FACULTY OF COMMERCE & MANAGEMENT

F.Y.B.Com – w.e.f. A Y 2019-20

SEMESTER - I
Sub - Banking
60+ 15 Pattern : External Marks 60 + Internal Marks 15 = Maximum Total Marks :75
(Required Lectures hours 45 )

A) Title of Paper 116 B - Principles & Practices of Banking- I

Detailed course contents

Topics Sub Topic

Unit I - Money, Finance and 1.1. Meaning , Functions and Importance of Money
Banking 1.2. Forms Of Money : Money and Near Monies
1.3. Money & the Capitalist Economy
i. The Circular Flow of Money in the Economy
ii. Problems Of Maintaining Balance
iii. Role Of Banking, Non-Banking Financial
Institutions (NBFIs) & Government

Unit -II –Banking: Meaning, 2.1 Concepts, Meaning & Evolution Of Banking
Functions & Classification 2.2 Functions and Services of Bank
2.3 Role Of Banking In Economic Development

Unit -III – Classification and 3.1 Structural Classification Of Banks : Features , Merits & Demerits
Types Of Banks
Unit -IV – Payment
Settlement System in India
i. Unit Banking
ii. Branch Banking
iii. Group Banking
iv. Chain Banking
3.2 Functional Classification of Banks
3.4 Ownership Classifications Of Banks
3.5 Modern Banking
i. Concepts Of Wholesale Banking & Retail Banking
ii. Merchant Banking.
iii. Universal Banking
iv. Virtual Bankin/Cyber Banking/E-Banking/Online
Banking
& 4.1 Meaning and Importance
4.2 Evolution of Payment System in India.
i. Electronic Clearing Service
ii. Internet Banking
iii. Real Time Gross Settlement System
iv. National Electronic Funds Transfer System
v. Cheque Truncation System (CTS):
 vi. National Electronic Clearing Service (NECS)
vii. Mobile Banking
viii. Satellite Banking
Unit -V – Bankers and 5.1 Deposit Accounts
Customers i. Types:Saving A/C, Current A/C, Fixed Deposit &
Recurring Deposit.
5.2. Type of Customer :General Precautions for Opening Of Accounts
of
i. Minor Account
ii. Joint Account
iii. Partnership Account
iv. Accounts Of Limited Companies
v. Account Of Trust
vi. Government Bodies Account
Unit – VI- Banking Operations 6.1 Cheques
i. Essentials Privileges Of Cheque Holder
ii. Liabilities Of Paying Bank & Collecting Bank
iii. Crossing , Dishonor and Endorsement Of Cheque
iv. Precautions To Be Taken By The Paying Banker
v. Protection to the Paying and Collecting Banker
 Unit I

Money, Finance and Banking

Introduction

The most common and shortest definition of money, as it appears in dictionaries, such as The
Concise Oxford Dictionary, is “a current medium of exchange, which is recognized and widely accepted
in payments for goods and services and for the settlement of debts”. One could add to the above definition
the following: “money is a current medium of exchange in the form of coins and banknotes; money
represents coins and banknotes collectively”. When it comes as standard pieces of gold, silver, copper,
nickel, etc., stamped by government authority and used as a medium of exchange and measure of value, it
is called hard money; money may be any paper note issued by a government or an authorized bank and
used in the same way; when appearing as bank notes (or bills1), money is also called paper money.

Money is also used as a chosen means of value: when selling / buying a commodity of some kind, its
price is conventionally expressed in a certain number of units of money; this is the recognized value of
money, accepted both by the seller and the buyer, because the conventional value can be used furthermore
to purchase other goods, merchandise or services.

A monetary unit chosen as a value measure need not be always used extensively. In America, to
take one example, during the colonial period, the British pound represented the standard of value, while
the then currently accepted medium of exchange was the Spanish currency.

Why Money Exists

Money proved its efficiency, this is why it exists even in centrally planned economies. The existence of
money and its functions as a medium of exchange and a measure of value facilitate the transactions of
goods and services and the continuous specialisation of production. In a barter-based economy, where
money was not used, trade would consist in the direct exchange of one commodity for another, just as
primitive peoples used to do. It was a terribly intricate system, in which the main problem is posed by the
so-called “double coincidence of wants”: for instance, a farmer selling tomatoes who needs a pair of new
shoes would not only have to find a shoe-maker wishing to buy tomatoes, but also need to settle some
kind of agreement as to what the tomatoes / shoes exchange rate should be, depending on the relative
prices of these two products, of course. Barter is still practised in some areas worldwide, but nowadays
money is regarded as a more practical means of exchange, facilitating a larger amount of economic
transactions. In a money economy, a producer or the owner of a commodity may sell it for money that can
be used in further payments for goods and products, thus avoiding the time and effort that are necessary to
find someone who could accept a barter. In our modern economic society, money is regarded as a
keystone of everyday life, and this perception is really effective because:

 money is accepted as a unit of account;

 it proves to be a universally accepted means of exchange;
 it is easily dividable;
 it can be durable and stable with regard to value;

When Did Money Appear?

The very first pieces of information about the use of money appear in Mesopotamia around 2,500
BC, and, at about the same time, in the ancient kingdom of Lydia. (Some other historical sources maintain
that coinage was invented by the Chinese in the second millennium BC). Here money replaced the barter
system and determined a real explosion in the variety of goods offered for trade purposes. Money was
mainly implemented from non-economic causes involving either ancient ceremonial rites and their rich
ostentatious ornaments, or primary forms of barter. Trade in kind improved gradually, and some goods
tended to be selected in preference to others, mainly because of their qualities in being used as media of
exchange: some of them were durable and conveniently stored, others were easily portable and had high
value densities. Such commodities became largely desired, proved easy to exchange and came to be
accepted as money.

Early forms of money were used for trading goods before paper money (i.e. banknotes / Amer.
Eng. bills) and coins were introduced. For example, rice or various small tools in China, cowrie shells in
India, cocoa beans in Central America, dog‟s teeth in Papua New Guinea, quartz pebbles in Ghana or
gambling counters in Hong Kong, metal cylinders of various sizes in ancient Asia Minor, metal disks in
Tibet, and limestone disks in Yap Islands became the first exchange instruments used as forms of
primitive money. Such objects, originally accepted for one-purpose trading activities only, gradually
proved their increasing acceptability and tended to be utilised for other non-economic purposes and
general trading use, supplementing barter and finally replacing it successfully. China is the nation now
most widely recognized as the cradle of paper notes used as money (about AD 800).

