Money and Banking Dynamics:

Money is the commonly accepted medium of exchange. In economies with multiple individuals, money facilitates market transactions. Money facilitates exchanges by allowing individuals to sell their produce for money, which is then used to purchase necessary commodities. It serves various functions in a modern economy, including the facilitation of exchanges, market transactions, and facilitating the exchange of goods and services.

Money and Banking form an interdependent relationship. Once the money is in circulation, it is mainly the banking sector that gets involved in the transaction process.

How has the role of Money and Banking transformed from a Medium of Exchange to facilitating Cashless Transactions?

• Money as a Medium of Exchange: Money and banking are significant aspects of our daily lives. Money is used in various transactions, such as buying and selling goods and exchanging services, and hence acts as an effective medium of exchange.
  • Example: In a market system, if a shoe manufacturer needs to exchange his shoes in order to buy wheat, a process known as double coincidence of wants has to work. 
    • This requires both parties to agree to sell and buy each other’s commodities. 
    • This happens in a barter system where goods are directly exchanged without the use of money, but transactions in terms of money make it all easier.
  • An Intermediate Step: Money serves as an intermediate step in an economy, Thus eliminating the need for a double coincidence of wants. 
• Convenient Unit of Account: Money acts as a convenient unit of account.
• Example: A certain wristwatch is worth Rs 500, It  means that the wristwatch is exchangeable for 500 units of money, with the rupee serving as the unit of currency in this instance. 
• Determining Relative Costs and Prices: Money helps in calculating the relative cost of an item. 
  • Example: If the price of a pencil is Rs. 2, and the price of a pen is Rs 10, then a pen is worth 10÷2 = 5 pencils. 
•  Determining Value and Comparing Relative Worth: This also helps in calculating the worth of money in relation to other commodities. 
  • Example: A rupee is equivalent to 1÷ 2 = 0.5 pencils or 1÷10 = 0.1 pens in the example above.
• Universal Acceptability: A barter system has limitations, such as difficulty in carrying wealth forward due to perishable items and storage costs. 
  • Money, on the other hand, is not perishable and has lower storage costs and universal acceptability. 
• Store of Value: It can act as a store of value for individuals, but its value must be stable to function effectively. 
  • Other assets like gold, landed property, houses, or bonds can also act as stores of value but may not be easily convertible or universally acceptable. 
• Dynamic in Nature: When commodity prices increase in terms of money, the purchasing power of money decreases, allowing a unit of money to purchase less of any commodity.
• Cashless Nature: Some countries are moving towards a cashless society, where financial transactions are made through digital information. 
  • Example: the Indian government has been investing in reforms like Jan Dhan accounts, Aadhar-enabled payment systems, e-wallets, and National Financial Switch to promote financial inclusion.

Money and Banking: Understanding modern forms of money

Money has served as a medium of exchange, with Indians using grains and cattle since ancient times. Metallic coins like gold, silver, and copper were introduced in the last century.

What roles do Modern Money and Banking play in today’s financial landscape?

• Modern forms of Money: It includes currency — paper notes and coins.
• • It is not made of precious metals like gold, silver, or copper, nor is it everyday use like grain or cattle, but has its own unique use.
• Authorised by the Government: It is accepted as a medium of exchange because the currency is authorised by the government of the country.
  • The Reserve Bank of India issues currency notes on behalf of the central government in India, no other individual or organisation is allowed to issue currency. 
• A Non-rejectable Payment: The law also legalises the use of the rupee as a non-rejectable payment medium in transactions.
  • Hence, the rupee is widely accepted as a medium of exchange in India. 
  • This deep integration of money and banking is a cornerstone of the modern financial system, shaping economic transactions and financial stability.

Relationship between money and banking: Why do people hold money in deposits with banks?

• Money Holding Behavior: People hold money in deposits with banks, as they need only some currency for their daily needs at a certain point in time.
• Withdrawal of Money: People also have the provision to withdraw the money as and when they require it.
• Demand Deposits: Since the deposits in the bank accounts can be withdrawn on demand, these deposits are called demand deposits. 
• A Cheque: It is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued(Refer to Figure ).
  • For payment through cheque, the payer who has an account with the bank, makes out a cheque for a specific amount.
• Essential Features: Demand deposits, along with currency, are widely accepted as a means of payment in the modern economy. 
  • Hence they share essential features of money. 
• The Symbiotic Relationship: The modern forms of money (currency and deposits) are closely linked to the working of the modern banking system.

Cheque

How do Income and Interest Rates influence the demand and supply of money in the Context of Money and Banking?

Factors influencing Money Demand: 

• Determinants of Money Demand: The demand for money is determined by the value of transactions and the quantity of money demanded. 
• Income Impact on Money Demand: As the quantum of transactions depends on income, an increase in income leads to a higher demand for money.
• Interest Rates and Demand for Money: People keep their surplus income in the form of savings in banks. 
  • The amount of money people keep in banks depends on the rate of interest. 
  • The higher rate of interest decreases interest-earning deposits and subsequently decreases the demand for money.

How do money and banking work together in the modern economy?

Money in a modern economy includes cash and bank deposits. These are created by the central bank and commercial banking system. 

Let’s have a look at them in detail. 

• Central Bank: Functions and currency control

• • The Reserve Bank of India, established in 1935, is a crucial institution in the Indian economy. 
  • It performs various functions.
    • Like issuing currency.
    • Controlling the money supply through methods like bank rates and reserve ratios. 
    • It acts as a banker to the government.
    • It is  custodian of foreign exchange reserves. 
  • The central bank’s currency, known as high-powered money or reserve money, serves as a basis for credit creation.
• Role of Commercial Banks in money creation:
• Money-creating System: Commercial banks are essential for the economy’s money-creating system. 
• Differential Interest Rates in Banking: They accept public deposits from depositors and lend to borrowers, with different interest rates for both. 
  • Normally, interest rates for depositors are lower than for borrowers. 
  • This difference between these two interest rates is called the ‘spread’.
• Financial Intermediaries: Commercial banks act as intermediaries between individuals or firms with excess funds and those in need of funds. 
  • They offer interest on deposits and make transactions more convenient and safer. 
• Security and Utility of Demand Deposits: In the modern context, demand deposits make transactions more secure, even without earning interest. 
• Deposit Repayment Assurance: They must ensure they can repay depositors on demand to maintain their survival.
  • To ensure that sufficient funds are available to repay any depositor on demand, banks must balance their lending activities.
  • This ensures that banks can continue to serve their customers and maintain a healthy financial system.