The Importance of Studying Money, Credit and |1

Banking

CHAPTER
1

THE IMPORTANCE OF STUDYING

MONEY, CREDIT AND BANKING

LEARNING OBJECTIVES
After studying this chapter, you should be able to…
1. Explain the nature and characteristics of money, credit and banking.
2. Describe the various areas of finance which include
a. Investments
b. Public finance
c. Financial institutions and markets
d. Corporate finance
e. Personal finance
3. Describe the major components of finance involved in
a. Microfinance
b. Microfinance

There are times when we hear people, out of desperation, wish loudly about money falling like rain from the
sky. To them, having more money means the end of their financial woes! To the finance literate, however, that is one
of the fallacies that must be disregarded.
If that wish is only in the mind of a single person, then no considerable harm to the economy may be
forthcoming. If this is the collective thinking of the majority, however, it may indicate a serious need to educate people
in terms of financial literacy.

A MOST IMPORTANT SUBJECTS

Money, Credit, and Banking are realities that confront modern man almost every hour of his life. Changes in
whatever aspect regarding money, credit, and banking affect the lives of people. Although the effects may not be
readily seen, developments along these three concerns may improve or ruin financially and individual, a business, or a
nation.
Cases of individuals facing financial hardships are regular features in the daily newspapers. When this happen,
families are seriously affected, the education of children sacrificed, or a happy marriage may reel under the great
pressure of breaking up.
The lack of sufficient knowledge about money, banking and credit may make businesses get bankrupt or may
not be able to meet their financial obligations, and may be forced to shut down operations. If these happen, the
immediate effect will be the reduction of the supply of products or services the businesses are producing. These would
also be a corresponding reduction in the demand for labor, funds and capital equipment.
Literature abounds with proofs of the ill effects to humankind of not having sufficient knowledge about
money, credit and banking.
Inspire of the widespread occurrence of financial failures throughout the world, some individuals, businesses
and nations remain afloat, confident of surviving the economic and financial pressures brought about by developments
all around. It appears that the key to their success lies in the correct handling of finances.
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Banking
The right management of finances can minimize if not prevent financial failures. The pre-requisite to right
management however, is the acquisition of the right knowledge. If this statement is true, it brings us to the importance
of studying money, credit and banking.

WHY STUDY MONEY

Many people equate money with power. The magnitude of this power, however, will depend on such factors
like inflation, devaluation, money supply and a host of others. As money is used as a means of exchange, its holder is
said to have the power to purchase.
Increasing the quantity of money one olds, most often, provides subsequent increases in the financial strength
of the holder. At other times however, the purchasing power of the same quantity of money may diminish without the
knowledge of the holder. He may become aware of its reduced value later, but by then, it may be too late for him to do
anything.
It comes to us then, that money must be managed properly if one wants to continually enjoy its benefits. To do
it, however, one must have sufficient knowledge about its nature and characteristics.

Money and Inflation

If of a 200 square-meter residential lot is priced today at ₱200,000 and if a person is able to raise through
savings the same amount after five years, can he still buy the said lot at the same price? If there is no physical change
in the condition of the lot, chances are inflation would affect the selling price of the lot. Most probably, there would a
price increase.
So, how could that person hope to buy that lot without worrying whether or not he could catch up with price
increases? For the person who is money literate, some solutions may be considered.
Not everybody could be aware that inflation is a natural occurrence in the economies of most countries.
Inflation in the Philippines, for instance, was recorded at 4.40% in June 2014. In contrast, Indonesia’s inflation rate
was 6.30% in the same period, while Japan has 3.707% also in June 2014 (Trading Economies 2014). Shown in
Exhibit 1.1 is a more comprehensive presentation of inflation throughout the world.

Money and Business Cycles

Business cycle refers to “the inevitable ups and downs of economic activity, as measured by periods of
economic growth and contraction” (Investor Guide, 2014). When trade expands, jobs are easier to find and the
unemployment rate declines; when it slows down, the opposite happens.
To minimize the ill effects of business cycle, the government attempts to make necessary adjustments to
monetary policy.

Exhibit 1.1
INFLATION RATE IN VARIOUS COUNTRIES
(Annual Basis)
June 2014
Inflation
Country Country Inflation Rate
Rate

1. Austria 2.775% 20. Israel 0.491%

2. Belgium 0.270% 21. Italy 0.280%

3. Brazil 6.533% 22. Japan 3.707%

4. Canada 2.358% 23. Luxembourg 0.854%

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Banking

5. Chile 4.761% 24. Mexico 3.753%

6. China 2.417% 25. Norway 1.943%

7. Czech Republic 0% 26. Poland 0.323%

8. Denmark 0.539% 27. Portugal 0.419%

9. Estonia -0.354% 28. Russia 7.810%

10. Finland 0.926% 29. Slovakia -0.061%

11. France 0.486% 30. Slovenia 0.764%

12. Germany 1.042% 31. South Africa 6.836%

13. Great Britain 1.906% 32. South Korea 1.659%

14. Greece -1.092% 33. Spain 0.086%

15. Hungary -0.294% 34. Sweden 0.226%

16. Iceland 2.238% 35. Switzerland 0.050%

17. India 7.018% 36. The Netherlands 0.900%

18. Indonesia 6.309% 37. Turkey 9.164%

19. Ireland 0.393% 38. U.S. 2.127%

*From: Globaal-rates.com/economic-indicators/inflation/inflation.
aspx. July 23, 2014

