BCom Money and Finance in India Notes Study Material

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BCom Money and Finance in India Notes Study Material

MEANING OF MONEY

Money is a commodity accepted by general consent as a medium of exchange. It is the medium in which prices and values are expressed. It circulates from person to person and from country to country for purchases and sales of goods and services and facilitates trade. It is considered the basis of all economic activities. (BCom Money and Finance in India Notes Study Material)

Different Economists have defined money in their own way.

According to Walker, “Money is what money does.”

“Money is something that possesses general acceptability.” -Saligman

“Money is anything that is generally accepted as a means of exchange and at the same time act as a measure and store of money.” -Crowther

Crowther’s definition may be considered better as it includes both the aspects of money i.e. general acceptability and all the other important functions of money.

In India, the present monetary system is managed by the Reserve Bank of India. It is based on inconvertible paper currency. For internal purposes, there are rupee coins and currency notes. For external purposes, the rupee is convertible into other currencies of the world.

SUPPLY OF MONEY IN INDIA

Supply of money refers to the stock of money held by people, demand, and time deposits with the commercial banks and deposits with the post offices which draw by depositors through cheques, etc. at any time. Money held by Central Government or treasury, Central Bank and Commercial Banks cannot – be included in the supply of money since it does not come into circulation.

The RBI has adopted four measures of money supply in India. The four concepts of money supply are:

M₁ = Currency with the public + Demand deposits with Banks + Other deposits with the RBI

M₂ = M₁ + Post Office saving deposits

M₃ = M₁ + Time deposits with Banks

M₄ = M₃ + Total Post Office deposits

These are known as ‘Money Stock Measures or measures of monetary aggregates. Out of the four concepts of money. RBI emphasizes only two concepts M₁ and M₃. M₁ is also known as ordinary money or narrow money and M₃ is referred to as broad money or aggregate monetary resources of the people. (BCom Money and Finance in India Notes Study Material)

(i) Narrow Concept of Supply of Money or M1

M₁ consists of currency (currency notes and coins) with the public, demand deposits with banks (commercial and cooperative), and other deposits with The Reserve Bank of India. It bears upon the medium of exchange function of money. Thus, it includes the following constituents:

(a) Currency with the Public (C): The currency components of the money supply are composed of currency notes and coins in circulation but exclude cash held by the bank. Currency money is legal tender money, has general acceptability, and is used in all transactions and settlement of debts. It is also known as ordinary Money. Thus,

Currency with the public (C) = Notes in circulation + Rupees coins + Small coins – Cash with the banks

(b) Demand Deposits with the Bank (DD): It includes demand deposits with all commercial banks and cooperative banks (excluding inter-banking deposits). It can be created in the banks in two ways: (1) Active and (2) Passive. Active deposits are created when people deposit money in banks. These are created by the government or by the RBI. It is also known as “High Powered Money”. Passive deposits come into being when banks create deposits by sanctioning loans. It increases the money supply immediately. Passive deposits are also called, “Credit Creation” by banks. (BCom Money and Finance in India Notes Study Material)

(c) Other Deposits with RBI (OD): RBI has two types of deposits – One is the deposits of the Commercial banks with the RBI and the other is the deposits of certain individuals and institutions with RBI. (BCom Money and Finance in India Notes Study Material)

M₁ = C + DD + OD

(ii) M2 Concept of Money Supply

M₂ is an expansion of M₁ with savings deposits from post office savings banks. It is less liquid as compared to M₁. The reason is that the savings deposits of the post office savings banks are less liquid than demand deposits. However, saving deposits with post offices are more liquid than time deposits with banks.

M₂ = M₁ + Saving deposits with Post Office Saving Banks

(iii) Broader Concept of Money Supply or M₃

The broader concept of money supply (M₃) includes currency with the public, demand deposits with the banks, other deposits with the RBI, and time deposits with banks. Thus,

M₃ = Currency with the Public + Demand deposits with Banks + Other deposits with RBI + Time deposits with Banks

or

M₃ = M₁ + Time deposits with Banks

The M₃ concept of money is still less liquid as compared to M₂ and M₁. The inclusion of time deposits in this concept makes it so. The time deposits are less liquid than even the post office savings bank deposits. In recent years M₃ has become a popular measure of the money supply.

