chapter-viii money & banking

7/28/2019 Chapter-VIII Money & Banking

1/18

General Economics 8. 1 Money And Banking.

CHAPTER-VIII

MONEY AND BANKING

Money:Barter refers to the direct exchange of goods and services. In this way, barter system refers

to that system by which one commodity is exchanged for another without use of money.Under this system, an individual produces some goods in greater quantity than what hecould consume, so as to exchange the surplus with another person for something he neededin return. For instance, if one person who has surplus wheat wants cloth and anotherperson having surplus cloth wants wheat. When both the persons meet and exchange theirsurplus goods, such exchange is barter.

Some important problems of barter system are:1. Lack of double coincidence:Double coincidence is the most difficult problem of barter system. In barter system a person

having a surplus of one commodity should be able to find another person. Who not onlywant that commodity, but has something acceptable to offer in exchange. Unless the doublecoincidence of wants on the part of those engaged in the barter is not matched exactly, noexchange will take place.

2.Lack of divisibility:There are certain costly goods, such as horse, cow, table etc. which on be useful as a whole.They will lose their identity and utility is these are cut into small pieces. These commoditiescannot be exchanged in pieces for different things. For example, person A has a horse andhe wants to take shoes from person B and wheat from a different C. He cannot enter intotransaction with A, B, and C, because he cannot cut his horse in pieces.

3.Lack of measure of value.There is no common measure in the barter system. All Commodities do not possess equalvalues. Suppose, a goat is to be exchanged for rice, it is difficult to decide the amount ofrice worth a goat i.e. in what proportion the two goods are to be exchanged. It is alsodifficult to settle the terms of exchange, as there is no common measure in terms of value.

4.People of store of value:Barter system does not provide any method of storing purchasing power. People can storepurchasing power for future by holding stocks of certain commodities to be exchanged forother commodities later. Such holding of stocks of certain commodities is subject to certain

problems like spoilage, cost of storage, depreciation of stock etc.

Meaning of Money:Money may be anything chosen by common consent as a medium of exchange. Other say,anything that performs the functions of money is money. Moneyis what money does. Itis given and received irrespective of the standing of the person who offers it in payment.All commodities are expressed and valued in terms of money. In wider sense, the termmoney includes all medium of exchangegold silver, copper, paper cheques, commercialbills of exchange etc., This definition is too wide. Therefore, some writers offered thenarrow definition that is, anything that is generally accepted as a means of exchange and

that at the same time, acts as a measure and as a store of value.


2/18


Definitions of Money:Money as a concept is defined by various writers in different ways. Some important viewsabout money are as follows:In the words of Prof. Colborn It is the means of valuation and of payment as both theunit of account and the generally acceptable medium of exchange.

Robertson defined money as anything which is widely accepted in payment for goods,or in discharge of other kinds of business obligations.

In the words of G.D. H. Cole, Money is anything that is habitually and widely used as ameans of payments and is generally acceptable in the settlement of debts.

According to Kent, money is anything which is commonly used and generally acceptedas a medium of exchange or as a standard of value.

With the study of above definitions it can be concluded that money is the medium ofexchange, measure of value, store of value and transfer of value.

Money is classified as (i) Fiat Money and (ii) Fiduciary money.Fiat money, also known ascurrency is a legal tender. It has legal power to discharge debts. The creditor cannotrefuse it. Fiduciary money is the demand deposits are the demand deposits of the bank.It is accepted as money on the basis of the trust that their issues command. A person canrefuse to accept bank money (cheque), because there is no guarantee that the cheque willbe honoured.In India, coins and paper money constitute supply and are known togetheras currency.

To modern economists or empiricists, money includes the following functions:1. Currencies and demand deposits of banks2. Financial assets such as bonds, government securities and equity shares3. Time deposits with banksAbove categories of money some economist categories as1. Near money includes as financial assets2. Pure Money includes as cash and chequable with commercial banksIn modern sense, financial assets are also considered as money on the following criteria:1. Stability of the demand function,2. High degree of substitutability, and3. Feasibility of measuring statistical variations.Classification of Money:Money can be classified on the basis of relationship between the value of money as moneyand the value of money a commodity.1.Full-bodied Money2.Representative full bodied Money3.Credit Money

1.Full-bodied Money:The money, whose value as a commodity for non-monetary purposes is as great as itsvalue as money is known as full-bodied money.Gold coins in gold standard, silver coinsin silver standard or gold and silver coins in bimetallic standard were the examples of

full-bodied money. In the metallic standard the precious metal like gold and silver waswasted by the process of gradual depreciation, so full bodied money was replaced byrepresentative full-bodied money.


3/18


2.Representative Full-bodied Money:Instead of actual metallic coins paper money is used. Though its non-monetary value isnegligible but it represents in circulation an amount of money with a commodity valueequal to the value of money. The money which has higher face value than its intrinsicvalue is known as representative Full bodied Money. The paper money is lighter, easy to

carry, convenient to use and also avoids wastage of precious metal as depreciation.