Many ancient societies had their established codes expressed by certain laws, which were widely
accepted by the community, requiring compensation for crime or payment 2 for brides; this was a wide-
spread custom, accepted in order to compensate the head of the family for the loss of a daughter‟s
services. Rulers imposed taxes on, or exacted tribute from, their subjects, and the religious leaders also
ordained payment of tribute or various forms of sacrifice (or offerings). This is how money evolved out of
deeply rooted customs in ancient societies.

From the so-called commodity money, such as rice, cattle3 and cowrie shells,4 which replaced the
earlier barter system, various forms of money have developed: hard money, made of precious metals
(especially gold and silver bars and ingots,5 or coins), token money, made of other metals (e.g. copper),
paper money or soft money (also called representative money), like the banknotes (Amer. Eng. bills)
used today. They were rapidly followed by forms of substitute money, such as: credits and bank
deposits, transferable by cheque, treasury bills, or bills of exchange.

Recent developments such as the cheque (Amer. Eng. check) and the credit card fulfill many, if not all,
the traditional functions of money.

Barter System

During the primitive stages of civilization, human needs were simple and every person produced
all that was needed to sustain life - he gathered his own food, sewed his own clothes and built his own
shelter. Robinson Crusoe collected his own food, wore fig leafs and lived in caves. He fulfilled all his
requirements and exchanged nothing because it was a one man economy. Though, earlier societies were
not one man society, they fulfilled all their requirements on their own. In course of time, people started
different occupations and with specialization in production of some goods and services, trade among
people came into existence. In the beginning, trade was direct. It involved exchange of goods for goods.
For example, exchange of rice for shoes by some individuals. This exchange of goods for goods was
known as barter. In this system of exchange, there were several difficulties and inconveniences.

Difficulties of Barter System

Barter system had certain difficulties which created numerous inconveniences to people. They are:
  The most obvious inconvenience of barter system was the requirement for a double coincidence
of wants. A man, who wanted to exchange some rice for cloth, had to find another person who not
only wanted that same good i.e., rice, but had cloth to offer in exchange.
 The quantity of goods which the two parties wanted to exchange should be equal in value to each
other. One cannot exchange one cow for 10 kg of rice. The value of a cow and 10 kg of rice are
different.
 Those who enter in barter trade should know how to calculate the value of commodities
exchanged. For instance, a shoemaker and a farmer wanted to exchange shoe against rice.
 They should first come to a decision in what ratio the two goods should be exchanged.
Difficulties were experienced in this exchange as there were no agreed prices. There was no
common measuring unit in terms of which value of goods could be expressed. The price of goods
or exchange ratio was determined by the intensity of each other's demand.
 In barter system, exchange would not be possible if the possessions or property of a person could
not be divided or sub-divided without loss. For example, if an individual's wealth consisted of
cow, it would be almost impossible for him to barter them for value of small article.
 The exchange of services would be far more complicated than the trading of goods. For example,
how to pay for the services rendered by a teacher or a barber is not easy to decide in a barter
system.
 In a barter system, it is very difficult to accumulate wealth for future use. Most of the
commodities like, corn, cattle, wheat, etc., lack adequate durability and deteriorate over time and
therefore cannot be stored conveniently for long duration for future use.

Thus, the difficulties associated with this barter system compelled human beings to give up this sort
of exchange and to look for something easily recognizable and generally acceptable to all. This
commonly accepted commodity or thing had to act as a medium of exchange. This medium of exchange
formed the basis for earlier definition of money.

Money may be anything chosen by common approval as a medium of exchange. The chosen thing or
commodity should be commonly accepted in payment for goods and services and to clear debts. Money is
given and received without reference to the standing of the individual who offers it in payments for goods
and services. Money is defined by its use in exchange or commerce. This gives the widespread notion of
money as a 'medium of exchange' or 'means of payments'. Some economists defined money in terms of its
general- acceptability. D. H. Robertson defines money as, "Anything which is widely accepted in
payment for goods or in discharge of other kinds of business obligations". In the opinion of Walker,
"Money is what money does." Seligman defines it as, "One thing that possesses general acceptability."
These definitions are too narrow and put light one or two aspects of money. Crowther termed it as,
"Anything that is generally acceptable as a means of exchange and at the same time acts as a measure and
store of value." Some definitions provided by economists makes it clear that the definition of money is
fundamentally functional and also must satisfy the general acceptability criterion. In this context, the
definition provided by Crowther may be considered superior.

Money was once recognized with coins. This remains the first definition of money given by the
Oxford English Dictionary: 'coin: metal stamped in pieces of portable form as a medium of exchange and
measure of value'. The recognition of 'money' with 'coin' reinforces the idea of the physical presence of
money whereas the idea of 'commodity money' implies that 'money' is abstract and that any asset might
potentially serve as money. The abstract character of money is preserved in the function of money as a
'unit of account'. That is, the use of money allows the value of different goods and services to be
expressed in a common unit or numeraire. The definition of money does go on from coins and allows the
possibility that money consists of 'any currency'. Currency, in turn is defined as anything that circulates
from person to person in the process of exchange and so we have the possibility that money might take a
variety of forms. Nevertheless, for most people the word 'currency' indicates notes and coins or cash or
what might be called 'ready money' in everyday use. And yet, the underlying idea remains that money is
anything that is acceptable in payment for goods and services.

DEFINITION AND MEANING

Money is any object or record that is generally accepted as payment for goods and services and
repayment of debts in a given socio-economic context or country. The main functions of money are
distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,
a standard of deferred payment. Any kind of object or secure verifiable record that fulfills these functions
can be considered money.

Money is historically an emergent market phenomenon establishing commodity money, but

nearly all contemporary money systems are based on fiat money. Fiat money, like any check or note of
debt, is without intrinsic value as a physical commodity. It derives its value by being declared by a
government to be legal tender; that is, it must be accepted as a form of payment within the boundaries of
the country, for "all debts, public and private". Such laws in practice cause fiat money to acquire the value
of any of the goods and services that it may be traded for within the nation that issues it.

The money supply of a country consists of currency (banknotes and coins) and bank money (the
balance held in checking accounts and savings accounts). Bank money, which consists only of records
(mostly computerized in modern banking), forms by far the largest part of the money supply in developed
nations.

