Banking Banking Introduction Finance is the life blood of all economic activities such as trade, commerce, agriculture and industry. A bank is generally understood as an institution which provides fundamental financial services such as accepting deposits and lending loans. Banking sector acts as the backbone of modern business world. The banking system significantly contributes for the development of any country. Due to the importance in the financial stability of a country, banks are highly regulated in most countries.Historical Development of BankingHistorical Development The Ricks Banks of Sweden, which had sprung from a private bank established in 1656 is the oldest central bank in the world. It acquired the sole right of note issue in 1897. But the fundamentals of the art of banking have been developed by the Bank of England (1864) as the first bank of issues. A large number of central banks were established between 1921 and 1954 in compliance with the resolution passed by the International Finance Conference held at Brussels in 1920. The South African Reserve Bank (1921), the Central Bank of China (1928), The Reserve Bank of New Zealand (1934), The Reserve Bank of India (1935), the Central Bank of Ceylon (1950) and the Bank of Israel (1954) were established.History Of Indian BANKS * The first bank of India was Bank of Hindustan (1770) {Us * The Banking system in India was controlled and d Banks. There were three Presidency Banks: 1. Bank of Bengal (1809) 2. Bank of Bombay (1840) 3. Bank of Madras (1843) All Merged (1921) &Commercial banks Commercial bank refers to a bank, or a division of a large bank, which more specifically deals with deposit and loan services provided to corporations or large/ middle-sized business - as opposed to individual members of the public/small business.Commercial banks Commercial bank refers to a bank, or a division of a large bank, which more specifically deals with deposit and loan services provided to corporations or large/ middle-sized business - as opposed to individual members of the public/small business. They do not provide, long- term credit, as liquidity of assets is to be maintained. © Bard en ars ‘ate Bak of Ina (oT fs. aa dies LO mane won [22S REE Gd A eb tere ay IOlFunctions of Commercial Banks Tt | ] 1. Accepting 9. Other Services a | epost: a 8. Safe Custody [o] 7. References EE 2. Providing Credit S23 Facilities 6. Agency and fit Utility Services 3.Paymentand 4.CreditCreation 5.Inter-Banking ~ & Withdrawal Transactions ' I FacilitiesRole of Commercial Banks in Economic Development of a CountryRole of Commercial Banks in Economic Development of a Country 7. Employment Generation eee Bak Exomote Ente ree eee edCentral Bank A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates.Functions of Central Bank (Reserve Bank of India)Role of Central Bank ‘Banker to the Government-SSSuisr ‘its 7 ee auCONCEPT OF MONEY SUPPLY a Concept og : Money SupplyConcept of Money Supply - Money supply plays a very important role in the economic growth of a country. Any increase or decrease in the money supply directly affects the rate of economic growth. A proper amount of money supply can accelerate the economic growth but excess of money supply can halt it. The proper management of money supply is very important for the study growth of the economy.Money Supply - Money supply is the total stock of money or medium of exchange available to the public for use in connection with the economic activity of the country. There are two important things about the money supply - First, the money supply refers to the total sum of the money available to the public in the economy ata point of time. So we can say that the Money supply is a stock concept. And second, money supply always refers to the amount of money held by the public. The term public includes the households, firms, businesses and institutions other than banks and the government. There is a difference between the users and producers of the money. Public uses money for different transactional purposes but the banks and the government produces money for the use by the public. The money held by the government and by the banks isn’t used for the transactional and any other speculative purposes and also excluded from the standard measures of money supply.Money supply has two components — 1. Currency with the Public - To find the total currency with the public we add a. Currency notes in circulation issued by the central bank of a country b. The number of notes and coins in circulation c. Small coins in circulation Cash reserves with the banks has to be deducted from the value of the above three items of currency to find the total currency with the public because cash reserves with the banks must remain with them and can't be used for making payments for goods or any transaction by commercial banks. All the paper currency and coins are fiat money, which means they serves as money on the basis of the fiat (order) of the government. In simple terms, on the authority of the government, no one can refuse to accept them as payments for transactional purposes. That’s why they are called legal tender.2. Demand deposits of the Public with Banks — Other important component of the money supply is the demand deposits of the public with the banks. These are held by the public and also called bank money or deposit money. These deposits are mainly of two types - Demand Deposits and Time Deposits. Demand deposits are those deposits which can be demanded by the public at any time and can be withdrawn by drawing cheques on them. Deposits can be transferred by drawing cheques on them to other for making payments. Demand deposits are the fiduciary money. Fiduciary money is the money which functions as money on the basis of trust of the persons who make payments with it rather than on the basis of the authority of government. Bank deposits are created when people deposits money with the banks. Banks also creates deposits when they give loans to businessmen or other borrowers. Banks operates on the basis of fractional reserve system, which helps them to create much more credit with the small cash reserves they held.MEASURES OF MONEY SUPPLY ivtetttec: a ; cee aay :Measures of Money Supply - Many definitions of money supply have been given and many measures have also been developed based on them. Components of money supply have been differentiated on the basis of their functions. For example, demand deposits, credit card and cash or currency which is used by the people primarily as a medium of exchange for buying goods and services and for other transactional purposes is generally called as M1. Another measure of money supply is M3 