(iv) M₄ Concept of the Supply of Money

M₄ is an expansion of M₃ with the total deposits with the post office savings organization. It includes M₃ besides total deposits with the post offices. Thus,

M₄ = Currency with Public + Demand deposits with Banks + Other deposits with the RBI + Time deposits with Banks + Total Deposits with Post Office

or

M₄ = M₃ + Total Post Office deposits

RESERVE MONEY OR HIGH-POWERED MONEY

Reserve money is also called base money or high-powered money. It can be called Government money, produced by the RBI, and is held by the public and the banks. It is really the cash held by the public and the banks. Thus

Reserve Money (RM) = Coins and Currency held by the General Public + Other deposits of the General People with RBI + Cash Reserves of Banks (which are composed of cash with banks themselves and banker’s deposits with the RBI).

or

RM = C + OD + CR

FACTORS AFFECTING MONEY SUPPLY

The factors that influence the money supply in the economy emanate from the Government as also from the private sector. We describe these factors necessitating the expansion of money under three principal heads. (BCom Money and Finance in India Notes Study Material)

(i) Deficit Financing: It is a very important factor that affects the money supply in India. This consists of government spending over and above its receipts from such sources as taxes, profits from public enterprises borrowing from the public, etc. These receipts imply withdrawals of money from the people’s money income and do not constitute new money.

In case government wishes to spend more than this, then new money has to be created. In case of such spending or to meet deficits, the government borrows from the RBI by way of loans and advances or by the sale of government securities and treasury bills. The government may also get funds from commercial banks, involving credit creation through the sale of securities. As a result of these operations, the money supply increases. (BCom Money and Finance in India Notes Study Material)

(ii) Bank Credit: The second important factor is the increase in bank credit. This takes place largely to meet the needs of producers and traders in the economy. The production and distribution activities require finance to oil their wheels. They have to directly depend upon banks. Much of their expenditure is to meet the current spending to bridge the gap between the production and the sale of goods in the case of producers or stocking and sale of goods in the case of traders etc. To meet their needs, the banks create credit and this in turn forms part of the money supply.

In India, a large amount of credit has to be required for a large rise in production and trading activities. However, it becomes harmful when these credits get created for illegitimate speculation. (BCom Money and Finance in India Notes Study Material)

(iii) Foreign Exchange Reserves: Another, third factor influencing money supply, is the change in foreign exchange reserves. In case of a country acquires an excess of foreign currency (i.e., when receipts exceed payments), the domestic supply of money expands, as the holders of foreign currency get paid in their own currency in return for the foreign currency which they surrender to the bank. The opposite happens in the case of deficit, (i.e., when receipts of foreign currency). In this case, the money supply gets contracted via those who pay domestic/rupee currency to the bank to get foreign exchange for meeting their obligations.

All this and the country’s foreign exchange earnings, whenever these have exceeded payments, have contributed to the rise in the money supply.

INDIAN FINANCIAL SYSTEM

Meaning

A financial system is an integral part of the Indian economy. The word ‘System’ means an organized framework; an assemblage of facts, principles, or components relating to a particular field and working for a specified purpose.

But the word system in the term ‘financial system’ represents a set of closely held financial institutions, financial services, and financial instruments or claims. The arrangement of financial institutions, markets, and instruments is called the financial system of a country. Hence, the financial system of a country can be defined as a set of organizations, instruments, markets, services, methods of operations, and procedures that are closely interrelated with each other. (BCom Money and Finance in India Notes Study Material)

The financial system can also be explained as a methodical arrangement in the economy that helps to pool the resources from the surplus sectors and redistributes them to the deficit sectors. Some analysts say that a financial system is a group of various units that are continuously engaged in gathering the monetary resources in the economy to allocate them to the needful areas. Each and every entity in the system will address some specific issues and functions meeting the prescribed regulations.

A well-developed financial system indicates a strong economy. If the financial system is efficient the mobilization of savings and the allocation of collected resources will also be efficient. (BCom Money and Finance in India Notes Study Material)

Money, finance, and the credit function are three main components of the financial system of any country. Money is a medium of exchange in the financial system. Finance is the aggregate resources of the economy, which are of monetary nature and include equity and debt funds of an individual company, state, or government. Credit represents the sum of money, which was taken from other economic units as debt and is usually returned with interest. (BCom Money and Finance in India Notes Study Material)

Finally, we can say that the financial system can be described as a collection of markets, institutions, laws, regulations, and techniques through which bonds, stocks, and other securities are traded, interest rates determined and the financial services produced and delivered.

Prerequisites of an Efficient Financial System

The basic requirements for any financial system to be efficient are:

(i) Efficient monetary system,

(ii) Facilities for the creation of the capital, and

(iii) Efficient financial markets.

The first important feature is an efficient monetary system indicates the efficiency of the medium of exchange for goods and services. It is the unit of measurement in the economy. For the exchange function to be effective, there must be a unit of measurement and account for determining the prices. This must be acceptable in the international markets also.

The system should have the facilities to create capital to meet the demands of the economy. The capital will be necessary to undertake the production activities. The financial system helps to meet such demands by mobilizing the savings of the surplus units to the demanding units. The third important feature of a financial system is the developed financial lets and methodologies which facilitate the process of transfer of resources and conversion of financial claims into money.