FUNCTIONS OF MONEY

In the past, money was generally considered to have the following four main functions, which are
summed up in a rhyme found in older economics textbooks: "Money is a matter of functions four, a
medium, a measure, a standard, a store." That is, money functions as a medium of exchange, a unit of
account, a standard of deferred payment, and a store of value. However, modern textbooks now list only
three functions, that of medium of exchange, unit of account, and store of value, not considering a
standard of deferred payment as a distinguished function, but rather subsuming it in the others.

There have been many historical disputes regarding the combination of money's functions, some
arguing that they need more separation and that a single unit is insufficient to deal with them all. One of
these arguments is that the role of money as an exchange in conflict with its role as a store of value: its
role as a store of value requires holding it without spending, whereas its role as a medium of exchange
requires it to circulate. Others argue that storing of value is just deferral of the exchange, but does not
diminish the fact that money is a medium of exchange that can be transported both across space and time.
http://en.wikipedia.org/wiki/Money - cite_note-22 The term 'financial capital' is a more general and
inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.

The use of money has removed the drawbacks of barter system. Broadly speaking the functions of
money may be classified into primary (basic) and secondary functions.

Primary or Basic Functions:

(i) Medium of Exchange

Money acts as a medium of exchange of all goods and services. The use of money has greatly facilitated
process of exchange by dividing it into two parts i.e. sale and purchase. It has removed the difficulty of
double coincidence of wants found under the barter system. Therefore, in modern world we hardly find
any evidence of exchange of goods and services without the use of

money.

Example: You pay ` 10 to buy a pen. The seller receives ` 10 from you by selling the pen. So a pen is
exchanged for ` 10.

(ii) Measure of Value

Money helps to measure value of goods and services in terms of price. The use of money has completely
removed the confusion regarding value of one good/service vis-a-vis the other. This function has greatly
facilitated the process of exchange of different goods and services. The value of a good is determined by
multiplying its price with the quantity purchased. Since the

price is expressed in monetary units, the value of a good is also expressed in monetary terms.

Example: Let price of rice be ` 20 per Kilogram. One bag full of rice weighs 25 Kilograms. Then the
value of the bag of rice is ` 20X25= ` 500

Secondary Functions:

(i) Store of Value or Wealth

Money is the most convenient and economical means to store wealth which does not lose its value so
quickly over time. Thus, it is the most accepted means to store wealth or value. As medium of exchange
you can pay money to buy goods. This means if you have money, you have the power to purchase a good
or a service. So money has purchasing power. The value of the good is contained in that purchasing
power. Hence value of good is indirectly stored in money, you hold. Similarly, as a seller of good, you
receive the money which means value of good you sold, comes back to you through money.

Example: Harpreet sells furniture to a buyer for ` 2500.This means a value of ` 2500 was exchanged. The
buyer, who purchased the furniture, has the purchasing power to give ` 2500 as value. Hence a value of`
2500 was stored Government Budget in the money received by Harpreet as a seller. Harpreet could not
have stored furniture but she can definitely store money which in turn has stored the value of ` 2500.

(ii) Standard of Deferred Payments

Deferred payments are those payments which are promised to be made in future. Money acts as a means
of deferred payments mainly because it has general acceptability. Its value remains relatively constant
over time and it is more durable as compared to other goods. In case of borrowing and lending activities
only money is normally acceptable to be paid at a future date. Goods loose their value over time and due
to possibility of lack of double coincident of wants they are not acceptable to settle debts in future.

(iii) Transfer of Value

This function of money is derived from the store of value function of money. Money is used to transfer
value from one place to another or from one person to another. As a traveller when you move from one
place to another, you can easily carry money to make necessary transactions on the way and in your
destination place. You can also transfer the money through bank. Now people carry ATM card and
withdraw cash wherever the facility is available.

Other functions of Money

(i) Distribution of National Income

Income is generated by the factors of production engaged in the production process. The factors are land,
labour, capital and entrepreneurship. For the supply of these factor services to the production units, the
supplier of labour gets wage, the supplier of land gets rent, the supplier of capital gets interest and the
supplier of entrepreneurship gets profit. It should be noted that wage,

rent, interest and profit are paid by the firms in money terms and received by the respective suppliers as
factor incomes. Thus national income is measured by using income method.

(ii) Liquidity and Uniformity of Value

Money can be easily carried and is easily divisible into smaller units as per convenience. The liquidity
feature of money is manifested at the time when it can be withdrawn from the bank account repeatedly in
certain amount in each transaction. For example, your father has `10,000 deposited in his bank account.
You want to purchase a shoe worth `600. Your father can withdraw the amount from the bank to give
you. The balance of `9,400 will remain in

your father’s account. Money brings uniformity in value of different goods and services which are not
comparable physically due to their differences in the units of measurement.

For example a Kg. of rice and a liter of cooking oil cannot be added together as these are given in
different units. But they can be added together if expressed in monetary units. If a Kg. of rice is worth `25
and a liter of cooking oil is worth `75, the combined value of rice and oil comes out to be `100

Features of Money

1. Durability. A cow is fairly durable, but a long trip to market runs the risk of sickness or death for the
cow and can severely reduce its value. Twenty-dollar bills are fairly durable and can be easily
replaced if they become worn. Even better, a long trip to market does not threaten the health or value
of the bill.

2. Portability. While the cow is difficult to transport to the store, the currency can be easily put in my
pocket.

3. Divisibility. A 20-dollar bill can be exchanged for other denominations, say a 10, a 5, four 1s, and 4
quarters. A cow, on the other hand, is not very divisible.

4. Uniformity. Cows come in many sizes and shapes and each has a different value; cows are not a very
uniform form of money. Twenty-dollar bills are all the same size and shape and value; they are very
uniform.

5. Limited supply. In order to maintain its value, money must have a limited supply. While the supply of
cows is fairly limited, if they were used as money, you can bet ranchers would do their best to
increase the supply of cows, which would decrease their value. The supply, and therefore the value,
 of 20-dollar bills—and money in general—are regulated by the Federal Reserve so that the money
retains its value over time.

6. Acceptability. Even though cows have intrinsic value, some people may not accept cattle as money.
In contrast, people are more than willing to accept 20-dollar bills. In fact, the U.S. government
protects your right to use U.S. currency to pay your bills.