3.Credit Money:The money whose money value is greater than the commodity value of the material fromwhich the money is made is known as credit money. It can be in the forms of token coins,representative token money, circulating promissory notes, issued by central governmentand deposit at banks.

Forms of Credit Money:1.Token coins:Metallic coins of the value of 5 paise, 10 paise, 20 paise Re.1 Rs. 2 and Rs. 5 circulating in the

country are token coins. The value of these coins as money is far above the value of themetal contained in them.

2.Representative token money:It is usually made of paper. It is just like a circulating warehouse receipt for token coins oran equivalent amount of bullion, which is backing it. Here, also the value of money asmoney is greater than the value of money as a commodity or the bullion if it is made ofmetal.

3.Circulating promissory notes issued by central Bank:These are the currency notes issued by Reserve Bank in India. These notes are worth Rs.

1,000, Rs. 500 Rs. 100, Rs. 50 Rs. 20 Rs. 10 Rs. 5 and Rs. 2. On these notes we find. I promiseto pay the bearer the sum of Rs written and signed by the Governor, Reserve Bank ofIndia. These notes are simply circulating promissory notes signed by governor, ReserveBank of India.

4.Deposits at banks:Deposits are claims of creditors (depositors) against bank. These deposits can be transferredfrom one person to another through the cheques.

Indian Monetary System:We have adopted at present managed paper currency standard with a minimum reserve

system of note issue in India. The legal money, in which the government discharges itsobligations, is known as standard money. India is on paper currency standard becauseIndias monetary authority, the Reserve Bank of India has adopted standard currency madeof paper.Paper currency in India is unlimited legal tender, it means that it can be used to makepayments and settle debts upto an unlimited amount. Light and cheap metal coins are alsoused to facilitate small payments. These coins are limited legal tender, because these coinscan be accepted in limited quantity.Reserve Bank of India has the sole responsibility to issue currency notes except Re. 1note and coins, which are issued by Ministry of Finance, Government of India. This

authority has been granted to the government by Indian Coinage Act. The circulation ofthese coins is made by Reserve Bank of India.


4/18


The special feature of Indian Monetary System is that it has adopted Minimum ReserveSystem. Paper Currency is not convertible into precious metal (gold) that is backing it.Thus, currency is said to be inconvertible.

Functions of Money:

Money plays a very important role in an economy due to its various functions. Thefollowing the various functions of money. The functions of money can be studied under thefollowing headings:1) Primary Functions,2) Secondary Functions3) Contingent Functions.In a static sense, money serves:1) Primary Functions of money:

1. Medium of exchange:

Money as a medium of exchange or medium of payments is used in the sale and purchaseof goods and services. Anyone can get commodities in exchange of money. It means thatwe can get goods and services in exchange of money available with us. In this way, moneyremoved the problem of double coincidence of wants, faced in the Barter System and thusreduced time and energy in the transaction. Money is also called as bearer of options orgeneralized, purchasing power. The money in this way offer freedom of choice. Its ownercan use it at the article, place and the way he likes.

2. Measure or Unit of value:Money measures value of goods and services of facilitate sales and purchases of goods andservices. The value of each good and service is expressed as a price, which is the number of

monetary units for which the goods and services can be exchanged. Measure value ofgoods and services in terms of money simplifies accounting as all items are recording in thebooks of accounting in terms of monetary value. Money is defined as the purchasingpower, which increase or decreases with the money supply. The more is the supply ofmoney, the lesser will be its value. Rs. 40 per kg, Rs. 20 a dozen, Rs. 15 per litre etc.represent measure of value.

2) Secondary Functions of money:

1. Store of value:Money serves as a store of value (i.e. wealth in liquid form).In modern world, people want

to have some currency notes or coin in their pocket, home, bank account etc. to use anytime for the purchase of anything. It is possible only with the help of money. We can storevalue in the form of generalized purchasing power and can use the moment, we like.

2. Standard for deferred payments:Money is also helpful in payment for goods and services after a lapse of time. It means thatwith the help of money, people can buy and sell goods and services only on commitmentand payment can be made in the form of installments, loans, etc., are the examples ofdeferred payments.

3. Transfer of value:

Sale and purchase of movable and immovable property can also be made with the help ofmoney. In simple words, value available with a person in the form of assets can betransferred to another person. Now, it is also possible to sell goods and services at one


5/18


place, realize the proceeds in money and purchase the other necessary goods and servicesat other place from this money.

3) Contingent Functions of money:1. Basis of credit:

The progress of business activity is fully linked with the credit system of the country. Theentire strength of the credit system is based upon money. It is the changes in the quantityof money that brings about the changes in supply of credit in the country. Money supplyaffects the credit system of the country.

2. Liquidity:Money is the most liquid asset which can be converted into other assets quickly. Money isalso helpful to avail of the opportunity of investment into business by which an investorcan get good amount of profit.

3. Maximum Utilization of resources:

Money is a common rod of measurement. It helps the producers in measuring the value oftheir products also. In this way, both in the field of consumption and production, the bestuse of resources is possible in accordance with law if substitution.

