TOPIC 4

MONEY, BANKING AND

FINANCIAL SYSTEM

1
 Definition of Money
• Anything that can acts as a medium
of exchange.

Functions of Money :
• Medium of Exchange
• Measures of value and a unit of account
• Store of value or wealth
• Standard of deferred payment
2
 Qualities of money/
characteristic of money
• Acceptability
• Durability
• Divisibility
• Stability
• Scarcity
• Portability or transportability
• Uniformity / homogeneity

3
 Types of money
• Commodity money
• Fiat money
• Legal tender
• Token money
• Demand deposits

4
 Supply of Money
• Every country has its own supply of money
which is used in the transaction.
• Money Supply is divided into 3 categories :
M1, M2 and M3.

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M1= directly used for transaction/most liquid
money
• Consists of
i. Currency: coins & paper money issued by BNM.
Also called fiat money.

ii. Demand deposits: checking account balance

(checkable deposits) kept in commercial banks.

iii. Current deposit

iv. Traveler's check

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 M2= near money plus M1/almost liquid
money
• Consists of :

i. M1

ii. Saving and fixed deposits in commercial banks

iii. Negotiable certificates of tender (NCD)

iv. Re purchase agreements (Repos)

v. BNM certificates

vi. Treasury bills

* any other instruments in commercial bank

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 M3= broad money
• Consists of :

i. M2

ii. Savings and fixed deposits in other financial

institutions.

*any other instruments in other financial institution

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 Quasi money
• Definition :
Almost liquid money. Cannot be used
immediately for transaction but can be easily
changed into cash.

• Broad Quasi Money : M3 – M1

• Narrow Quasi Money : M2 – M1

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 Demand for money
• According to Keynes's, there are three motives of
demand for money ( why people want to hold
money)
1. Transactionary motive
2. Precautionary motive
3. Speculative motive

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 Transactionary motive
• People hold money to buy goods and services or
having business transaction.
• Mt = money demand for transactionary motives
• This expenditure depends on the amount of
disposable income (Yd)
• Yd increase, Mt increase, vice versa
• Diagram:

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 Transactionary motive
Mt

1200

900

Yd
1500 2000

12
 Precautionary motive
• People hold money as preparation for uncertainties
such as accidents, sickness, etc.
• Mp= money demand for precautionary motives
• This expenditure also depends on the amount of
disposable income.
• Yd increase, Mp increase, vice versa
• Diagram:

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 Precautionary motive
Mp

800

600

Yd
1500 2000

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 Speculative motive
• Money that is not used for any expenditure is known as idle balance.

• Msp= money demand for speculative motives

• For some people this idle balance is used to buy shares or bonds. For
investment purpose.

• Buying shares depend on the rate of return, r (profit)

• If r is high, idle balance is used to buy shares and if r is low people would
hold idle balance.

• Also depends on interest rate (i ). i will determine the cost of borrowing. If

i increase, cost of borrowing increase, so Msp will decrease. People will not
willing to hold money for speculative motives, instead they will choose to
save money to gain from the high interest rate, i
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 Speculative motive
Msp Msp

200 200

100 100

3.5% 5% r (rate of return) 4% 6% i (interest rate)

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 Financial System
• Three main groups :

1. Banking institutions
a) Central bank
b) Commercial bank (Maybank, CIMB etc)

2. Non-bank financial institution

a) finance companies
b) Islamic bank (Bank Islam, Bank Muamalat, Tabung haji)
c) Merchant banks
d) Discount houses
e) Development bank : BSN ,agro bank and etc

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 Financial System, cont..
3. Non-bank intermediaries
a) development financial institution
b) Employees Provident Fund (EPF)
c) Tabung Haji (LUTH)
d) Insurance companies

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 Balance Sheet of Commercial Bank
Balance Sheet
Assets Liabilities
LIQUID ASSETS CAPITAL AND RESERVES DEPOSITS
1. Coins & notes a) Demand deposits
2. Reserve with BNM & balance with
b) Fixed deposits
other banks
c) Savings deposits
3. Money-at-call & short term notice
d) Other deposits
4. Bills discounted
a) trade bills e) Special deposits
b) treasury bills
EARNING ASSETS
5. Investments
6. Loans & Advances
PHYSICAL ASSETS 19
 Credit Creation
• A process where a small given deposits will lead to a
greater increase in the money supply in the
economy.
• Assumptions :
 Cash ratio is fixed by the government
 No leakage in the economy
 Bank does not keep access reserve
 Only two types of assets : cash and loans
 Only one liability : demand deposits
 Multiple banks

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 Process of credit creation
BNM- determine CR
(10%) or a certain
portion to all bank
Financial RM100+RM1000+
intermediaries RM10000

People with People with

surplus of money BANK A shortage of
money

Ali – 1000 Laila

1000- CR(10%)
Muthu-10000 100=900 Maya
Cheng-100000 Gana

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 Example :
 Ali has an excess of money amounted to RM1000 and he decided to save it in Bank
A. The money will be recorded in the liability section as a deposit. Bank A will not
left the money idle but will loan out the money to a person which has shortage of
money. Before Bank A loan it out, Bank A need to fulfill the BNM Cash Ratio (CR)
requirement which is 10% out of the total deposit. Total money that can be loan out
will be RM900 after deducting the CR.
 Below is the balance sheet of Bank A

Initial reserve Initial deposit

Assets RM Liabilities RM
Cash (CR=10%) 100 Deposits 1000
nitial loan Loans 900
Total 1000 Total 1000

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 Formula :

• Cash ratio = R.R / initial deposits X 100%

• Money multiplier = 1/ CR

• Total money supply = (1/ CR) X initial deposits

• Total Reserves = (1/ CR) X initial reserve

• Total Credit Creation = (1/CR ) X initial loan

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Calculate :

a) The cash ratio = 100/1000 x100 = 10%

b) The money multiplier =

1/ CR
1/ 0.1 = 10, the money will multiply by 10 times.

*If cash ration 7% its is 1/0.07 not 0.7..be extra careful

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Calculate :

c) Total money supply (TMS)

1/ CR x initial deposit
1/ 0.1 x 1000 = 10000

d) Total reserve (TR)

1/ CR x initial reserve
1/ 0.1 x 100 = 1000

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Calculate :

e) Total Credit Creation (TCC)

1/ CR x initial loan
1/ 0.1 x 900 = 9000

TMS = TCC + TR
10000 = 9000 + 1000

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 Limits to credit creation
• Change in cash ratio
50 % ..from 1000 now reserve will be 0.5 x 1000= 500… loan out 500..
5%..from 1000 now reserve will be 0.05 x 1000= 50… loan out 950..

• Clearing house
• Available of collateral security
• BNM’s monetary control
• Leakage in the banking system

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 Islamic Financial Products

• Al Wadiah Yad Dhamanah – savings with guarantee

• Al Mudharabah – The lender agrees to finance the
entrepreneur’s project on a profit sharing basis.
• Al Musyarakah – A Partnership for a specific
business (joint venture). The lender provides capital
as well as may also participate in the management.

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 Islamic Financial Products, cont…

• Al Murabahah – (cost plus) sale of good at a

price which includes a profit margin agreed by
both parties
• Al Bai Bithamin Ajil – the borrower is allowed
to defer settlement.
• Al Ijarah – leasing Financing.
• Al Takjiri – leasing financing however it allows
the lessee to own the asset.

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 Islamic Financial Products, cont…

• Al Wakalah – nominating another person to

undertake certain transaction on his behalf.
• Al Qardhul Hassan – benevolent loan. The
borrower just repay the principal sum
borrowed on maturity of the loan

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