7. Liquidity: Liquidity refers to the ease with which an asset, or security, can be converted into ready
cash without affecting its market price. Cash is the most liquid of assets, while tangible items are less
liquid.

Well, it seems "udderly" clear at this point that—based on the characteristics of money—U.S. 20-dollar
bills are a much better form of money than cattle.

To summarize, money has taken many forms through the ages, but money consistently has three
functions: store of value, unit of account, and medium of exchange. Modern economies use fiat money-
money that is neither a commodity nor represented or "backed" by a commodity. Even forms of money
that share these function may be more or less useful based on the characteristics of money.

Significance and Role of Money in Economic Development

Economic development is generally believed to be dependent on the growth of real factors such
as capital accumulation, technological progress, and increase in quality and skills of labour force. This
view does not adequately stress the role of money in the process of economic development.

 Consumption Sector
 Production Sector
 Exchange Sector
 Distribution Sector
 Trade
 Income and Expenditure
 Base of Capital Creation
 Base of credit money
 Economic Development Index

It is said that money is a mere veil and intrinsically unimportant. What matters is the real goods
and productive factors which money buys. However, this extreme view about the unimportance of money
as such is no longer believed. Not only is money an important factor without which modern complex
economic organisation is impossible, but it is also an important factor for promoting economic
development. We discuss below the importance of money in the process of economic development.

In the economy today money performs several functions. Money serves as a standard of value in
which other values are measured. Money is a store of value, that is, the means in which wealth can be
held. It acts as a standard for deferred payments.

However, the most important function of money which distinguishes it from other goods is that it
serves as a medium of exchange. That is, money is a means of payment for goods and services. It is this
use of money that distinguishes a monetary economy from a barter economy. A monetary economy is one
in which goods are sold for money and money is used to buy goods.
Money Promotes Productivity and Economic Growth:
Barter system was full of difficulties of exchanging goods and services between individuals. In
the absence of easy exchange of goods and services the barter system worked as an obstacle to the
division of labour and specialisation among individuals which is an important factor for increasing
productivity and economic growth. Further, the process of economic growth leads to the expansion of
production of goods and services and consequential rise in incomes of the people.

As a result, volume of transactions in the developing economy increases. This raises the demand
for money to finance the increased transactions brought about by the expanded level of economic activity.
Thus, the process of economic growth would be held in check if adequate supply of money is not
forthcoming to meet the requirements of increase in the level of economic activity.

Money Promotes Investment:

From the viewpoint of development another important role of money lies in making the
magnitude of investment independent of the current level of savings. In a barter system, the goods not
consumed constitute the savings as well as investment. That is, investment is not different from current
savings. The greater the current savings, the greater the investment. However, in a modern economy, this
is not so. Whereas it is households which save in the form of money, it is the firms which invest money in
capital goods.

Therefore, investment can differ from saving because investment activity is separated from the act of
saving. More importantly, investment in a monetary economy can exceed the current level of savings.
This excess of investment over savings is possible because new money can be created by the Government
in the form of currency or by banks in the form of bank deposits. And this is what is important for the
purpose of economic development.

In the developed countries in times of depression when idle productive capacity exists, the in-
crease in investment made possible by creation of new money by the Government or banks would lead to
the increase in aggregate demand for goods and services. In such times the supply of goods and services
is elastic due to the existence of excess capacity. Therefore, increase in aggregate demand generated by
the investment financed by created money brings about expansion in output of goods and services and
thereby causes an increase in the level of employment.

In developing countries, the created money can play a useful role in promoting economic devel-
opment. Rapid economic development can be achieved by stepping up the rate of investment or capital
formation. But additional resources are required to increase the rate of investment. But in a country where
a majority of the people are living at the bare subsistence level, voluntary savings, taxation.

Government borrowing cannot by themselves provide sufficient investible resources for development.
The government therefore attempts to increase the volume of investible resources beyond what is possible
on the basis of current level of savings through creating new money. The newly created money can be
spent on investment projects both in the industrial and agricultural fields which would lead to the increase
in output, income and employment.

Money and Investment in Quick-Yielding Projects:

It is widely believed that any increase in the supply of money in developing countries would lead
to the rise in prices or to the emergence of inflationary pressures. However, this is not always true. A
reasonable amount of newly created money helps the development of the economy by raising the level of
investment. In the developing economies a lot of natural and human resources lie un-utilised and
underutilized which can be employed for productive purposes.
 If the newly created money is used for investment in those projects such as small irrigation
works, land reclamation schemes, flood control and anti-soil erosion measures, cottage industries which
yield quick returns, then the danger of inflation will not be there. These quick- yielding projects will
increase the production of essential consumer goods in the short run and will therefore prevent the rise in
prices.

Further, if development strategy is such that a higher priority is assigned to agriculture and other
wage goods industries and further that organisational and institutional reforms are undertaken to provide
all farmers with irrigation facilities, fertilizers and high- yielding varieties, agricultural output can be
raised in the short period. In this framework, new money can be created to increase the level of
investment without much adverse effect on prices.

Monetization and Economic Growth:

Further, as is well known, most underdeveloped countries have a large non-monetised (i.e. barter)
sector where production is for the purpose of subsistence only. To break the subsistence nature of
economic activity and thus generate new forces for economic growth, its monetisation is required. The
introduction of money helps in bringing it in contact with the modern sector. This contact of the
subsistence sector with the modern sector will lead to the expansion of its output.

In order to obtain the products of the modern industrial sector, the people engaged in the
subsistence sector will make efforts to raise their output. Thus, a surplus of output over their self-
consumption will be generated in this way which will ultimately break their subsistence nature.

It is supported by the past history of the developing countries. During the colonial period, the
monetisation of the peasant sector led to the expansion in exports in exchange for the imported industrial
products. This stepped up their agricultural development to a good extent.

Similar to the growth of production for exports the introduction of money in the subsistence
agricultural sector and its contact with the modern sector, would lead to the increase in marketable surplus
of foodgrains and other agricultural products which is an important factor in economic development.

If some rise in agricultural prices occurs as a result of increase in investment financed by the
created money, as is likely the case, it would serve as an incentive to produce more foodgrains and supply
it the market. The rise in agricultural incomes will increase demand for industrial products and would
therefore accelerate their growth.