Money and Interest Rates

Fluctuations in interest rates happen partly because of money. In general, as the money growth rate rises, the
interest rate also rises. A change in the money supply, however, can affect interest rates in two ways. (Exhibit 1.2)
 The Importance of Studying Money, Credit and |4
Banking
Exhibit 1.2
POSSIBLE EFFECTS OF CHANGES IN MONEY SUPPLY

MONET SUPPLY

INCREASE DECREASE

FALL IN FEWER
RISE IN INCREASE SECURITY FUNDS
SECURITY IN THE PRICE AVAILABLE
PRICE SUPPLY OF FOR
LOANABLE LENDING
FUNDS

MARKET
REAL
MARKET INTEREST
INTEREST
INTEREST REAL RATES RISE
RATES WILL
RATES WILL INTEREST
RISE
FALL RATES
FALL

INVESTMENTS WILL
INVESTMENTS
FALL
WILL RISE

WHY STUDY CREDIT

Credit has become a great influence in the development of economies. When properly used, it can help nations,
businesses, and even individuals engage in wealth-enhancing activities. The United States, the world’s greatest
economic power, owes much of its exalted position to credit. As the U.S. economy grew, so too its borrowings. Exhibit
1.3 shows this growth over the years.
Taking a look at balance sheets of big corporations will reveal that a large percentage of their capital is
attributed to liabilities for instance, the total debt of Philippine Long Distance Telephone Company was reported at
2.344 billion pesos in 2013. Another example Corporation with total liabilities of 364.193 billion pesos by yearend
2013.
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Banking
WHY STUDY BANKING
Banks constitute a very important sector of modern economies. They serve as intermediaries between the
providers of funds and those which require them. It will be very difficult and uneconomical for the borrowers and
lenders to relate with one another without the services provided by banks.
The activities of banks has immediate effects on the operations of business. When lending is reduced,
businesses are forced to reduce their output. This will mean lesser purchases of materials from suppliers, lower demand
for labor, lower demand for rent of buildings, etc.
When banks are properly managed, the entire nation benefits, but when they become inefficient, the economy
goes into disarray. When Asian economies went into deep trouble in 1997, Ranjit Gil (1998) proposed that for recovery
efforts to succeed, the problem in banking must be addressed first.
When people know more about banking, they will be better prepared to relate their activities with
developments in the financial sector. It may even make them wiser in choosing who their political leaders will be.
These advantages provide us with sufficient reasons to study banking.

WHAT IS FINANCE
Finance is that subject area in economies that encompasses the study of money, credit, and banking. For the
freshman student of finance, it is useful for them to have a working knowledge of the basic terms in finance.
Finance is that branch of economics concerned with resource allocation as well as resource management,
acquisition, and investment.

Exhibit 1.3
PUBLIC DEBT OF THE UNITED STATES
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End of Fiscal Year Debt in Billions

Source:
2013 $16,738 National
Debt by
2012 16,066 Year – US
Economy
2011 14,790 –
2010 13,562

2009 11,910

2008 10,025

2007 9,008

2006 8,507

2005 7,933

2004 7,379

2003 6,783

2002 6,228

2001 5,807

2000 5,674

1990 3,223

1980 908

1970 371

1960 286

1950 257

1940 43

1930 16
About.com
July 26, 2014.

The various areas of finance include the following:

1. Investments
2. Public finance
3. Financial institutions and markets
4. Corporate finance
5. Personal finance
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Banking
Investments refer to the study of the investment process. An investment refers to the commitment of funds to
one or more assets that will be held over some future time period.
Public Finance deals with taxation, bond issues, budgeting, asset management, and financial planning
activities of the government.
The management of financial institutions and assuring the efficiency of financial markets are concerns that
constitute another area of finance.
Corporate Finance deals with the proper acquisition of cash and the efficient allocation of that cash within the
corporation.
Personal Finance is an area of finance that deals with the proper management of an individual’s money to
achieve personal economic satisfaction.

Major Components of Finance

Finance may also be classified into major components, namely:
1. Microfinance – that part which deals with the study of the decision making process within the firm.
2. Macrofinance – that part which deals with the environment that effects corporate financial decisions.

EXERCISE 1

I. True or False. Write “T” on the blank provided if your answer is true on the statement indicated. Otherwise,
write “F” if your answer is false.

1. If everyone has billions of pesos, everyone will be rich.

2. The study of money, banking, and credit is a waste of time.
3. Money gives the holder the power to purchase
4. The purchasing power of money is subject to change anytime.
5. When trade expands, the unemployment rate declines.
6. The government is not entirely helpless in dealing with business cycles.
7. As the money growth rises, the interest growth rate also rises.
8. Credit should be avoided because it is not always a useful option.
9. When lending is reduced, businesses are forced to scale down operations.
10. Microfinance is the only component of finance.

II. Match column A with column B.

A B
________ 1. a person’s financial ruin A. can minimize if not prevent financial failure
 The Importance of Studying Money, Credit and
________ 2. a result of bankruptcy
________ 3. right management of
finances
________ 4. money
________ 5. business cycle
________ 6. rise in security price
________ 7. banks
________ 8. Investments
________ 9. microfinance
________ 10. public finance
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Banking
B. the inevitable ups and downs of economic
activity
C. effect of increase in money supply
D. serve as intermediaries between borrows and
lenders
E. an area of finance
F. a major component of finance
G. deals with taxation, bond issues, budgeting,
asset management and financial planning
activities of the government
H. equal the power to purchased
I. forced shut down of business operations
J. may be caused by lack sufficient knowledge in
money, credit, and banking