3.1 – Money and Banking

Money

What is money?
A medium of exchange of goods and services.

Why do we need money?
We need money in order to exchange goods and services with one another. This is because we aren’t self-sufficient – we can’t produce all our wants by ourselves. Thus, there is a need for exchange.

In the past, barter system (exchanging a good or service for another good or service) prevailed. This had a lot of problems such as the need for the double coincidence of wants (if the person wants a table and he has a chair to exchange, he must find a person who has a table to exchange and is also willing to buy a chair), the goods being perishable and non-durable, the indivisibility of goods, lack of portability etc.

Thus the money we use today is in the form of currency notes and coins, which are durable, uniform, divisible (can be divided into 10’s, 50’s , 100’s etc), portable and is generally accepted. These are the characteristics of what is considered ‘good money’.

The functions of money:

• Money is a medium of exchange, as explained above.
• Money is a measure of value. Money acts as a unit of account, allowing us to compare and state the worth of different goods and services.
• Money is a store of value. It holds its value for a long time, allowing us to save it for future purposes.
• Money is a means of deferred payment. Deferred payments are purchases on credit – where the consumer can pay later for the goods or service they buy.

Banking

Banks are financial institutions that act as an intermediary between borrowers and savers. It is the money we save at banks that is lent out as loans to other individuals and businesses.

Commercial banks are those banks that have many retail branches located in most cities and towns. Example: HSBC. There is also a central bank  that governs all other commercial banks in a country. Example: The Reserve Bank Of India (RBI).

Functions of a commercial bank:

• Accept deposits in the form of savings.
• Aid customers in making and receiving payments via their bank accounts.
• Give loans to businesses and private individuals.
• Buying and selling shares on customers’ behalf.
• Provide insurance (protection in the form of money against damage/theft of personal property).
• Exchange foreign currencies.
• Provide financial planning advice.

Functions of a central bank:

• It issues notes and coins of the national currency.
• It manages all payments relating to the government.
• It manages national debt. Central banks can issue and repay public debts on the government’s behalf.
• It supervises and controls all the other banks in the whole economy, even holding their deposits and transferring funds between them.
• It is the lender of ‘last resort’ to commercial banks. When other banks are having financial difficulties, the central bank can lend them money to prevent them from going bankrupt.
• It manages the country’s gold and foreign currency reserves. These reserves are used to make international payments and adjust their currency value (adjust the exchange rate).
• It operates the monetary policy in an economy.(This will be explained in a later chapter)

Notes submitted by Lintha

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