Further, the monetisation of the subsistence sector will also help in raising the volume of savings.
Monetisation will bring this sector in contact with the financial institutions such as commercial and
cooperative banks and insurance companies.

The opportunities of earning more income through interest on saving will raise the propensity to
save of the people in the present-day subsistence sector. If proper monetary policies are pursued, then
instead of consuming or hoarding all their therefore incomes, these people can deposit a part of them in
the financial intermediaries.

Classification of Money
Different economists have classified money in different ways. We shall discuss some of the important
forms of money in this section.:
Actual Money and Money of Account

J.M. Keynes in his Treatise on Money has distinguished between actual money and money of
account. Actual money is that money which actually circulates and is current in practice in a country.
Actual money is the medium of exchange of goods and serives in country. It is in the shape of actual
money that all payments are made and a store of general purchasing power is held. For example, in India,
the coins and paper notes of various denominations are actual money.

Money of account is “that in which debts and prices and general purchasing power are expressed. It is
that form of money in terms of which the accounts of a country are kept and transactions made.” The
monetary unit in which the money of account is expressed may not exactly be a circulating medium.

Generally speaking, money of account and actual money are not different. At certain unusual time they
might, however, be different. For instance, during the hyper-inflation of 1920’s in Germany, all
payments were made in terms of German Marks. But the money of account changed tot eh US dollar or
Swiss franc because of relative stability in their value.

Commodity Money and Representative Money

Actual money may be either commodity money or representative money. Commodity money is
made of certain mortal, and its face value is equal to its intrinsic value. It is also referred to as full-bodied
money. Commodity money is both a medium of exchange and a store of value.

Representative money means those notes which are freely convertible into full-bodied money. It
may be made either of cheap metal or convertible paper money. This money is not a good medium for
storing purchasing power, because it commands little intrinsic value.

Representative money is further sub-divided into: (i) Convertible money, and (ii) Inconvertible
money. Convertible money refers to that money which the issuing authority is under an obligation to
convert into commodity money. Inconvertible money, contrary t representative money, is that money
which the issuing authority is under no obligation to convert into commodity money.

Legal Tender money and Optional Money

Money is different not only on the basis of the relationship between its monetary usage and
commodity usage but also from the standpoint of the law.

Certain kinds of money are granted ‘legal tender’ power by the government. They are legal
tender money. It is that money which every individual is bound to accept in exchange for commodities
and services, and in the discharge of debts. The legal tender status given by a government to a certain kind
or kinds of money may be limited or unlimited.

(1) Limited Legal Tender Money is that money which no person can be forced to accept beyond a
certain maximum limit. The maximum limit is fixed by the government under statute. In our country,
coins of small denominations are limited legal tender money.

(2) Unlimited Legal Tender Money is that money which a person has to accept up to any limit because it
is an unlimited legal tender. This type of money is accepted by the people to an unlimited extent. In our
country, two-rupee coin, one-rupee coin, half-rupee coin and paper notes of all denominations are
unlimited legal tender money.
 Optional Money is non-legal tender but is genially accepted by the people in final payments. It
consists of credit instruments like bills of exchange, cheques, handiest, etc., which do not enjoy any
statutory backing. Nobody could be forced to accept this type of money. The acceptance of optional
money depends upon the choice of a person.

Money and Near-Money

The general acceptability which characterizes money also makes it the most liquid of assets. liquidity is
the quality of being immediately and always exchangeable in full value for money.

Obviously, money is by definition 100 per cent liquid. One way of categorizing other assets is by
how liquid they are. At the other end of the liquidity spectrum are illiquid assets, such as houses. Between
the two extremes, certain assets can be identified as ‘near-money’ because they can be held with little
loss of liquidity. National savings deposits, building society deposits and other similar securities are not
money because they are not generally acceptable in paying debts, but they can be easily and quickly
exchanged for money without ant loss. So they are highly liquid forms of ‘near-money’ or quasi-
money.

Metallic Money and Paper Money

This classification depends upon the material of which money is made. money made of some metal is
called metallic money, and that of paper is known as paper money.

(i) Metallic money is further classified under two sub-hands:

(ii) Token Money.

(i) Standard Money is the money of ultimate redemption. If the government has adapted gold standard,
the banks and the government will upon demand pay out gold in exchange for any other form of money.
The face value of a standard coin is equal to its intrinsic value. it is unlimited legal tender, and has free
coinage.

(iii) Token Money. It is that unit of currency the face value fo which is higher than its intrinsic value.
Our rupee is a token money.

(3) Paper Money. Pater money, though introduced long ago, has com into prominence only during the
present century. Paper money includes bank notes and government notes which circulate without
difficulty.

Paper money can classified under four heads: (i) Representative Paper Money; (ii) Convertible Paper
Money, (iii) Inconvertible Paper Money; and (iv) Fiat Money.

 Representative Paper Money. Representative paper money is 100 per cent backed and is full
redeemable in some commodity such as gold or sliver.
 Convertible Paper Money. Convertible patter money is that which can be converted into
standard coins at the option of the holder. A less than 100 per cent reserve in metallic form is
maintained for his kind of paper money. The basic principle underlying the system is that all the
notes are not simultaneously presented by the public for encashment. Therefore, the value of gold
and silver kept in the reserves is less than the value of notes issued by the monetary authority.
  Inconvertible Paper Money. Inconvertible paper money is that money which an not be
converted into full-bodied money. Our one-rupee note is good example of inconvertible Paper
Money.
 Fiat Money. Fiat money is another type of inconvertible paper money. It is that money which
circulates in the country, under extra-ordinary circumstances, on the command of the State. It is
issued generally at a time of crisis. Fiat money is issued by the government without any backing
of reserve.

Credit Money

With the introduction of paper money. credit money also came into vogue. Credit money. also known as
bank money, refers to bank deposits kept by people with banks which are payable on demand and can
transferred from one party to another via the use of cheque . The cheque is an in instrument used to
transfer bank deposits and it offers the some conveniences as money.

Some of the advantages of money are as follows:

Money occupies a unique position in a modern capitalist economy. In its absence, the whole prosperous
economic life would collapse like a pack of cards.

The advantages or uses of money can be best understood by considering the system in which money is
absent.

1. Money has overcome drawbacks of barter system. We have read drawbacks of barter system which
make exchange process burdensome and highly inefficient. In fact, money was invented by the society to
overcome these drawbacks.

