Money and Banking Class 12 Notes Economics Part B Chapter 3

Lesson at a Glance

Barter System: When wants were not so multiple, goods were exchanged for goods. Exchange is a sign of interdependence. Barter system of exchange is a system in which goods are exchanged for goods.

Money: According to Fisher,` Money is what money does.’ In the words of Crowther, Money can be defined as anything which is generally acceptable as a means of exchange and also acts as a measure and store of value. Money is a function of four; medium, standard, unit and store. Money is anything
which performs following four functions:
Medium Of Exchange
General Acceptability I.E.Standard Of Deferred Payments
Store Of Value
Unit Of Value

• Demand Deposits: The balance in current and saving accounts held by the public in commercial banks are called demand deposits because these accounts can be used to settle transactions. These deposits are payable by the bank on demand of the account holder.

• Time Deposits: Those deposits which have a fixed period of maturity are referred to as time deposits for e.g. fixed deposits.

• Near Money: Those assets which are not n the form of coins, notes or demand deposits but can be easily converted into these forms without much loss of time and money are called near money like gold, financial instruments etc.

Currency Deposit ratio: It is the ratio of money held by public in currency to that they hold in bank deposits.
cdr = CU/DD It means if a person gets `1, he will keep 1/1 + cdr in bank and cdr/1+ cdr with himself as cash.

The Reserve Deposit Ratio: It is the ratio f total deposits that commercial banks keep as reserves.

High Powered Money: The total liability of the monetary authority of the country (RBI in India) is called high powered money or monetary base. It consists of currency-notes and coins in circulation with the public and vault cash of commercial banks) and deposits held by the government of India and commercial banks with RBI.

Deficit Financing: When government expenditure increases its revenue then its sells treasury bills or government securities to RBI who in return issues currency to the government by new currency. The government then pays for its obligations with this money and money ultimately comes in the hands of general public and becomes apart of money supply. This method of financing budget deficit is called deficit financing.

Sterilization by RBI: RBI often uses its instruments of money creation for stabilizing the stock of money in the economy from external shocks. This operation of RBI s called sterilization.


Meaning and Functions: Reserve bank of India is the central bank of India. RBI performs all central banking functions for Indian Economy. A central bank is one which constitutes the apex of the monetary and banking structure of a country and which performs in the national interest following functions:

Issue of Currency: The central bank is the sole authority for the issue of currency in the country. It is so because it brings about uniformity in note circulation and gives central bank direct control over money supply. All the currency issued by the central back must be backed by assets of equal value. These assets generally include gold coins, gold bullion, foreign securities, and the domestic government’s local currency securities. For this function RBI is also called ‘Bank of Issue’.

• Banker to the Government: Central bank acts as a banker to both central as well as State governments. As a banker to the government RBI performs following functions:

• It transacts all the banking business for government departments. It accepts money, makes payment and also transfers the funds.

• It manages Public debt.

•It advises government on the quantum, timing and terms of new loans, capital markets and economic policy matters.

Custodian of Foreign Exchange Reserves: All foreign exchange reserves of a country remain in the custody of RBI. This function helps the central bank to overcome the problems of foreign exchange fluctuations and BOP difficulties. In order to minimize the foreign exchange fluctuations, central Bank buys or sells foreign currencies in the market when their value falls or rise.

Banker’s Bank and Supervisor: The RBI has extensive powers to control and supervise commercial banking system under RBI Act, 1934 and Banking Regulations Act 1949. Banks need to keep a minimum proportion of their net total liabilities with the central bank, it is called cash reserve ratio. CRR is used as an instrument of credit control in the economy. The central bank supervises, regulates and controls the commercial banks. The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation, The control is exercised by periodic inspection of banks and the returns filled by them.

Controller of Credit: It is the principal function of a central bank. The central bank controls the money supply and credit in the best interest of the economy. By making use of various tools of monetary policy, it ensures that monetary system in the economy functions according to the national priorities. Various instruments that help in controlling credit are called instruments of monetary policy. Such instruments can be:
Quantitative credit control instruments
Qualitative credit control instruments

Lender of Last Resort: Central bank is under an obligation to provide funds to commercial banks in the times of crisis. The aim is that no sound and genuine transaction should be restricted or abandoned due to shortage of funds. Commercial banks approach the central bank as a last resort in distress. The central bank advances loan to the commercial banks, subject to certain terms and conditions.

Acts as a Clearing House: Central bank acts as a clearing house in Inter-Bank transactions. Central bank also gives facility of transfer of funds at zero cost. All banks have interbank transactions which are easily settled down by involvement of central bank, which otherwise will be a very complicated process.

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