which includes both M1 and time deposits held by the public in the banks. Time deposits are used as a store of value. The main reason for differentiating money in various measures on the basis of its functions is that useful predictions can be made about the likely effects on the economy due to changes in different components of the money supply.For example, If M1 is increasing, then it can be expected that people are planning to make a large number of transactions. If M3 is increasing, then it can be expected that people are planning to save more and consume less. The different measures of money supply are used to do the monetary analysis and to make right monetary policy for economic growth and development. In India as well as in some other developed countries, four concepts or measures of money supply have been used to classify the money supply. From April 1977, the Reserve Bank of India has adopted these four concepts or measures of money supply in its analysis of quantum of and variations in money supply.1. Money Supply M1 or Narrow Money — The narrow money is composed the currency with the public, demand deposits of the public with the banks and other deposits of the public held with the Reserve Bank of India. This (narrow money) money supply is the most liquid measure of money supply because the money included in this can easily be used as a medium of exchange. Mi=C+DD+0D C=currency with the public DD = demand deposits of the public with the banks OD = other deposits of the public with the Reserve Bank of India Currency with the public includes a. Notes in circulation b. Circulation of rupee coins as well as small coins c. Cash reserves on hand with all banksDeposits held by a bank in other banks are excluded from this measure. Other Deposits Other deposits held by the central or state government with RBI such as RBI Employees Pension and Provident Funds are excluded. Other deposits of RBI includes a. Deposits of institutions such as UTI, IDBI, IFCI, NABARD etc. b. Demand deposits of foreign central banks and foreign governments. c. Demand deposits of IMF and World Bank2. Money Supply M2 - M2 is a border concept than M1. M2 includes all components of M1 and saving deposits with the post office saving banks. M2 = M1 + Savings deposits with the post office saving banks M2 is different from M1 because savings deposits with the post office saving banks are not as liquid as DD with commercial banks as they are not chequable accounts but they are more liquid than the time deposits.3. Money Supply M3 or Broad Money - M3 is a broad concept of money supply. M3 includes all components of M1 and Time Deposits of the public with the banks. M3 = M1 + Time Deposits of the public with the banks It is generally believed that the time deposits serves as a store of value and shows the savings of the people. Time deposits are not as liquid as the DD or the savings deposits with the post office savings banks but people can take loans against these time deposits which can be used for transactional purposes. M3 is also called Aggregate Monetary Resources (AMR).4. Money Supply M4 - M4 includes all components of M3 and total deposits with Post Office Savings Organization. This excludes the contributions made by the public to the national saving certificates. M4 = M3 + Total Deposits with Post Office Savings OrganizationDETERMINANTS OF MONEY SUPPLYDeterminants of Money Supply - Money supply is composed of currency held by the public (CP) and demand deposits of the public with the banks (D). M=Cp+D M = Total money supply with the public Cp = Currency with the public D = Demand deposits of the public with the banksThe two important determinants of the money supply are (a) the amounts of high powered money which is also called Reserve Money by the RBI and (b) the size of the money multiplier.High Powered Money (H) - The high powered money consists of the currency notes and coins issued by the government and RBI. A part of this currency is held by the public and a part of is held by the banks as reserves. A part of these currency reserves of the banks is held by them and a part is deposited in the RBI in the Reserve Accounts which banks hold with RBI. H=Cp+D H =the amount of high powered money Cp = currency held by the public D =cash reserves of currency with the banksAnimportant point is that RBI and government are the producers of the high powered money and the commercial banks do not have any role in producing high powered money, but commercial banks are the producers of demand deposits which is also used as money. But for producing demand deposits they have to keep reserves of currency with them according to the cash reserve ratio fixed by the RBI or by the government. These cash reserve serves as a basis for the creation of the demand deposits which are an important part of the total money supply in the economy. It provides high poweredness to the currency issued by the RBI and government. The theory of determination of the money supply is based on the demand for and supply of high powered money. It is also called ‘The H Theory of Money Supply’. It is also called ‘Money Multiplier Theory of Money Supply’ because it explains the determination of money supply as a certain multiple of the high powered money.Conclusion Money forms the key part of the financial superstructure of any economy. Hence its control becomes the basic needs in almost every micro economy system. It is, therefore, important to identify the main determinants of the money supply. In economics, the money supply is the total amount of monitory asset available in an economy. And it is done by finding the components of Money Supply M1, M2, M3 and M4.Factors Affecting Money Supply The money supply in the economy depends on many factors. First, open market operations allow central banks to have some control over the money supply. Second, money comes into the economy using government securities like bonds and treasury bills, affecting supply. Third, increasing liquidity in the banking system due to the conversion of commercial banks’ illiquid securities into deposits at the central bank. Due to the increasing demand, the price of such assets rises, and interest rates fall. Commercial banks may now lend these sums because of the multiplier effect of fractional-reserve banking, which causes the value of bank deposits and loans to rise many times over the initial investment.As a result, when the central bank toughens the money supply, it takes liquid cash out of the banking system by selling assets. So as the supply of such assets increases and interest rates rise, the price of such securities decreases. This has a multiplication impact, as well.