The barter system suffers from four main drawbacks, each of which is overcome by a specific function of
money as explained below:

(i) Money as medium of exchange solves the barter’s problem of lack of double coincidence of wants as
money has separated the acts of sale and purchase. You can sell goods for money to whosoever wants it
and with this money you can buy goods from whosoever wants to sell them.

Money is accepted as medium of exchange. People exchange goods and services through medium of
money when they buy goods or sell goods. Thus, money becoming intermediary solves barter’s problem
of double coincidence of wants.

(ii) Money as measure (unit) of value or a unit of account solves the barter’s problem of absence of
common measure (unit) of value. Money serves as a unit of value or unit of account and acts as a
yardstick to measures exchange value of all commodities. The value of each good or service is expressed
as price (i.e. money units) which guides both consumer and producer to make a transaction. Thus money
makes keeping of business account possible.

(iii) Money as store of value solves the barter’s problem of difficulty in storing wealth (or generalised
purchasing power). Moreover, money in convenient denominations (like Indian coins of 5, 10, 20, 50, 100
paise and currency notes of 2, 5, 10, 100, 500, and 1,000) solves the barter’s problem of absence or lack
of divisibility. (Coins of less than 50 paise are no longer in use now.)
(iv) Money as standard of deferred payments helps to solve the barter problem of lack of standard of
deferred payment. Again, it helps to make contracts which involve future payments. Doubtlessly money
helps in removing the difficulties of barter system.

2. It facilitates exchange of goods and services and helps in carrying on trade smoothly. The present
highly complicated economic system will not exist without money.

3. Money helps in maximising consumers’ satisfaction and producers’ profit. It helps and promotes
saving.

4. Money promotes specialisation which increases productivity and efficiency.

5. It facilitates planning of both production and consumption.

6. Money can be utilised in reviving the economy from depression.

7. Money enables production to take place in advance of consumption.

8. It is the institution of money which has proved a valuable social instrument of promoting economic
welfare. The whole economic science is based on money; economic motives and activities are measured
by money.

Demerits of money:
1. Income disequilibrium:-

money is responsible for instability of economy which is almost found in capitalist economics.
When there was no money saving was not divorced for the investment. Those who saved also invested.
But in monetized economy, saving ai done by certain people.

2. Economic Instability.

A great disadvantage of money is that its value does not remain constant which creates instability
in the economy. Too much of money reduces its value and causes inflation (i.e., rise in price level) and too
little of money raises its value and results in deflation (i.e., fall in price level). Inflation distorts the pattern
of distribution in favour of the rich ; thus, it makes the rich richer and the poor poorer. Deflation, on the
other hand, results in unemployment and hardships to the working class.

3. Inequality of Income:

Money, through its excessive use and inflationary effect, creates and widens the inequalities in the
distribution of income and wealth. This had divided the society into 'haves' and 'have-nots' and has led to
a class conflict between them.

4. Growth of Monopolies:

The use of money leads to the concentration of wealth in a few hands and this gives rise to
monopolies. Growth of monopolies results in the exploitation of the workers, brings misery and
degradation to them.

5. Over-Capitalization:
 Easy borrowing and lending facilities, made possible through money, may lead certain industries
to use more capital than is required. This over-capitalization, in turn, results in over-produc­tion and
unemployment.

6. Misuse of Capital:

Money, which is the basis of credit, leads to the creation of more and more credit creation. Credit
creation, if not matched by the increase in production, results in inflationary rise in the prices.

7. Hoarding:

In the materialistic world, people give undue importance to money and, instead of utilising in
productive activities, may start hoarding. This would adversely affect the growth of income, output and
employment of the economy.

8. Black Money:

Money, due to storability characteristic, is the cause of the evil of black money. It provides people
a convenient way to evade taxes by concealing their income. Black money, in turn, encourages black
marketing and speculative activities.

9. Political Instability:

Wide fluctuations in prices and business activities, caused by money, may lead to political
instability. This may result in the change of government.

10. Moral and Social Evils:

In the modern times, moral values have been sacrificed at the alter of money. People have become
so much money-minded that they openly indulge in corrupt practices to satisfy their greed for money.
Money is also the root cause of thefts, murders, frauds and other social evils.

11. Danger of over issue:

When the money is over issued it can give the birth to the hyper inflation which is also dangrious for the
stability of economy of a country.

Types of Economy

There are four types of economic systems –

1. Traditional Economic System

This economic system retains essential characteristics in which there is very less specialisation or division
of labour.

A traditional economic system is most likely to be found in rural settings, or in such developing nations
where farming is predominant. Such settings usually have very few resources to share.

2. Command Economic System (Socailist Economy)

Command or Socialist economic system has a dominant centralised authority in the form of government.
The economy in such a country is controlled by the government. It is the sole decision-making authority
for determining production and allocation.

Ideally, the command system takes into consideration the best interest of its populace.

3. Market Economic System (Capitalist Economy)

Market economic system or capitalist economy involves very less government interference and
incorporates the principles of the free market. There is a scant exercise of control over resources. Market
forces regulate demand and supply.

However, there does exist some degree of government intervention in the form of regulations against
monopoly, and in favour of fair trade.

4. Mixed Economic System

A mixed economic system combines the features of both socialist and free-market economic systems. It is
also known as dual systems. Most of the countries today have a mixed economic system with the
existence of both public services as well as private industries.

Do you know?

Economic liberalisation in India was initiated in 1991, and Dr ManMohan Singh was the pioneer of this
liberalisation.

In economic liberalisation, government restrictions and regulations are reduced to facilitate the
participation of private entities to a much greater extent. It is an inherent principle in Classical Liberalism.
"Controls" were removed to drive economic development, which was in a rocky state.

The liberalisation of the Indian economy provided access to foreign investors, which subsequently
increased foreign trade. Such changes went on to create higher job opportunities for the people of India.

Difference between Types of Economy

Parameters Market Economic Command Economic Mixed Economic System

System System

Determination Demand and supply in a The central authority,
of price market determine the most likely the
price government, decides
prices of goods and
services
Price is influenced by market
forces of demand and supply as
well as government regulations,
in certain instances

Property Ownership vests with There is public ownership Property is owned by both
ownership private entities of property public and private entities

Production Production is undertaken The underlying objective Production in a mixed economy

only with a profit motive of production is social includes both profit motive and
welfare social welfare

Competition There exists competition There is no competition in Only entities in private sector
among entities present in a market owing to State experience competition
 such market ownership of firms.

