UNITY UNIVERSITY

MONEY AND BANKING COURSE

Lakew Alemu (PhD)

2023

Chapter One
1. Money: Evolution and Functions
1.1 Origin
• The word money is derived from the name of an ancient Roman
Goddess, Juno.
• The first money was minted by Romans in her temple in Rome
around 300 BC.
1.2 Meaning/ Definition
• Money is defined as anything that is generally acceptable as
means of exchange and that at the same time acts as a measure
and a store of value.
Money is defined by different scholars from different perspectives
some of which are indicated below.
Functional Definition:
• means of valuation and payment. (Coulborn)
• Money is what money does. (H. Withers).
• It is a means to an end not for its own sake, but as a means of
obtaining other articles or of commanding the service of
others.
 Legal Definition:
• Anything which is declared by the state as money, becomes
money. (Knapp)
Common Acceptability Definition
• Money is one thing that possess general acceptability.
(Saligman)
• Money is simply purchasing power, something which buys
things. It is anything which is habitually or widely used as
a means of payment and is generally acceptable in the
settlement of debts. (G. D. H. Cole)
• 3. 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 is held. (Keynes)

1.3. Evolution of Money

• Commodity Money (Salt bar, beads, cattle, cartridge, knives …)
• Metal Money (Gold and Silver)
• Paper Money (Representative, Convertible and Inconvertible
Bank Notes.
• Credit Money (Checks, drafts…)
1.4 Functions of Money
Primary Functions of Money
• Medium of Exchange
• Measure of Value – value of goods and services is measured in
terms of money
Secondary Functions of Money
• Standard of Deferred Payments (due to its durable and stable
quality)
• Store of Value (never looses utility and can be easily converted into
assets)
• Transfer of Value (liquid means of exchange and easily
transferrable)
Contingent Functions of Money
• Basis of Credit (banks create credit on the basis of money)
• Basis of Income Distribution (GDP components and their
distribution)
• Basis of Maximum Satisfaction and Production (marginal utility
and marginal productivity)
• Makes Capital Liquid and Mobile
• Guarantee of Solvency (personal savings)
• Bearer of Option (accumulation of wealth)
Dynamic and Static Functions of Money
• Static Functions (help the operation of the economy but do not
create movement in the economy like medium of exchange,
measure of value, store of value and measure of deferred
 payments).
• Dynamic Functions (Money actively influences the economic
system through its impact on price level, interest rates, volume of
productions, distribution of wealth and income…)
1.5 Kinds of Money
• Commodity (hard) money (gold and silver)
• Fiduciary (soft) money – financial instruments such as checks, B/E,
bank notes, that are converted into fiat or other money.
• Fiat money (currency) – backed by governments not by tangible
assets or commodity ($ and others). Payment is based on trust of
governments.
• Bank and electronic money (deposit balances that can be transferred
via cards, or electronically.)

1.6 Monetary Standards

The Silver Standard
• Dates back to ancient Greek. First metal used as currency by
Sumerians from 3000 B.C until 1873 and many other countries.
The Gold Standard (1821 – 1931)
• The price of national currency is determined by gold prices
locally or internationally. That means, the price of a currency
against other currencies is determined on the basis of what the
national currency contains in terms of gold against the contents
of pure gold in other countries’ currency
• Gold Coin Standard: Represented by gold coins. Circulating
paper money were convertible into its equivalent gold.
• Gold Bullion Standard: paper money could not be converted
in to gold coins since the value was high. This resulted in the
use of gold bullions.
• Gold Exchange Standard: currency exchange rate against
other currencies was determined based on gold contents
The collapse of Gold Standard, reasons for its collapse.
• Shortage of gold to meet the needs of monetary system.
• Mismatch between cash in circulation and shortage of available
gold to back currencies.
• Unequal distribution of gold reserves among countries after
WWII. Most gold was held by USA, France…
The Bimetallism Standard (before 1875)
• Was dependent on the connection between the currency of one
country and the unit value of both metals from other countries.
(US$ = (1:15).
• The system failed due to the differences in the market the unit
values of gold and silver.
The Paper Money Standard (1971)
• Monetary standard since 1973 to present time.
 • Currently, paper money is used by all countries. It has legal
backing (force) regarding its issuance and use.
• Paper money cannot be transferred into its equivalent amount of
gold.
• Modern money must possess six characteristics: divisible,
portable, acceptable, scarce, durable and stable in value.