STRUCTURE OF A FINANCIAL SYSTEM

A financial system consists of a financial institution, financial markets, financial instruments and services, and the rules governing their functioning and interaction with each other. (BCom Money and Finance in India Notes Study Material)

(A) Financial Institutions

These include organizations like banks, finance companies, insurance companies, cooperative societies, and other institutions, which help inculcate the habit of pooling savings in the people. These institutions also provide credit or finance to the constituents of the economy. The financial institution can be classified based on the degree of specialization and the type of activities they are involved in. These financial institutions can be regulatory, non-regulatory, intermediaries, non-intermediaries, and others.

(i) Regulatory Institutions: Regulatory institutions try to ensure the smooth functioning of financial intermediaries, financial markets, and other constitutes of the financial system by imposing prudential norms on them. In India, there is a multiplicity of regulatory and supervisory authorities. With some amount overlapping in the coverage, the financial system is regulated and supervised mainly by two government agencies under the Ministry of Finance, viz. the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) with the help of various acts and policies. (BCom Money and Finance in India Notes Study Material)

Apart from the RBI and the SEBI, there are other institutions that supervise and regulate particular segments of the financial sector. For example, the Insurance Regulation and Development Authority (IRDA) regulates and supervises the working of Insurance companies. The supervision of exchange trading futures with underlying assets as commodities are under the purview of the Forward Market Commission. The Department of Company Affairs (DCA) regulates the working of limited liability firms.

(ii) Financial Intermediaries: Financial intermediaries are the business organizations that act as mobilizers and depositors of savings and as purveyors of credit and financial services. Financial intermediaries can be differentiated from non-financial organizations on the basis of their primary activities. (BCom Money and Finance in India Notes Study Material)

Nonfinancial organizations, such as manufacturing units, are engaged in productive activities. They deal in real assets such as machinery equipment, stocks of goods, real estate, and so on. Whereas financial intermediaries or institutions, in general, are engaged in providing financial services which include other services like exchanging financial assets on behalf of the customers, providing investment advice, creating market opportunities for the issuers, etc. (BCom Money and Finance in India Notes Study Material)

The intermediaries play an important role in stimulating the markets and providing the necessary impetus for their all-around development. They form the crucial link between the issuer of financial claims and the party that assumes the risk. Financial intermediaries are institutions that assist both sides of the market by providing a host of services to facilitate financial transactions.

The various services provided by the financial intermediaries include providing assistance in evaluating investment proposals, offering diversified investments in a large number of projects for their investors or clients and monitoring such projects on an ongoing basis, helping businesses in raising finances by structuring a variety of instruments providing consultancy and customized services, etc.

Financial intermediaries can be classified into two types namely, depository institutions and non-depository institutions. Depository institutions mainly include commercial banks, saving and loan institutions (S & Ls), and credit unions. The depositories play a crucial role in channelizing savings into the economy and thereby provide scope for the economic growth of the country. They also play a key role in transmitting the monetary policy to the financial markets, borrowers, and depositors and ultimately to the real economy.

Non-depository institutions include finance companies, mutual funds, security firms, investment bankers, pension funds, and insurance companies. (BCom Money and Finance in India Notes Study Material)

(iii) Other Financial Institutions: Apart from financial intermediaries, a financial system may consist of various other financial institutions providing a variety of financial services. Examples of such intermediaries are venture capital, which provides startup capital for new firms, and merchant banks, which help in international trade finance and provide business advisory services.

(B) Financial Markets

Financial markets are the vehicle through which financial intermediaries deal with financial borrowers and lenders. Financial markets are the centers or arrangements that provide facilities for buying and selling of financial instruments, such as shares, debentures, credit, and financial services. The corporations, financial institutions, individuals, and government trade in financial products in these markets either directly or through brokers and dealers on organized exchanges or off-exchanges.

The participants in these markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers, and others. All these participants are interlinked by the laws, contracts, and communication networks. (BCom Money and Finance in India Notes Study Material)

The financial market can be classified into two categories i.e., money markets and capital markets are based on the differences in the period of maturity of financial assets issued in these markets. (BCom Money and Finance in India Notes Study Material)

(i) Money Market: The money market is a center for dealings in financial instruments or assets of short-term nature which have an initial maturity period of less than one year. Because of their short maturity period, they are highly liquid. Therefore, they compete closely with monetary assets (i.e. cash and deposits) which are the most liquid assets in the portfolio of households and other commercial units.

The money market provides a platform for meeting these surplus units that want to depart funds only for a short duration with those deficit units that want funds only for working capital or any other short-term requirements. Thus, this market provides an avenue for equilibrating the supply of and demand for short-term funds. (BCom Money and Finance in India Notes Study Material)

Objectives of Money Market: The following are the main objectives of a money market:

(a) To provide an outlet to lenders and a source of supply to borrowers to employ short-term funds.

(b) To provide a boost for overcoming short-term deficits.