Government Government has very The government retains Government has a full holding
intervention less role to play in a full control over firms in the public sector but a
market economic limited role in its private
system counterpart

ROLE OF MONEY IN CAPITALISTIC ECONOMY:-

Today money is considered one of the out standing inventions of the entire history of mankind. The
introduction of money has eliminated all the difficulties of barter system in which goods have to be
exchanged for goods. Money facilities trade by acting as a medium of exchange and standard of value. It
has made easy to save wealth for future. It has played a significant role for the specialization in business
through division of labour. Although money itself creates nothing but it is very helpful in the process of
production, consumption and exchange.

1. Importance For Producer :-

The use of money enables entrepreneur to concentrate attention upon the technical problems of his
business. Without money it is not easy for the producer to distribute product which is not divisible like
"Bus" or motor car among the four factors of production.

The price mechanism controls the capitalistic economy. In a free enterprise economy many decisions like
" What to produce , how to produce, where to produce and for whom to produce are guided by the profit
motives. Money prices reflect the aggregates of individual demands and supplies."

2. Importance For Consumer :-

People can sell and buy the goods and services which they need by parting with money. In the absence of
money a great variety of things would never have entered in our consumption list and our satisfaction
would have been at the lowest level.

3. Exchange Transaction :-

The use of money has successfully removed the disadvantage of barter. Money has greatly stimulated the
exchange of goods.

4. Distribution Of National Income :-

Every year we produce the certain amount of goods and services by combining the four factors of
production. The reward of each factor like rent, wages, profit and interest is paid in terms of money.

5. Importance In The Field Of Public Finance :-

Money performs a valuable services in the field of public finance. The government can easily increase the
revenue through the medium of money and can spend it for the betterment of the society. If the money is
properly managed, it ensures rising level of production, income and employment in the country.

ROLE OF MONEY IN SOCIALISTIC ECONOMY :-

 A socialistic economy also can not operate smoothly and with maximum efficiency without
money. After the revolution of 1917 in Russia, Govt. experimented for a short period with a moneyless
system but it was found that the system could not work at all and it was given up soon after.

The basic feature of socialistic economy is that all means of production are owned and managed
by state. The individuals can not possess profit earning properties. The operation of the economy is
controlled by the state and not by the price mechanism. As a matter of fact-socialistic economy will
remain a monetary economy. In a socialistic society persons would be paid money wages for their
services. These wages would be used for the purchase of Govt. produced goods. Prices would be fixed by
the Govt. which would ensure that total demand would be equal to the total supply. In order to determine
the order of priority and for the selection of the most efficient and economical method for the production,
the importance of various projects and costs of various methods of production must be determined. The
calculations of such costs can only be made in monetary terms.

The Circular flow of Money

The circular flow of Money or circular flow is a model of the economy in which the major
exchanges are represented as flows of money, goods and services, etc. between economic agents. The
flows of money and goods exchanged in a closed circuit correspond in value, but run in the opposite
direction. The circular flow analysis is the basis of national accounts and hence of macroeconomics.

Two-sector model

Two-sector circular flow diagram

In the basic two-sector circular flow of income model, the economy consists of two sectors: (1)
households and (2) firms (Some sources refer to households as "individuals" or the "public" and to firms
as "businesses" or the "productive sector." The model assumes that there is no financial sector, no
government sector, and no foreign sector. In addition, the model assumes that (a) through their
expenditures, households spend all of their income on goods and services or consumption and (b) through
their expenditures, households purchase all output produced by firms. This means that all household
expenditures become income for firms. The firms then spend all of this income on factors of production
such as labor, capital and raw materials, "transferring" all of their income to the factor owners (which are
households). The factor owners (households), in turn, spend all of their income on goods, which leads to a
circular flow of income.

Three-sector circular flow diagram

 Three-sector model

The three-sector model adds the government sector to the two-sector model.] Thus, the three-
sector model includes (1) households, (2) firms, and (3) government. It excludes the financial sector and
the foreign sector. The government sector consists of the economic activities of local, state and federal
governments. Flows from households and firms to government are in the form of taxes. The income the
government receives flows to firms and households in the form of subsidies, transfers, and purchases of
goods and services. Every payment has a corresponding receipt; that is, every flow of money has a
corresponding flow of goods in the opposite direction. As a result, the aggregate expenditure of the
economy is identical to its aggregate income, making a circular flow.

Four-sector model

The four-sector model adds the foreign sector to the three-sector model (The foreign sector is also
known as the "external sector," the "overseas sector," or the "rest of the world.") Thus, the four-sector
model includes (1) households, (2) firms, (3) government, and (4) the rest of the world. It excludes the
financial sector. The foreign sector comprises (a) foreign trade (imports and exports of goods and
services) and (b) inflow and outflow of capital (foreign exchange). Again, each flow of money has a
corresponding flow of goods (or services) in the opposite direction. Each of the four sectors receives
some payments from the other in lieu of goods and services which makes a regular flow of goods and
physical services. The addition of the foreign sector

Role of Banks in Economic Development

Banks role in economic developmentBanks have always played an important position in the
country’s economy. They play a decisive role in the development of industry and trade. The main
contributions made by the banks to the economic development of the nation;

1. Capital Formation
 Banks play an important role in capital formation, which is essential for the economic
development of a country. They mobilize the small savings of the people scattered over a wide area
through their network of branches all over the country and make it available for productive purposes.

2. Creation of Credit

Banks create credit to provide more funds for development projects. Credit creation leads to
increased production, employment, sales, and prices, and thereby, they cause faster economic
development.

3. Channelizing the Funds to Productive Investment

Capital formation is not the only function of commercial banks. Banks invest the savings
mobilized by them for productive purposes. Pooled savings should be distributed to various sectors of the
economy to increase the productivity of the nation.

4. Fuller Utilization of Resources

Savings pooled by banks are utilized to a greater extent for the development purposes of various
regions in the country. It ensures fuller utilization of resources.

5. Encouraging Right Type of Industries

The banks help develop the right type of industries by extending loans to the right type of
persons. In this way, they help the country’s industrialization and the country’s economic
development.