4. Guarantor of Solvency:Money is the guarantor of solvency of a person. If a person is able to pay his debt, he willbe called solvent. On the other hand, if a person fails to honour its obligations, he will becalled as insolvent or bankrupt.

5. Distribution of national income:Money is helpful in measuring the contribution of national income of various parts of thecountry. In this way, we can assess the distribution of national income of various parts ofthe country. In this way, we can assess the distribution of national income among thepeople through money.

Importance or Significance or Need of Money:Money is the lubricant of an economy. Without money economic activities such asproduction consumption, capital formation (investment) cannot be performed. This showsthat money is the life blood of an economy. Important of money can be studied as follows:

1. Importance of money in consumption:As we know that money is the medium of exchange. So, we can exchange money with anycommodity and services at any time and can satisfy our wants.

2. Importance of money in trade:With the help of money, trading process becomes easy. Money can be given in the exchangeof goods and received against the sale of goods. So, money is also helpful in the process oftrading.3. Importance of money in budgeting:Government revenue and expenditures can be measured in terms of money. Economicpolicies of tax and interest on loan are also formulated on the basis of money. Budgets arealso prepared and presented in money.

4. Importance of money to measure national income:National income of the country is calculated in terms of money which shows the standardof living of people. Without money measurement of national income cannot be done.


6/18


5. Importance of money is production:In production process entrepreneur has to compensate all factors of production for theircontribution for which he pays rent to land, wages to labour, interest to capital and profit toenterprise. Without money we cannot assess the exact compensation of factors ofproduction.

In dynamic sense, money serves:1. Directs economic trends:Money directs idle resources into productive channels and thereby, affects output,employment, consumption and consumption and consequently economic welfare of thecommunity at large.

2. As encouragement to division of labour:In a money economy, different people tend to specialize in the different goods and throughthe marketing process; these goods are bought and sold for the satisfaction of multiplewants. In this way, occupational specialization and division of labour are encouraged by

the use of money.

3. Smoothens the transformation of savings into investments:In a modern economy, savings done by households and firms invest. Financial institutionsand banks help in mobilizations of saving into investment with the help of money. Moneyso borrowed by the investors when used for buying raw materials, labour, factory.

Money Supply:Money supply or supply of money means total amount of money available in aneconomy. In other words, Money supply refers to the volume of money held by the

people in the country for transactions or for settlement of debts. In an economy,production consumption and capital formation (i.e. investment) are the continuing process.These transactions (i.e. sale and purchase of goods and services) depend upon money. Thebuyer gives money to shopkeeper for getting goods to satisfy his wants and shopkeeperuses this money to purchase other goods which are required by him. In this process oftransaction, amount of money is the economy remains stables with the flow of money fromone hand to another hand. Therefore, the supply of money of a country at any point of timeis the total amount of money is circulation or in existence.

Definitions of money supply:According to Gurby and Shaw money supply includes supply of money plus deposits of

the banks, building societies, loan associations and deposits of other credit and financialinstitutions. In real practice the deposits of non-bank financial institutions are notincluded in the definitions of supply of money.

According to Keynes, Money to be supplied is defined as the currency with the publicand demand deposits with the commercial banks. Demand deposits are current accountof the depositors. Depositors can withdraw this amount through cheque at any time.Demand deposits with the commercial banks plus currency with the public are togetherdenoted as M1 and the supply of money.

Milton Friedman defines the money supply at any time refers to literally the number ofdollars (currency units) people are carrying around in their credit at banks in the form of

demand deposits and also commercial bank time deposits.

Factors Determining or Affecting or Influencing money supply:


7/18


Modernization increases the money supply for the satisfaction of production andconsumption needs, because people want more money to fulfill their increasing needs andwants. Following factors are also responsible for change in money supply.

1. Central bank:Central bank is the first determinant of supply of money, because central bank is

responsibilities to issue currency notes in the country. So, it may increase or decreasesupply of money.

2. Commercial bank:Commercial bank of a country also affects the money supply. Amount deposited by thepublic may or may not be tended by the commercial banks. If commercial banks keep moreamount within the bank, the supply of money will be less and vice-versa.

3. Government:Government is also responsible to make change in money supply, because governmentdecrease money supply with the increase in public revenue charged in the form of taxes

under its fiscal policy. On the other hand, if government increases its expenditure byproviding more salary to its employees, the money supply will increase.

4. Volume of trade:Volume of trade (i.e. volume of sale and purchase of goods and services) also affects themoney supply. An increase in the volume of trade necessitates a large of money and vice-versa.

5. Balance of payment:The change in the foreign assets also changes the money supply. The foreign exchanges areavailable in the country to pay for imports. This will increase the money supply in the

country. In order to meet this adverse balance of payment, the country will have to disposeoff some of its foreign assets. There will be less money supply in the country.

6. Velocity of circulation of money:If the velocity of circulation of money increase, the money supply also increase and thedecrease in velocity of circulation of money decrease the money supply.