(c) To enable the Central Bank to influence and regulate liquidity in the economy through its intervention in this market.

(d) To provide reasonable access to users of short-term funds to meet their requirements quickly, adequately, and at reasonable costs.

Components of Money Market: Various components of the money market which are common to most money markets are as follows:

(a) Call Money Market: The Call Money Markets are highly liquid markets for an extremely short period loan of one to fourteen days. These loans are repayable at the will of either borrower or the lender. The interest rate varies sharply on a day-to-day, hour-to-hour, and also center-to-center basis. Generally, it is highly volatile and sensitive to changes in demand and supply of call loans. The Indian call money markets are associated with stock exchanges. (BCom Money and Finance in India Notes Study Material)

(b) Treasury Bill Market: “A treasury bill is a promissory note or a finance bill issued by government”. It is highly liquid because its payment is guaranteed by the government. It is an instrument for short-term borrowing. It is issued by the government for a maturity period of 91 days, 182 days, or 364 days. The treasury bills are of two types-ordinary or regular and ad hoc treasury bills. The regular treasury bills are issued to the public, banks, and other financial institutions to fulfill the short-term financial requirements of the central bank. The ad hoc treasury bills are purchased by the central government only. (BCom Money and Finance in India Notes Study Material)

(c) Commercial Bill Market: Commercial Bills are basically negotiable instruments accepted by buyers for goods and services obtained by them on credit. The commercial bill market is the market for bills of exchange arising due to credit sales. The seller draws a bill on the buyer for a promise to pay the debt at a later date as specified in the bill. The seller discounts this bill through commercial banks to get immediate payment. (BCom Money and Finance in India Notes Study Material)

(d) Short-term Loan Market: The short-term loan market facilitates the corporate to meet their working capital requirements. The commercial banks provide temporary overdraft facilities to the business houses and extend cash credit for one year to the entrepreneurs.

Another financial instrument under the short-term loan market is a certificate of deposit. It is a borrowing note for the short-term just similar to that of a promissory note. The bearer of a certificate of deposit receives interest.

(ii) Capital Market: The capital market is an organized market mechanism that provides an institutional support system for the marketing of long-term instruments or assets. These are the assets that have an initial maturity period of more than a year. For example, equity shares, preference shares, debentures, bonds, etc. (BCom Money and Finance in India Notes Study Material)

In the widest sense, it consists of a series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities. (BCom Money and Finance in India Notes Study Material)

Like all markets, the capital market is also composed of those who demand funds and those who supply funds. The demand for the funds comes from private sector manufacturing industries, the agricultural sector, Govt. both central and state. The supply of funds to the capital market comes from commercial banks, and insurance companies like LIC, GIC, etc. Provident funds and various special institutions viz., the IFCI, ICICI, IBI, UTI, etc. (BCom Money and Finance in India Notes Study Material)

Constituents of Capital Market: Indian capital market is one of the largest capital markets in the world. In India, the capital market is broadly divided into two categories:

(a) Gilt-Edged Market: The gilt-edged market is backed by the RBI for marketing government and semi-government securities. Since the government cannot default on its payment obligations, these securities are risk-free and hence are known as gilt-edge, which means, of the best quality. In these securities, the returns are guaranteed and there is no scope for speculation and manipulation of the market. As the value of the securities remains stable, these securities are always demanded by banks and other financial institutions.

(b) Industrial Securities Market: Industrial securities market is a market where securities issued by companies i.e. shares, bonds, and debentures can be bought and sold freely. It consists of the new issues market, called as the primary market, and the market for old already issued securities, called the secondary market or the stock exchange. (BCom Money and Finance in India Notes Study Material)

(c) Financial Instruments: Financial instruments are the assets of the creditors and liabilities of borrowers. I will be a claim against a person or an institution, for payment of some of the money at a specific future date. These instruments include treasury bills of different maturity periods; commercial paper, certificates of deposits, bonds, stock indices, derivatives, etc.

(d) Financial Services: The term, financial services can be defined as “activities, benefits, and satisfaction connected with the sale of money that offers to users and customers, financial related value.”

The efficiency of emerging financial systems largely depends upon the quality and variety of financial services provided by financial intermediaries. It includes underwriting agencies, credit rating agencies, merchant bankers, depositories, etc.

In the last 60 years, the Indian financial system has shown tremendous growth in terms of quality, diversity, innovations, and complexity of operations. Indicators like money supply, deposits and credit of banks, primary and secondary issues, and so on, have increased rapidly. India has witnessed different phases of the economy like diversification, disintermediation, securitization, liberalization globalization, etc. and the volume and growth of the capital in the country very much depends upon the efficiency and intensity of the operations and activities in the financial market. Hence for a country to progress on the economic front it is necessary that its financial system works efficiently.

BCom Money and Finance in India Notes Study Material

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