depositor account to another for making a pay ment.
in turn ad ance loans
Commercial bank is an institution which accepts chequeabie deposit trom the public and
for the purpose of investment.

12.2 FUNCTIONS OF COMMERCIAL BANKS

Deposits are of thi ce
(1) Accepting Deposits : This is the most inportant tunction at comerciai banks
forms :
(a) Saving Account : Deposits in this account earn interest at nominal rates s the bankS can alvavs be callei
upon by a depositor to release his account
(b) Current Account : These are also known as deinand deposits, snce uny sum or any number of withdrawals
can be presented by such an acount holder.
(c) Fixed Deposits : These are also known as time depos1ts or term deposits since the anount deposited with
abank cannot be withdrawn before the matur1ty of the period for which they have been contracted.
(2) Extending Loans : This is the second important function of the commercial banks. Loans and advances
may take diflerent forms like (a) provision of over drat fasilities (b) discounting bills of exchange (c) advancing
outright loans and advances
The dierent types of loans and adv ances are
(i) Cash Credit : In this arrangement, an cligible borrower is first sanctioned a credit init upto which he
may borrow tronm the bank
(ii) Demand Loans : A denmand Loan is onc that can be recalled on demand. It has no stated maturity. The
entire loan is paid in lumpsum by crediting it to the loan account oe the borrower. hus the entire loan amount
becomes chargeable lo interest.
(ii) Short Tern Loans : Short term koans may be yiven as personal loans, loans finance working cpital
or as priority sector advances These are secured loans against some security. lu is chargeable to interest
(3) Traasfer of Funds : Irade and commerce in the modern world is becoming increasingly more complex.
lis conplenity requires the trunster oe tunds trom one place to anotheE.
(4) Agency Funetions : ('ommerial banks are increasingly acting as financial agents fur their clents Thes
295
 REDIU KE VIION: BANAS \ ) PORTFO OVI\1GEIE\I 296

ullet amt make all sontl ol payments tor then lient lke t. ke premmun pson la, dadend clams ot
ital lemand Tbe ageCy sCIles o ded by the banks atc
(I) Insfer of funds
(2) Collectuon ol lunds
(3) Purchase and sales of shares nd securities
(4) (ollccton of div idends and interest
(S) Payment of billk and nsurance premmia as per customer's directions
(6) Acling as eNCCutors and trustees of wills
(7) ProVIston ol ncome tax consultane
(8) Acting as correspondent . ayent or representative of customers as vellas securing documentations for air
and sea passaye

12.3 BANKING SYSTEMS

There are four types of banking systems found in the world. They are: unit banking. branch banking, group pi
banking. and chain banking.
Unit Banking. Unit banks are independent, one-office banks. Their operations are confined in general to a
single oflice. The unit banking is peculiar to the USA. The unit banks operate in small towns and cities and are called
country banks and city banks respectively. The various types of country banks and city banks are able to operate
eflicienty through acorrespondent relationship with one another. The country banks have deposits with city banks
and city banks have deposits in stale banks in the same and other cities. The centre of correspondent banking is New
York city, followed by Chicago and other regional centres in big American cities.
Branch Banking. Branch banking is found in the majority of countries such as England, Australia Canada.
India. clc
Under branch banking system, a big bank has a number of branches in different parts of the country and even
Imany branches within a cosmopolitan city. Small commercial banks also carry on branch banking operations within
u state or rcgion.
the
Group Banking. Group banking is a type of multiple office banking consisting of two or more banks under
control of a holding company. The term Bank holding company' is based on 25 per cent ownership or control of
fwo or more banks. The holding company is called the parent company and the banks under the parent company 12
fe called operating companies. This svstem of banking is found in the USA.
two or more
Chain Banking. It is a banking system where the same individual or group of individuals controls opt
ownership in two or
banks, as against control by a holding company under group banking. This is done by stock
more banks
Ob
12.4 TYPES OF COMMERCIAL. BANKING
(ommercial banks are classified into (wo catlegories
which are included in the
(a) Scheduled Banks : Scheduled Comimercial banks are those commercial banks
included in the second schedule it has
second schedule of the Reserve Bank of India Act, 1934. Before a Bank is casl
proj
lo satisty the following conditions
of not less than rupees five lakh.
() lnust have a paid up capital reserves of an aggregate value
not being conducted in a mner detrimental to the
(i) I must sat1sfy the Reserve Bank that its aflairs are ISse
Interest of its deposilors or

On the basis of ownership, scheduled

commercial banks are classified into bank
 () Banks n the l'ublie Sector

th) AsoCtes Bnks of the State Bank oi Inda

19 Nalional1scd Banks
td) Keonal [Link] Banks
(n) Banks in the Private Sector
( Joot stock banks in private swctor n Inda number i5 present
(h) Torcign banks n privale selot are branches ot banks incorporated in toreign couniries Ihere are 4.4 such
banks with I89 branches

th) Non-Scheduled Banks are all tlhose banks whch are not included in the second schedule In 1939 there
were, in undivided lndia. about 500 joint stock banks of which over 1400 were non-scheduled banks. Some of these
Mere tining institution with a paid :up capital of less th.n R s0,000 The number of non-scheduled bank are ut
present stands at only 3