7. High price level:A high level price level of goods and services necessitates a larger supply of money ofrecover payment of goods and services. If the price level of commodities is lower, supplyof money will also be less due to fewer requirements.

8. Distribution of national income:If the distribution of national income will be unequal (i.e. high gap between have and havenot) money supply requirement will be more and vice-versa.

9. Banking habits of people:This influences the currency component of money supply. Whether the currencycomponent of money will be high or low depends upon the banking habits of the publicpeople would prefer to conduct the transactions through cheques rather than coins andnotes. Thus, we find that the supply of money varies directly with the changes in themonetary base and inversely with the currency and required reserve ratio.

10.Amount of demand deposits:


8/18


Demand deposits mean the things available in place of money as a medium of exchange.High availability of demand deposits decreases the money supply and less availability ofdemand deposits increases the money supply.

Measurement of Money supply or money stock Measures:

In 1979, the RBI classified money stock in India in the following four categories.M1 = Currency with the public i.e., coins and currency notes + Demand deposits of thepublic known as narrow money.M2 = M1 + Post office saving depositsM3 = M1 + Time deposits of the public with banks called broad money.M4 = M3 + total post office depositsThe basic distinction between narrow money (M1) and broad money (M3) is the treatmentof time deposits with banks. In the present context, total Money stock in India refers to M3only.The RBI working group has now redefined its parameters for measuring money supply.

M1 = Currency + Demand deposits + Other deposits with RBI.M2 = M1 + Time liabilities portion of saving deposits with banks + Certificates of depositsIssued by banks + Term deposits maturing within a year excluding FCNR (B) Deposits.M3 = M2 + Term deposits with banks with maturity over one year + call /term borrowingsof the banking system.M4 has been excluded from the scheme of monetary aggregates.

Commercial Banks:Commercial Banks: A commercial bank is an institution that operates for profit. It acceptsdeposits from the general public and extends loans to the households, firms and thegovernment. Though borrowing and lending constitute the main business of banks,Commercial banks perform a variety of functions. Examples of commercial banks arePunjab National Bank and State Bank of India.

Role of commercial banks:1. Encourage the saving and capital formation:The economic development depends upon the rate of savings. Banks offer facilities forkeeping savings and thus encourage the habits of savings in the society.

2. Mobilization of savings:Banks encourage savings and mobilize savings into productive investments. Without banksthese savings would have remained idle and would not have been utilized for productiveand investment purpose.

3. Optimum utilization of savings:After nationalization, commercial banks also allocate resources in the way that maximizeproduction or social welfare, such as agriculture, small-scale industries (SSI) and weakersections of the society.

4. Increase the rate of investment and credit creation:By encouraging savings and mobilizing them from public, banks help to increase theaggregate rate of investment in the economy. Banks also create deposits or credit, whichserve as money.

Functions of commercial Banks:


9/18


The functions of a bank can be summarized as follows:1. Receipt of deposits:The most important function of a bank is to accept deposits from the public (individual,firms and institutions). Such deposits may be different types:a. Demand or current deposits:It includes current deposits and savings deposits. Deposits which are withdrawable ondemand are called demand deposits.b. Time deposits:Deposits withdrawable after the expiry offixed time period called fixed deposits.Interest paid by banks is highest for fixed deposits and lowest or even nil for currentdeposits.

2. Lending of money:Banks lend money mainly for industrial and commercial purposes. This lending may takethe different form like a.Cash creditsb.Overdraftsc. Loans and advancesd.Discounting of bills of exchangeInterest charged by banks on such lending varies according to the amount and periodinvolved, social prioritynature of security offered the standing of the borrower etc.

3. Agency Services:A bank renders various services to consumers as an agent, such asa.Collection of bills, promissory notes and chequesb.Collection of dividends, interests, premiums, etc.,c. Purchases and sale of shares and securitiesd.Acting as trustee or executor when so nominatede.Making regular payments such as insurance premiums etc.,

4. General services:A modern bank performs following general services to the public-a. Issue of letters of credit, travelers cheques, bank drafts, circular notesb. Safe keeping of valuables in safe deposit vaults (Lockers)c. Supplying trade information and statisticsd. Conducting economic surveyse. Preparation of feasibility studies, project reports etc.,f. Underwriting of shares and make loans for long-term purposesCauses of Nationalisation of commercial Banks:Government announced the nationalization of 14 major commercial banks with effect from

July 1969. 6 more banks were nationalized in 1980. Two banks were merged in 1993, so atpresent there are 19 nationalized banks. The following factors were responsible fornationalization of commercial banks in India.1. To remove private ownership of commercial banks and concentration of economic

power:At the time of independence, one or more business houses controlled all major banks. Thus,

private ownership of banks resulted in concentration of income and wealth in few hands.To remove the private ownerships and concentration of economic power nationalisationwas compulsory.


10/18


2. Urban-bias:Prior to nationalization, many commercial banks were in urban areas. But afternationalization more and more branches were opened in semi-urban and rural areas. Thisurban biased nature of commercial banks led to slow rate of growth in the rural areas.