6. Bank Rate Policy

Economists believe that by changing the bank rates, changes can be made in a country’s money
supply. Federal or state banks in developing countries; the interest rate is to be paid by banks for the
deposits accepted by them and the rate of interest to be charged by them on the loans granted by them.

7. Bank Monetize Debt

Commercial banks transform the loan to be repaid after a certain period into cash, which can be
immediately used for business activities. Manufacturers and wholesale traders cannot increase their sales
without selling goods on a credit basis. But credit sales may lead to locking up of capital.

8. Finance to Government

The government is acting as the promoter of industries in underdeveloped countries for which
finance is needed it. Banks provide long-term credit to the Government by investing their funds in
Government securities and short-term finance by purchasing Treasury Bills.

9. Bankers as Employers

After the nationalization of big banks, the banking industry has grown to a great extent. Bank’s
branches are opened in almost all the villages, which leads to the creation of new employment
opportunities. Banks are also improving people for occupying various posts in their office.
 10. Banks arc Entrepreneurs

In recent days, banks have assumed developing entrepreneurship, particularly in developing

countries like India. Developing entrepreneurship is a complex process. It includes the formation of
project ideas, identification of specific projects suitable to local conditions, etc.

Finally, we can say that bank plays a vital role in the economic development of the country.

NBFC
During the economic crisis of 2009, businesses across the world got stuck because of not getting
finances. The banks which provided finance to them struggled to keep afloat. Relying on just a few
institutions has proved to be a costly mistake for many entities. Therefore, alternatives to transform the
economy’s savings into a capital investment was needed. India has had huge gaps in credit availability
and it was important to build institutions to help fill these blanks. This is where an NBFC or Non-Banking
Financial Company played an important role. By fulfilling the diverse financial needs of those customers
that don’t have access to banks and their services.
NBFCs are companies established under the Companies Act. These companies get NBFC
License with the Reserve Bank of India (RBI). NBFCs are intermediaries engaged in the business of
finances. NBFC accepts deposits, delivers credit, and plays an important role in channelizing the scarce
financial resources towards the creation of wealth. They supplement the organized banking sector in
meeting the increasing financial requirements of the corporate sector, delivering credit to the unorganized
sector and small local borrowers. However, they cannot finance any agricultural activity, industrial
activity, sale, purchase, or construction of an immovable property.
NBFC focuses on activities related to loans and advances, acquisition of shares, stock, bonds,
debentures, securities issued by the government/local authority or other similar marketable securities,
leasing, hire-purchase, insurance business, etc. The financial services offered by NBFCs include
disbursement of finances and loans, acquisition of stocks, shares or bonds, etc.

NBFC Role in the Economy

 Growth: In terms of year-on-year (YoY) growth rate, the NBFC sector beat the banking sector in
contributing to the economy every year. On average, this segment grew by 22% every year, in its initial
stages. Despite the slowdown in the economy and various setbacks faced in the last few years, the sector
is still growing and enhancing operations.

 Profitability: NBFCs have been more profitable than the banking sector because of lower costs. This
enabled them to offer cheaper credit to customers. As a result, the amount of money lent to customers by
NBFCs is higher than that of the banking sector with more customers opting for NBFCs.

 Enhancing the Financial Market: An NBFC caters to the urban and rural poor companies and plays a
complementary role in financial inclusion. These financial companies bring much-needed diversity to the
market by diversifying the risks, increasing liquidity in the markets thereby bringing efficiency and
promoting financial stability to the financial sector. They highlight the public issues of corporations as
well as providing funds needed by the start-up companies as capital. The financial market is dependent on
the functions that are taken care of by these lending companies.

 Infrastructure Lending: NBFCs by lending to infrastructure projects, contribute largely to the economy.
This is very important for the growth of a developing country like India. The amount involved is quite
large, the projects being risky, with no surety of returns, and profits occurring after a longer time-frame.
These factors deter banks from financing these projects. Since their inception, NBFCs have contributed
more to infrastructure lending than banks.
 Promoting Inclusive Growth: All the top NBFC in India cater to a wide variety of customers – both in
urban and rural areas. They finance projects of small-scale companies, which is important for the growth
in rural areas. They also provide small-ticket loans for affordable housing projects. Microfinance provided
by them plays an important role to attain stable financial inclusions. All these activities by the institution
with an NBFC License help promote inclusive growth in the country.

 Upliftment in the Employment Sector: With the growth in operations of the small industries and
businesses, the policies of NBFCs are uplifting the job situation. More opportunities for employment are
arising with the influence of the NBFCs in the private as well as government sectors. The business
activities in the private sector provide more employment opportunities and occupation practices. And
NBFC plays a key role in their growth and stability.

 Mobilization of Assets: With more public preferring to deposit in NBFCs because of their higher rate of
interest, NBFCs allow mobilization of resources; funds, and capitals. Due to their easier norms for
investing, these companies create a balance between intra-regional income and asset distribution. Turning
the savings into investments, these companies contribute to economic development as compared to
traditional bank practices. Proper organization of capital helps in the development of the trade and
industry, leading to economic progress. They operate not intending to maximize their profit and are,
therefore, engaged in activities that generate zero or very low revenue.

 Financing for Long-Term: NBFC plays a key role in providing firms with funds through equity
participation. As against traditional banks, NBFCs supply long-run credit to the trade and commerce
industry. They facilitate to fund large infrastructure projects and boost economic development. Long-term
finance permits growth with stable and soft interest rates. The economy thrives when businesses of SSIs
and MSMEs flourish.

 Raising the Standard of Living: NBFCs collaborate with the government for the upliftment of the
society. The NBFCs attract deposits from the general public and convert it into capital for industrial and
other sectors for smooth economic development. The rise in businesses consequently raises the demand
for workforce and creates employment opportunities raises the purchasing power of individuals and,
subsequently, raising demands. This works to upgrade the living standards of a society. Also, foreign
deposits are attracted to these financial institutions and support economic process and development.

 Innovative Products: NBFCs, by being flexible in terms of lending and investment opportunities than
banks, are more proactive in innovating financial products. This facilitates their growth in an exceedingly
prudent manner. They fine-tune their selling campaigns in regard to their target customers. These
corporations are the game changers within the developing economy. For instance, the factorization & bill
payment service has been revolutionized. NBFC P2P is a relatively new segment in India that is already
creating waves by providing considerably higher margins and facilitating loans at a lower cost.