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Money and Banking

Definition:

Money is any item or verifiable record that is accepted as payment for goods and services, or repayment of debts. It serves as a medium of exchange, a unit of account, and a store of value.

Money serves as a medium of exchange, a store of value, a unit of account, and a standard of deferred payment. These functions make it essential for facilitating trade and economic activity.

  • Medium of Exchange: Money allows goods and services to be exchanged without the need for barter. This makes transactions more efficient.
  • Store of Value: Money retains value over time, allowing individuals to save and transfer purchasing power to the future.
  • Unit of Account: Money provides a standard measure of value, allowing people to compare prices and costs effectively.
  • Standard of Deferred Payment: Money facilitates borrowing and lending by providing a standard for future payments.
Types of Money
  1. Commodity Money:
    • Money that has intrinsic value, like gold or silver. It can be used for trade as well as for its own value.
  2. Fiat Money:
    • Money that has no intrinsic value but is accepted as legal tender by government decree. Examples include paper currency and coins.
  3. Bank Money:
    • Money in the form of bank deposits, which can be accessed through checks or electronic transfers.
Definition:

Banking refers to the activities conducted by financial institutions (banks) that provide services such as accepting deposits, granting loans, and facilitating payments.

The banking system consists of financial institutions that provide services like accepting deposits, lending, and offering investment products. Banks play a crucial role in the economy by channeling savings into investments, facilitating payments, and supporting credit creation.

Types of Banks
  1. Commercial Banks:
    • These are the most common type of banks that provide a wide range of services, including accepting deposits, offering loans, and facilitating financial transactions. They serve both individuals and businesses.
    • Functions:
      • Accepting deposits: Savings, current, and fixed deposits.
      • Providing loans: Personal loans, home loans, business loans, etc.
      • Credit creation: Commercial banks lend out a portion of deposits, creating new money in the process.
      • Payment services: Facilitating electronic transfers, issuing checks, debit/credit cards.
  2. Central Banks:
    • Central banks are government institutions responsible for regulating the monetary system of a country. They control the money supply, set interest rates, and ensure financial stability.
    • Examples: The U.S. Federal Reserve, Reserve Bank of India (RBI), European Central Bank (ECB).
    • Functions:
      • Monetary policy: Controlling inflation and managing economic growth.
      • Regulation and supervision: Ensuring stability in the banking system.
      • Currency issuance: Issuing national currency.
      • Lender of last resort: Providing emergency funds to commercial banks in times of financial distress.
  3. Investment Banks:
    • Investment banks assist corporations, governments, and other institutions in raising capital, managing investments, and facilitating mergers and acquisitions.
    • Functions:
      • Underwriting: Helping businesses raise funds through stocks and bonds.
      • Mergers and acquisitions: Advising and facilitating corporate mergers.
      • Asset management: Managing investments on behalf of clients.
  4. Cooperative Banks:
    • Cooperative banks are owned and operated by their members, typically focusing on providing financial services to specific groups, like farmers, small businesses, or low-income individuals.
    • Functions:
      • Microfinance: Providing small loans to individuals who may not have access to traditional banking.
      • Savings: Encouraging community-based savings programs.
  5. Development Banks:
    • These banks are specialized in providing long-term financing for projects related to infrastructure, industrial development, and other economic sectors.
    • Examples

      : The World Bank, Asian Development Bank (ADB), Industrial Development Bank of India (IDBI).

Role of Commercial Banks
  1. Accepting Deposits:
    • Banks accept deposits from individuals, businesses, and governments, which they keep safe and return to customers when needed.
  2. Providing Loans:
    • Banks lend money to individuals, businesses, and governments for various purposes, such as buying homes, expanding businesses, or funding public projects.
  3. Credit Creation:
    • Through the process of lending, banks create new money. When a bank lends money, it credits the borrower’s account, effectively increasing the money supply.
  4. Payment Services:
    • Banks facilitate transactions between buyers and sellers through checks, electronic transfers, debit/credit cards, and online banking.
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