3. Neglect of agriculture sector:There was a total neglect of the agricultural sector and its finance prior to nationalization ofbanks. The banks increasingly advanced finances to commerce and industry 70% in 1951 to87% in 1968. Agriculture accounted only 2.2% of the total advances.

4. Violation of norms:Commercial banks often violated the norms and priorities laid down in the plans andgranted loans to even those industries, which figured nowhere in the priority list.

5. Speculative activities:Private commercial banks earned large profits and indulged in speculative activities. They

have given advances to hoarders and black marketers against high rates of interest.

6. Neglect of priority sectors:There was a complete neglect of agricultural sector, export and small-scale industries etc.In order to discipline the commercial banks so that they do not over look the nationalpriorities, nationalization of banks was undertaken first in 1969 and then in 1980.

Objectives of nationalisation:Objectives of nationalization were as follows: -1.Removal of control by a few hands.2.Provision of adequate credit for agriculture and small industry and export.3.Giving a professional bent to management.4.Encouragement of a new class of entrepreneurs and5.The provision of adequate training as well as terms of services for banks staff.

Nationalization Phase I:The Imperial bank of India was rechristened as State Bank of India and it was nationalizedin the ear 1955. The All-India Rural Credit Survey Committee recommended the merger ofthe State Associated Banks with the State Bank of India as its subsidiaries, so that the StateBank of India Group (i.e. the State Bank of India and the State Associated Banks) couldbecome strong enough to carry out the social banking task successfully, In accordance with

the recommendation of this Committee, the State Bank of India (Subsidiary Bank) Act waspassed in September, 1959 for the merger of the following ten State Associated Banks werenamely;1. The State Bank of Indore, Indore.2. The State Bank of Patiala, Patiala.3. The State Bank of Rajasthan.4. The State Bank of Bikaner, Bikaner.5. The State Bank of Jaipur, Jaipur6. The State Bank of Saurashtra, Bavanagar.7. The State Bank of Travancore, Tiruvanthapuram8. The State Banks of Hyderabad, Hyderabad.9. The State Bank of Mysore, Bangalore.10.The State Bank of Baroda, Vododara.


11/18


In the course of the merger, the State Bank of Baroda and the State Bank of Rajasthan werewould up so that only 8 state associated banks were merged with the State Bank of India asits subsidiaries. Of these 8 subsidiary banks, the State Bank of Bikaner and the State Bankof Jaipur were merged with each other and became one bank. So today, there are onlyseven state associated banks, which are connected with the State Bank of India as its

subsidiaries/ the seven subsidiary banks of the State Bank of India are namely:1.The State Bank of Bikaner and Jaipur.2.The State Bank of Patiala.3.The State Bank of Indore.4.The State Bank of Saurashtra5.The State Bank of Hyderabad.6.The State Bank of Mysore7.The State Bank of Travancore.

Nationalization phase II:

The Government of India nationalized 14 major Indian banks in the private sector havingdeposits of Rs. 50 Crores and over each as on the last Friday on June 1969 with effect from19th July 1969. By nationalizing the major banks, the Government secured control overwhat Mrs. Indira Gandhi described as the commanding nation on July 19 were toexpand bank credit to priority areas which have hitherto been somewhat neglectedremoval of control by a few, provision of a adequate credit for agriculture and smallindustry and export; giving a professional bent to management; encouragement of newclasses of entrepreneurs; and the provision of adequate training as well as terms of servicefor bank staff still remain and well call for continuous efforts over a long time.Nationalization is necessary for the speedy achievement of these objectives.

The 14 banks which were nationalized on 19-7-1969 are listed in table below:Name of Bank of India LtdNationalization

Date ofEstablishment

AfterNationalization

The Central Bank of India Ltd 21-12-1911 The Central Bank if India

The Bank of India Ltd 07-09-1906 The Bank of India

The Punjab National Bank Ltd 19-05-1894 The Punjab National Bank

The Bank of Baroda Ltd 20-07-1908 The Bank of BarodaThe United Commercial Bank Ltd 06-01-1943 The United Commercial Bank

The Canara Bank 01-0701906 The Canara Bank

The United Bank of India Ltd 12-10-1950 The United Bank of India

The Dena Bank Ltd 26-05-1938 The Dena Bank

The Union Bank of India Ltd 11-11-1919 The Union Bank of IndiaThe Allahabad Bank Ltd 17-04-1865 The Allahabad Bank

The Syndicate Bank Ltd 20-10-1925 The Syndicate Bank

The Indian Overseas Bank Ltd 20-11-1936 The Indian Overseas Bank

The Indian Bank Ltd 05-03-1907 The Indian BankThe Bank of Maharashtra Ltd. 16-09-1935 The Bank of Maharashtra

Nationalization phase IIIAgain, on 15th April 1980, six more banks, whose demand and time liabilities exceed Rs. 200Crores as on 14th March 1980.were nationalized.