The Bretton Wood System

• In 1944, 44 nations met in Bretton Wood, N.H, USA.
• The goal of the meeting was to design post WWII international
monetary system that ensures exchange stability without gold
standard.
• The meeting decided on the creation of two global institutions
(IMF and WB). IMF focuses on macroeconomic and financial
stability while the World Bank concentrates on long-term
economic development and poverty reduction in different
countries.

Chapter Two
2. Banking and their Functions
Meaning and Features of Banking
• Banks primarily deal in money; they facilitate the flow of money
in the economy.
• Accept deposits of money from the public for the purpose of
lending to borrowers or for investment. They act as
intermediaries between depositors (savers) and borrowers.
• The deposits are accepted on various terms and conditions and
on current, fixed and other types of accounts.
• The money is repayable on demand or otherwise and
withdrawable by check, draft, money order or other means.
• With the exception of the Central Bank, all other banks are
commercial in nature, they strive to maximize profits from
operations.
• Banks also provide various agency services to their clients.

Types of Banking
• Central bank (National Bank of Ethiopia)
• Commercial banks (Government (CBE) and other private banks)
• Development banks (Aid Bank)
• Mortgage banks (Goh Bank)
• Others (Cooperatives, credit unions…)
Features of Modern Banking
• Retail (consumer) banking providing debit/credit cards…
• Mobile banking to provide access to banking in inaccessible
remote areas
 • Online banking is also known mobile banking. Access to
services is done on bank’s website or on mobile apparatus.
Issues of Modern Banking
• Innovation and growth of technology are the driving forces of
modern banking.
• Open banking – integration of banking services through
Application Programming Interfaces (APIs) in the whole
industry.
• The use of Blockchain or high-tech record keeping and security
system to protect against hackers.
• The use of Biometrics which is a system of authentication of
identity for security purposes by scanning physical features of
clients.
• Cloud banking for storing large volume of data and intended to
cut costs of IT (software and hardware…).
• Artificial Intelligence & Machine learning for high-speed data
manipulation. AI is applied in the form of Chatbots, Robo
Advisors, Cybersecurity to trace patterns, indicators and
previous frauds…etc.

Chapter Three
Central Banking
Meaning
• A central bank is a public institution that is responsible for
implementing monetary policy, management of national
currencies or a group of currencies, and controlling of the
money supply in a country.
• It is an apex institution of a county’s monetary system that is
supposed to operate independently or free from government
 intervention in its major decisions.
• The goal of a central bank is to promote economic development,
stabilize the currency, control inflation, regulate the banking
system.
• It defines monetary policy and implements it through the use of
monetary policy instruments such as reserve requirement,
discount rate, open market operations and interest on
reserves….
Major Functions of a Central Bank
• Bank of issue and currency supply regulator
• Bank to the Government
• An advisor to the Government on policy issues
• Custodian of cash reserves of banks
• Lender of the last resort for banks
• Clearing house for transfers and settlements
• Controller of credit
• Protector of depositors’ interests
• Center of economic research and analysis
• Custodian of gold and Forex reserves
• Oversee the proper functioning of banks and their operations