Schematic Classificatinn of Commercial Banks

Commerc1al Banks

Scheduled ('omncrcial Banks Von-Scheduled Commercial Banks

Public Scctor Banks Priv ate Sector Banks Foreign Banks

SBI & Is Associates Other Nationalised Banks

 13.1 MEANING OF CENTRAL BANK
II Is an institution which is charged with the
cred1t or money in the economv responsb1litv of managIng the expansin nd contraction of
Central bank is a bank which control cred1t
Central bank IS J bank
and banking structure of its countrv which perform as best s it can In whrch constitutes apex of the monetarv
natenal conomc interest
13.2 FUNCTIONS OF CENTRAL BANK
() Monopoly Note Issue: Note issue is the sole privtlege of the
are full of legal tenders centrai bank in a country and is notes
(2) Banker to the Government: As the
of government govern1nent's banker, the central bank keeps the bank:ng Jccounts
for its customers
departments, board and enterprises and performs the same functiots s a commercai bank performs
(3) Control of Credit:AI functions of the central bank in nodern tmes is that of contoiling credt
vperations of commercial banks
(4) Maintenance of Exchange Rate : Another
important
stable. The central bank performs two major tunctions in the function of a central bank is to keep exhange rate
fiekd of foreign excnange () has become the
custodian of the countrv's reserves of international currences, and
of the currency. besides entforc ing exchange ()t maintains stabilin of the exchange rate
control regulations
(S) Central Bank as the Promoter of Ecoaomic
Development : In the underdeveloped countries whose maun
concern is the quick development of their economic potential,
is not merely regulatory to maintain stability but
central banks have every mportant role to play which
developmental and promotonal
(6) Lender of the Last Resort : Br granting
lo commercial banks, bill brokers, or other financialaccommodation
n the form of re-dscount and collateral atvances
Thus institutions the central bank xts as the lender ot the last esort
the central bank as lender of the last resort is a big
rates.
source of cash and also ntlucences prices and mauket

13.3 CREDIT CONTROL BY CENTRAL

BANK
Credit control is the means to control the lend1ng polcy of commercal banks by the
central bank
Objectives of Credit Control
The central bank controls credit to achieve the tollowng
objcctives
() Price Stability. lntlationary or detlationary rend need to e prev ented
Ths can be xhieved by sdopting
a judicious policy of cred1t control.
(i) Foreign Exchange Rate Policy. Since it is the volume ot credit money that attects
prices, the central bank
can stabilise the rate of toreign exchange by controling bank cred1t.
(ii) To Control Business Cycles, The Central bank can counteract cycical
bank credit during boom periods, and expansion ot bank credit during
tluctuations through contraction of
depresIon
(iv) Adjustent of Volume uf Credit According to Business Need. Credit is needed lo meet the
trade and industry. lherefore, it is the central bank which can mect the requirements of business by
requrements of
controlling cred1t.
() Full Employ ment. The am of cred1t control Is to help n achieving full employment and acelerated growth
with stab1l1ty in the ccoomy