The Six banks which were nationalized on 15-04-1980 are listed in table below:Name of Bank selected forNationalization & place of Established

Date ofEstablishment

ExistingName


12/18


The Andhra Bank Ltd., Hyderabad 20-11-1923 The Andhra Bank

The Corporation Bank Ltd., Udupi 28-05-1906 The Corporation Bank

The New Bank of India Ltd., NewDelhi

21-12-1936 The New Bank of India

The Oriental Bank of Commerce Ltd.,New Delhi

19-02-1943 The Oriental Bank ofCommerce

The Punjab and Sindh Bank Ltd.,Amritsar

24-06-1908 The Punjab and SindhBank

The Vijaya Bank Ltd., Mangalore 02-05-1931 The vijaya Bank Ltd.

On 4th September, 1993 the Government merged the New Bank of India withPunjab National Bank and as a result of this the total number of nationalizedbanks got reduced to from 20 to 19.

Progress of commercial Banks after Nationalisation (1969-2006):After the nationalization of 14 banks in 1969 and 6 banks in 1982 following developmenthave taken place

1. Expansion of branches:There has been a remarkable expansion of branches since nationalization. Compared to just8262 branch offices in 1969, the number of branches in 2005 has increased to 68500. As aresult, the population per bank office has reduced from 55,000 in 1969 to 16,000 in 2006.

2. Branch opening in rural and unbanked areas:Before nationalization, there was a clear urban bias in the operations of banks. But afternationalization they have started moving towards rural and semi urban areas. Compared to

just 22% in 1969bank branches in rural areas, has increased about 44% in June 2006.

3. Deposit mobilization:

There has been a substantial rise in the rate of deposit mobilization since nationalization.The aggregate deposits of commercial banks have increased from Rs.4,665 crore in 1969 toaround Rs.23,50,000 Crores in Dec 2006 forming almost 50% of the national income. Instate-wise deposit mobilization, Maharashtra leads all other states and accounts for morethan 1/5th of the aggregate deposits received by the banks. The states Delhi, U.P WestBengal Tamil Nadu, Karnataka and A.P account for 65% of the aggregate deposits.

4. Bank lending:There has been a great rise in the bank lending since nationalisation. It has gone up fromRs.3399 crore in June 1969 to more than Rs. 10,93,000 Crores in June 2006. The banks have

taken special care of the priority sectors like agriculture, small scale industries and smallretail trade accounted for about 15% of the commercial banks credit. This percentage hasgone up to about 37.5% in March, 2006.

5. Promotion of new entrepreneurship:Banks also promote entrepreneurship with the schemes such as IRDP, TRYSEM, JRY, NRY

etc.

Shortcoming of commercial Banking in India:The main drawbacks of commercial banking are as follows:1. Insufficient branches:


13/18


The growth of branches in numerical terms is insufficient in India. This is specially so withregard to rural areas having less than 45% (exactly 44%) of the bank branches but 70%(69.3%) of the population residing there.

2. Regional imbalance:Only few states have well developed banking facilities. Assam, Bihar, Arunachal Pradeshand Madhya Pradesh, on an average have lesser number of banks compared to other states.Even from the states which are well banked like Maharashtra, West Bengal and Tamilnadu,if big metropolitan cities are excluded the population per excluded the population per bankoffice is larger than the average for these states.

3. Increasing overdues:As a result of increasing loans and advances to unemployed and weaker section, the

commercial banks are facing the problem of bad debts, doubtful debts and overdues calledNon Performing Assets (NPA). NPA were more than Rs. 45,000 Crores in 1997-98, Rs.70,000 Crores in 2001-02 and Rs. 51,000 Crores in 2005-06. As a percentage of gross

advances, they have fallen from 16% to 10.5% and further to 305% over the above period.

4. Lower efficiency:The quality of services rendered has deteriorated. This has happened because of staffindiscipline and absence of the system of accountability, problem of effective managementand control. This has hampered the overall efficiency of the commercial banks.

5. Declining trends in profitability:The absolute profits of the banks are rising but the profitability ratio has been declining.Factors for declining trends in profitability are1. Lower interest on Government borrowings from banks.2. Subsidization of credit to priority sector.3. Directed credit programmes of the Govt.4. Lack of competition5. Increasing expenditure-overstaffing and mushrooming of branches

Profitability are declining due to increasing of non-performing assets (NPA), RBI has takensome steps to reduce NPAs. These include debt restructuring and recovery through LokAdalats, civil courts and debt recovery tribunals.

6. Professional bent to management:The public sector banks have lack-expertise in merchant banking and agricultural financingareas. There is a need for professional touch in these areas.

Important role of commercial banks after nationalization:To sum up, although after nationalization the commercial banks have played an importantrole in achieving national goals of the economy yet there is a need for:1. Spreading their activities to the untouched remote areas.2. Keeping up their profitability.3. Looking after the growing needs of the priority sectors.4. Improving the performance of rural/semi-urban branches.5. Improving the quality of loan portfolio.