Chapter Four
Commercial Banking
Meaning
• Commercial banks are institutions (government or private)
licensed to accept deposits and provide various types of loans
and other financial services to the general public.
• They make money or earn income by charging different fees for
services and mainly from interest on loans, that is the spread
between the deposit interest rates and lending interest rates.
• Some of the fees charged by commercial banks are account
maintenance fee, minimum balance fee, overdraft fee, NSF
charges, transfer fees, ATM charges, charges for safe deposit
boxes…. etc.
• Commercial banks are largely regulated by central banks (in
Ethiopia by NBE) as regards their licensing, standard of
operations, capital adequacy, lending activities, payment system,
corporate governance and reporting…etc.
• Commercial banks are different from investment banks which
mainly work for their clients as investment advisors,
underwriters and in other capacities.
• Banking institutions are controlled by governments with the
objective of protecting the interests of the public at large.
Major Functions of Commercial Banks
Commercial banks perform different functions the major ones of which
ae indicated as follows. The first four functions are primary functions
while the rest are agency services.
• Accept deposits from the public
• Advance different types of loans to borrowers
• Create credits (Overdrafts) for businesses
• Provide checks and other instruments
• Pay and collect credit repayments
• Purchase and sell shares, bonds…
• Trade in Bullions
• Make money remittances
• Deals in forex transactions
• Provide letters of credit facilities
• Facilitate payments by issuing cards, drafts, making transfers…
• Make payments and collections on behalf of customers
• Provide discounting services of financial instruments
• Provide Lockbox services
• Provide relevant information on the performance of the economy

Chapter Five: Bank – Customer Relationship

Relationship between a bank and a customer
• The relationship between a bank (banker) and a customer is
very important and comes into existence when the bank
agrees to open an account in the name of a customer.
• the relationship depends on the activities, products or services
provided by the bank to its customers or availed by the
customer.
• The relationship between a bank and its customers is basically
transactional in nature. That means, it focuses on the
provision of quick solutions and services that the clients
need. For instance, providing relevant information about the
type of loans they offer and related interest rates for a new
customer.
• Banks can also develop long-term banking relationship
(relationship banking) with their customers by closely
learning more about their customers’ needs and financial
 situations.
• The business of banking largely depends on the strong
bondage with customers. TRUST plays an important role in
building healthy relationship and sustainable bondage
between banks and their customers.
The relationship between a bank and a customer is broadly
categorized into two parts: general and special.
1. General Relationship
Debtor and Creditor Relationship
• This is a primary relationship. When a customer deposits
money in a bank, the bank becomes the bank becomes the
debtor and the customer is a creditor. On the other hand,
when a bank lends money to a customer, the bank is a
creditor and the customer is a debtor.
• In this relationship, the customer expects from the bank that
his money will be kept safe by the bank and it will be
returned to him on demand along with interest.

2. Special Relationships
Principal and Agent Relationship
• As a principal, the customer deposits checks, drafts, dividend
warrants…with his bank for collection. He also gives written
instructions to the bank to purchase shares, pay bills, loan
repayments…on his behalf.
• When the bank performs such agency services, it becomes an
agent to its customers.
Pledger and Pledgee Relationship
• When a customer pledges certain assets or securities with a
bank to secure a loan, the customer becomes a pledger or a
pawnor and the bank becomes the pledgee or pawnee.
• The asset or security will remain in possession of the bank
until the customer repays the loan to the bank.
Lessor and Lessee Relationship
• When a bank leases a safe deposit box (car, land…) to a
customer, it is a lessor and the client is a lessee.
• The lessee is required to pay some amount in the form of
service charges to the lessor (bank) for the right to use the
safe box or other property.
Bailor and Bailee Relationship
• Bailment is a contract for the delivery of personal goods by
one party to another party to be held in trust for a specific
period with understanding that the property is to be returned
when the purpose is over.
• Bailor is the party that delivers the goods and bailee is one to
whom the goods are delivered. If a customer gives a sealed
 box to the bank for safe keeping, he becomes a bailor and the
bank is a bailee.
• The bank (bailee) charges the bailor (customer) service fees
for safe keeping of the sealed box received from his
customer.
Hypothecator and Hypothecatee relationship
• Hypothecation occurs when an asset is pledged as collateral to
get a loan from a bank. Hypothecator is the owner of the
asset and does not give up title and ownership rights to the
asset including income generated by the asset.
• The lender bank (hypothecate) can siege the asset if the terms
of the agreement are not met by the borrower (hypothecator).
That means, the bank has the right to claim custody of the
asset in case of default by the borrower (hypothecator).
Trustee and Beneficiary Relationship
• A trustee holds property or money and performs certain
functions for the benefit of the beneficiary. A beneficiary
benefits from the trust’s assets while a trustee is responsible
for managing the assets in line with the intentions of the trust
creator.
• Trustees are expected to act in the best interests of the
beneficiaries. They cannot place their own interests above
those of beneficiaries. If they do, that would amount to
breach of trust.
• Directors of banks and corporate entities are trustees for
depositors and shareholders, respectively.