301
 302

Metltol ofCrelit (ontol

tual bank adopts Iwo Iypes of methods of cIed1t conttol
ualttve crcd1t conuol s also known as
quantitative and qualitative methods.
selcctive cicdit control.
(A) Qunntitative Credit Control. Quantitative credit
hy idojpng such lechniques is arialions n the bank rate,control ainns at controlling the cost and quantity of credi
ralius of commercial bnks.
open market operations, and variations in the reserve
(i) Bunk Rute. Bank rate is thc rate presca ibed by the central bank. I is
Ibank wiil discount tirst class bills of exchange or will advance thc minimum rate al which the central
banks Sometmes. it is called ilhe discount rate.
loans against approved securities held by conmercial
If the central bank wants credit cxpansion. it will lower the bank
rate
commercial banks, who lower their interest rates, The central bank will raisemaking credit cheaper, followed by
the bank rate to discourage credit
ereation under inflationary conditions.
For successful working of the bank rate mechanis1m the money
be a direct and organic type of relationship between the bank rate market imust be an integral whole, i.e., there must
and the other
whenevt there is a change in the bank ratce other money market rates of interest alsomarket interest rates, so that
cconomie structure of the economy has got to be elastic, so that changes in moneyuIdergo change. Again, the
and credit conditions are
pronptly reflected in the changes in other variables like costs, wages, prices, production and
(ii) Open Murket Operations. This method refers to the sale and employment.
LOvernment as well as private financial institutions by the ccntral bank. purchase of securities, bills and bonds of
If the central bank wishes to reduce the volume of credit, it sells
securities to public, for which it receives
payment cither in cash from the public (in which case thec quantity of money with the public to
that extent is reduced)
or it may received payments by cheques drawn on commercial banks. in which case the cash
with central bank is reduced, and to that extent, commercial banks are held by these banks
On the other hand, if the central bank wants to increase credit, it buys compelled to reduced the volume of credit.
approved securities from the market.
(ii)Changes in Resenve Reyuirements. In all countrics, every commercial bank is required by law
a certain amount of cash-reserve with the central bank, usually a certain or custom to keep
percentage of its time and demand deposits to
ensure liquidity and solvency of individual commercial banks. It is called cash reserve ratio or required
reserve ratio or
variable reserve ratio.
When the central bank raises the reserve ratio of the commercial banks, it means that the latter
are required to keep
more money with the central bank. Consequently, the excess reserves with the commercial banks are reduced and
can lend less than before. they
On the contrary, if the central bank wants to expand credit, it lowers the reserve ratio so as to increase
the credit
operation power of the comunercial banks.
(B) Qualitative (Selective Credit Control). Under selcctive (qualitative) credit control the effect is on certain specific
type of credit while other types of credit remain more or less unaffccted. Important selective credit controi
measures are:
(i) Regulution of Consumer Credit. Under this method the central bank of a country is
fenns and conditions for the proper regulation of consumer credit extended by the authorised to lay down
commercial banks of a country.
The regulation of consumer credit is a supplenentary instrumcnt along with more basic monctary and fiscal tools.
(i) Reguluton of Margin Requirements. Margins refers to the difference betwecn market value of securities
and the annount borrowed against these securities. The essence of this method is that a bank while
advancing credit
against a security does not lend the full amount but less. The higlher the murgin requirement, the lower is the loan
one can get on a sccurity f certain value. TIhe central bunk may altogether stop the advancing of loans ngainst F
any particular type of collateral such as foreign securities, comnodities like wlheat, rice or cotton.
(ii) Mural Suasion. Moral sausion is the method of persuation, of request, of informal
suggestion,
advice to the cominercial banks usually adopted by the central bank. Moral suasion implies informal request by
nd ol
central bank to commercial banks to contract loans in times of expansion and to expund credit in times of depression
(iv) Diret Action. Dircct action is in the fornn of directives issued from time to tine to the commercial banks
the
lo follow a particular policy which the central bunk wants to enforce inmediately. This policy muy not be used against
all banks but against erring banks.
0 Keep
osits to
atio or 14.2 THE QUANTITY THEORY OF MONEY
(1) Fisher's Quantity Theory of Money (The Cash-Transaction Approach)
okeep
d they The quantity theory of moneystates that the quantity ot money is the main determinant of the price letei r the
value of money.
credit According to Fisher, "Other things remaining unchanged, as the quontit t money in circulation inetease the
pricc level also increases in direct proportion and the valuc of money decreases and vic-versa
ccific Fisher has explained his theory in terms of his equation ot exchange
s are:
MV PT
down
uniry. where M is the stock of' money, V the velocity with which the neney circulates. Pis the yerage prc leve!
ools. and T the number of transactions.
rities
redlit In the above cquation MV represents total supply ot money nd PI demant tor money
loan The above equation was critieised by some ot the monetry cvperts tn gnorng rodt vnes nd its vehets
ainst Fisher, therefore, extended his original equation of exchange Js tollons
d of
MV M" P|
t by where M' is the total quantity o credit money, and V' the veloiIN o mulztin of !
sion. In order to tind out the etleet o the quuitity ol money the Ne l e e riihe vauc hey
nks the fisher's equation us
inst
MV M'V!
P

JOS
 LTRIN\rON OF THE PRICE LVEL 304

II [Link] A1 are doubled, wh1lc \ V and I reunan constant Price-level (P) also
I doubled, but the value ol money
Psreduced to halt h
Fisher's quantity theory of money can be explained with the help of following figure.
Panel I of the tigurc shows the etlect of changes in the
upply of money on the price level. When the moncy supply is
. the pricc level is P,. When the supply of
o M. the price level also doubled to P,
money is doubled

Pancl Il of the figure, the inverse relation between the

quantity of money and the value of money is depicted. When the
quantity of money is M,. the value of money is IP,. But with the and
doubling of the quantity of money to M,, the value of money
becomes one half of what it was before, 1/P,.
Assumptions of Fisher's Theory. Following are the main
assumptions of Fisher's quantity theory of money.
1. The ratio of credit money (M') to legal tender money
(M) remains constant.
M, M, whe
2 Vand V' are constant and independent of changes in M
reso
and M!
3. Price (P) is assumed to be a passive factor which is
to
alfeted by the other factors but does not affect those
factors.
The quantity of money is assumed as an exogenously
determined factor. whe
3. There is full employment in the economy. kep
note
6 The demand for money is proportional to the value of P,
transaction.

7. The theory assunes that T and V remain constant during

the short period. Since T depends upon the volume of
production and the technique of production remaining
unchanged during the short period. Similarly. Vdepends m, Im,
upon the size of population, state of cconomic Quantity of Money
develpment, money habits of the people, wihch renmain are
unaltered during the short period. man
The Cambridee Eguations: The Cash Balance Approach.