The Reserve Bank of IndiaMeaning of the Reserve Bank of India:


14/18


Reserve bank of India was set up in the year1935 as the shareholders bank. RBI was nationalized in

January 1949.The Reserve Bank of India (RBI) is the Central Bank of the country and itperforms all the central banking functions.

The central bank is the organ of government that undertakes the major financialinstitutions so as to support the economic policy of the government (Sayers).

A central bank is to help control and stabilize the monetary and banking system. Acentral bank is a bank of bankers. Its duty is to control the monetary base and control ofthis high powered money to control the communitys supply of money (Samuelson).A Central Bank is one which constitutes the apex of the monetary and banking structure of

the country and which performs, in the national economic interest, the following functions:

1. Issue of Currency:The RBI is the sole authority for the issue of currency in India other than one rupee coinsand notes and subsidiary coins, the magnitude of which is relative small. The RBI is alsocalled bank of issue.

2. Banker to the government:As a banker to the central and State Governments, the RBI performs the followingfunctions.1.It transacts all the banking business. It accepts money, makes payment and also carries

out their exchange and remittances.2.It manages public debt, advises the government on the quantum, timing and terms of

new loans.3.It also sells Treasury Bills to maintain liquidity in the economy4.It makes advances which are repayable within 90 days5.The RBI is the fiscal agent and adviser to the government in monetary and financial

matters in India. It has a special responsibility in respect of financial policies andmeasures concerning new loans, agricultural finance and legislation affecting bankingand credit and international finance

3. Bankers Bank:The RBI has extensive power to control and supervise commercial banking system underthe RBI Act, 1934 and the banking Regulation Act, 1949 the scheduled banks are required tomaintain a minimum of cash reserve ratio (CRR) with RBI. RBI controls the credit positionof the country. The RBI provides financial assistance to scheduled banks and statecooperative banks. The RBI also conducts inspection of the commercial banks and calls for

returns and other necessary information from banks.4. Customs of Foreign Exchange Reserves:The RBI is the custodian of monetary reserve in India and RBI also is the custodian ofnational reserve of international currency. It has to ensure that normal short-termfluctuations do not affect the exchange rate. When foreign exchange reserves areinadequate for meeting balance of payments problem, it borrows from the IMF. The RBI hasthe authority to enter into exchange transactions on its own account and on account ofgovernment. It also administers exchange control of the country and enforces the provisionof Foreign Exchange Management Act.

5. Controller of Credit:Credit control is generally considered to be the principal function of a central bank. Bymaking frequent changes in monetary policy, it ensures that the monetary system in the


15/18


economy functions according to the nations needs and goals. The RBI uses almost allquantitative and qualitative methods of credit controls.

6. Lender of the last resort:RBI is the official lender of the last resort. Lender of the last resort means Central Bankcoming to the rescue of other banks in times of financial crises. Financial crises might arisedue to improvement in lending operation and due to depression in the economy.

7. Central clearance, settlement and transfer of money:Central bank has a special position for conducting clearinghouse operations, inter-banktransfer of funds and settlement of accounts. Central bank also give facility for transfer ofmoney at free of charge.

8. Promotional functions:RBI also performs a variety of developmental and promotional functions. It is responsiblefor promoting banking habits among people, mobilizing savings, development of thebanking system, and provision of finance for agriculture, foreign trade and small-scaleindustries. But now these functions have been handed over to NABARD, EXIM Bank andSIDBI (State Industrial Development Bank of India) respectively.

9. Collection and publication of Data:It has also been entrusted with the task of collection and compilation of statisticalinformation relating to banking and other financial sectors of the economy.

10.Others:The RBI is responsible for overall monetary policy in India like monetary stability, stabilityof domestic price levels, maintenance of the international value of the nations currency etc.,

Role of Reserve Bank of India:The Reserve bank of India (RBI) occupies a very important position in the Indian economy.Its role is summarized in the following points:1. The RBI is the apex monetary institution of the highest authority in India. It plays an

important role in strengthening, developing and diversifying the countrys economicand financial structure.

2. It is responsible for the maintenance of economic stability and assisting the growth ofthe economy.

3. It is Indias prominent public financial institution given the responsibility for controllingthe countrys monetary policy.

4. It acts as an advisor to the government in its economic and financial policies, and its alsorepresents the country in the international economic forums.

5. It also acts as a friend, philosopher and guide to commercial banks. In fact, it isresponsible for the development of an adequate and sound-banking system in thecountry and for the growth of organized money and capital markets.

6. India being a developing country, the RBI has to keep inflationary trends under controland to see that main priority sectors like agriculture; exports and small-scale industryget credit at cheap rates.

7. It also has to protect the market for government securities and channelise credit indesired direction.


16/18


Difference between Commercial and Central Bank:The following difference found between central bank and commercial banks.