Advisor and Client Relationship

• When a bank acts as an advisor for its customers on different
issues, it is called an advisor and the customer is known as a
client. Banks can give advices either officially or unofficially.
• In its capacity as an advisor, the bank should listen to the
customer, understand his needs, objectives, financial situation
in order to be able to properly identify his request and offer
best solutions.
3. Other Relationships
Bank as a Custodian for Clients
• A custodian is a person or entity who acts as a caretaker for
something. He is responsible for protecting, caring for, or
maintaining something or someone.
• A custodian financial institution is a specialized bank
responsible for providing services such as post-trade services
on stock exchange and other solutions for asset owners, asset
managers, banks, broker-dealers…
• A custodian bank does not deal in retail banking as
commercial banks do.
Bank as a Guarantor for Clients
• Banks give guarantees on behalf of their customers in the
course of normal business activities.
• A guaranty is a contingent contract to discharge the liability of
the principal debtor, if he fails to pay as per the requirements
of the contract.
• Under certain circumstances, banks give guarantees to local
businesses or companies (on NBE’s approval) when they
wish to borrow from foreign financial institutions in foreign
currencies.
Obligations and Rights of Banks
The relationship between a bank and customers creates some obligations
on the part of the bank. The fundamental obligations of a bank towards
its customers are as follows.
Obligations of Banks
1. To Owner Customers’ Checks
• Legal obligation to honor customers’ checks provided money is
available in the customers’ account. This obligation is subject to
the following conditions.
• There must be sufficient fund in customers’ bank account.
• The funds must be applicable for payment of customers’
checks.
• The check must be properly drawn or should be complete
in all aspects.
• The check must be presented for payment in reasonable
time (180 days from the date of issue in Ethiopia).
• There must be no legal bar preventing payment of the
check such as court order
2. To maintain Secrecy of Customers
• The bank should not disclose details of customers’ accounts to
any other people as the act negatively affects the reputation and
business of customers.
• However, disclosure can be made under the following situations.
• When the law requires such disclosure to be made
• When practices by banks permits such disclosure
3. To maintain proper Records
• Banks are obliged to maintain accurate records of all transactions
of their customers made with the bank.
Rights of Banks
1. Right to General Lien
• A bank has the right of general lien to retain goods belonging to
its customers until the customers repay their obligations or
loans, after giving reasonable notice to the customers. He can
sell the goods and recover the loan amount.
• If valuables are deposited with a bank for safe custody
 (bailment), the bank cannot exercise the right of general lien.
• Banks cannot exercise the right of general lien when valuables
are deposited for safe custody, when money or documents are
deposited for specific purposes, when some shares are left with
the bank by mistake, when property is held by the customer as
trustee and the bank has notice of trust, and when there is an
express agreement that the bank shall not exercise the right of
general lien.
2. The Right of Set-off
• When a customer has two or more accounts in the same name
and capacity in a bank, the bank has the right to adjust the
amount standing to the credits of the customer against the debit
balance in his other account.
3. The Right of appropriation
• In case, a customer owes several loans to a bank, and deposits
some money with out specific instructions, the bank has the
right to appropriate the deposited amount to any loan, even to
time barred loan. But the bank must inform the customer about
the appropriation.
4. The Right to Charge Interest and Commission
• Banks have implied rights to charge interest on loans and
advances and also to charge commission for services rendered
by making debit entries to customer’s account.
5. The Right to Close the Account
• If the bank considers that a customer’s account is not properly
operated, it can close the account by sending mandatory notice
to the customer.
Termination of Banker - Customer Relationship
• Bank – customer relationship terminates on the following
grounds.
• Voluntary termination
• Death of the customer
• Bankruptcy of the customer
• Liquidation of the company
• Insanity of the customer
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