S.No Commercial Bank Central Bank1 It is profit-seeking institutions Its objective is not to make profit

2 It allows interest on deposits from

public

It does not allow interest on deposits from public

3 Its profits mainly from loans andadvances

Its profits mainly from Govt., securities, Loans andfrom public. Advances to Govt. and Commercialbanks

4 Commercial banks have largelypublic dealing

Central banks deals with Govt., Central and StateBank and other financial institution

5 It is part of State It is organ of the State

6 Banks mobilize savings andchannelise them into investments

Central Banks role is to ensure that the others bankproper use conduct their business in nationaleconomic interest

7 Functions of commercial banks

are different

Function of central banks are unique

Indian Monetary Policy:Monetary policy is the one employed by the State through its Central Bank, to control thesupply of money as an instrument of achieving the objectives of general economic policy.

Objectives of monetary policy are:(a)To regulate monetary growth and maintain price stability(b)To ensure adequate expansion in credit(c) To assist economic growth(d)

To encourage the flow of credit into priority and neglected sectors

(e)To strengthen the banking systemInstruments of credit control There are two types of instruments

Quantitative or general measures It influence the total volume of credit

Qualitative or selective measures It influencethe selective or particular sue of credit

(a)Bank Rate Policy(b)Open Market Operations(c)Variable Reserve Requirements

(i) Cash Reserve Ratio (CRR)(ii) Statutory Liquidity ratio (SLR)

(a)Margin requirements(b)Consumer credit regulation(c) Issue of directive(d)Rationing of credit(e)Moral Suasion(f) Direct Action

1. Quantitative or General Measures:It is used for changing the total volume of credit in the economy. Quantitative Controlsaffect indiscriminately (similarly) all sectors of the economy. Quantitative measure consistsof the following:

1. Bank Rate Policy:The Bank Rate is the official interest rate at which the Central Bank rediscounts theapproved bills held by a commercial bank. If Central Bank wish to control credit and

inflation and wishes to discourage investment at that time, it will increase the bank rate.If Central Bank wish to control deflation or wishes to boost production and investment atthat time, it will decrease the bank rate. At present, bank rate is % (in April 2009).


17/18


2. Open market operations (OMO):OMO imply deliberate and direct sales and purchases of securities and bills in the openmarket by the Central Bank to control the volume of credit. If it wishes to control credit andinflation, then Central Bank sells securities in the open market. If Central Bank wishesexpansion of credit at the time of deflation, then it purchases the securities.

3. Variable reserve requirements:The Central Bank also uses the method of variable reserve requirements to control credit.There are two types of reserves, which the commercial banks are generally required tomaintain:1.Cash Reserve Ratio (CRR)2.Statutory Liquidity Ratio (SLR)Cash Reserve Ratio refers to that portion of total deposits, which a commercial bank has tokeep with RBI in the form of cash reserves.

Statutory Liquidity Ratio refers to that portion of total of deposits of a commercial bank,

which it has to keep with itself in the form of liquid assets.If Central Bank wishes to control credit or discourage credit, it should increase CRR & SLRIf it wants to encourage credit, it should decrease CRR & SLR. At present, CRR % andSLR is % for entire demand and time liabilities.

Conclusions:During inflation, to control inflation and to discourage investment it is advisable to1. Increase the bank rate.2. Sale of securities in the open market.3. Increase the CRR and SLR.During deflation, to control deflation and to encourage investment, it is advisable to1. Decrease the bank rate.2. Buying of securities in open market.3. Decrease the CRR and SLR.But effect of increase in CRR or SLR will be reduced or nullified if Bank rate is reduced; soall things should be in the same direction.

2. Qualitative or selective measures:It regulates credit for specific purposes. The Central Bank generally use the following formsof credit control -1.Margin requirements:A margin requirement is the difference between securities offered and amount borrowedfrom banks. Increase in margin reduces the borrowing capacity and decrease the marginincrease the borrowing capacity. To control credit in selective areas, bank should increasethe margin requirements and vice versa.

2.Consumer credit regulation:The regulation of consumer credit consists of laying down rules regarding downpayments and maximum maturities of installment credit for the purchase of specifiedconsumer durable goods. Raising the required down payment limits and shortening ofmaximum period tend to reduce the demand for such loans and thereby check consumercredit.


18/18

3.Issue of directives:The Central Bank also uses directives in the form of oral, written statements, appeals, orwarnings, to various commercial banks for credit control.

4.Rationing of credit:Rationing of credit is a selective method adopted by the Central Bank for controlling andregulating the purpose for which credit is granted or allocated by commercial banks.

5.Moral Suasion:Moral suasion is a psychological means and purely informal and milder form of selectivecredit control. In moral suasion central bank persuades and morally requires to thecommercial banks to co-operate with the general monetary policy of credit control.

6.Direct Action:The Central Bank may take direct action against the erring commercial banks. It mayrefuse to rediscount their papers, and give excess credit, or it may charge a penal rate ofinterest over and above the Bank Rate, for the credit demanded beyond a prescribed limitBy making frequent changes in monetary policy, The Central Bank ensures that themonetary system in the economy functions in the national economic interest.

chapter-viii money & banking

Documents