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    Money and Financial Markets - PGP 26

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    Parth Bhatia
    The document discusses money and the financial system. It begins by describing primitive systems like barter economies and island economies. It then explains how economies transitioned to using money and became monetized. The next step was financialization, where financial claims and institutions emerged to help channel savings to investment. Key aspects covered include the functions of money, characteristics of good money, the Reserve Bank of India's role in ensuring monetary and financial stability, and how commercial banks are able to create money through the fractional reserve system.

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    Money and Financial Markets - PGP 26

    Uploaded by

    Parth Bhatia
    25 views27 pages
    The document discusses money and the financial system. It begins by describing primitive systems like barter economies and island economies. It then explains how economies transitioned to using money and became monetized. The next step was financialization, where financial claims and institutions emerged to help channel savings to investment. Key aspects covered include the functions of money, characteristics of good money, the Reserve Bank of India's role in ensuring monetary and financial stability, and how commercial banks are able to create money through the fractional reserve system.

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    Money and Financial Markets_ PGP 26

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    The document discusses money and the financial system. It begins by describing primitive systems like barter economies and island economies. It then explains how economies transitioned to using money and became monetized. The next step was financialization, where financial claims and institutions emerged to help channel savings to investment. Key aspects covered include the functions of money, characteristics of good money, the Reserve Bank of India's role in ensuring monetary and financial stability, and how commercial banks are able to create money through the fractional reserve system.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    25 views27 pages

    Money and Financial Markets - PGP 26

    Uploaded by

    Parth Bhatia
    The document discusses money and the financial system. It begins by describing primitive systems like barter economies and island economies. It then explains how economies transitioned to using money and became monetized. The next step was financialization, where financial claims and institutions emerged to help channel savings to investment. Key aspects covered include the functions of money, characteristics of good money, the Reserve Bank of India's role in ensuring monetary and financial stability, and how commercial banks are able to create money through the fractional reserve system.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 27

    Money and Financial system

    PGP 26 Economic Environment : Sec D and Sec E and


    PGP-Finance_03
    RAC Chair RAC Area Member RAC Cross-Area Member
    Lecture
    Prof. Anubha S. Sinha
    Prof. Sumit Mitra Prof. Debabrata Chatterjee
    Learning objectives
    o What is money?
    o What are the characteristics of good money?
    o Financial institutions and the functions of RBI
    o How do RBI ensure the stability of value of money?
    o How do banks create money?
    o Financial institutions and the functions of RBI?
    o What is money supply defined in RBI norms?

    27/06/2023 Board Capital and CSR 2


    Primitive System: Island Economy

    Robinson Crusoe

    THINGS GET COMPLICATED AS MORE PEOPLE ARRIVE


    Barter economy

    Inputs of land, labour, etc

    Households Firms

    Consumption of Outputs

    THE NEXT STEP IS A MONETISED ECONOMY


    Barter economy

    Incomes( rents, wages)

    Monetised Inputs of land, labour, etc


    economy

    Households Firms

    Consumption of Outputs

    Payment for outputs

    THE NEXT STEP IS A FINANCIALIZED ECONOMY


    Economy with
    Financial claims Barter economy
    Provide Savings

    Incomes( rents, wages)

    Monetised Inputs of land, labour, etc


    economy

    Households Firms

    Consumption of Outputs

    Payment for outputs

    Issue Financial claims


    Financialized economy and growth
    In a two sector economy
    Households provide savings to the firms which helps them to grow
    In return Firms can issue financial claims : Bonds, Ownership, Board position , share of
    distributed profits
    Problems
    1)Mismatch in requirement: Households have small amount of saving but firms require
    huge amounts
    2)Liquidity mismatch : Household can ask for money during emergency while firms might
    have invested in long term projects
    3)Risk appetite: Households wants risk aversion while firms might require this for risky
    ventures
    WE NEED A BROKER TO DEAL WITH THIS
    27/06/2023 7
    Financial System
    Provide Savings Provide Savings
    1. MARKETS

    Households Firms

    2. INSTITUTIONS

    Issue Financial claims Issue Financial claims


    Motivation: Why we need an integrated financial system
    oHouseholds can now channel savings into investment

    oGovernments and Firms can borrow and issue financial claims


    Additional benefit of financialized system
    During a business cycle, An upward increase in AD curve
    means more demand for money from households, and
    government to spent more and firms to expand or produce
    more.

    We are in equilibrium: Planned credit demand =50000 crores


    :Unplanned credit demand =0

    Disequilibrium : Planned credit demand =50000 crores


    : Unplanned credit demand =20000 crores

    So supply of money has to be taken care by financial


    institutions

    27/06/2023 9
    Money is what money does!

    Functions of Money:
    Medium of exchange
    Unit of account
    Store of value

    We need to understand properties of money


    Money with certain characteristics should be supplied
    by financial institutions for taking care of business
    cycle disequilibrium's.
    Commodity money vs. fiat money

    Earliest form of money was


    commodity money like gold/silver
    had intrinsic value
    Modern money or currency does not
    have intrinsic value (coins, notes) but:
    was commodity-backed till 1970s
    since then is fiat money
    has ideal properties
    Properties of Ideal or Good Money
    Stability of value:
    Intrinsic value
    Durable
    Control over supply leads to stable value
    Convenience:
    Should be easy to carry and easy to use for small purchases
    Technology has led to more convenient forms of money
    Coins vs Notes: Intrinsic value
    Coin minting: at Mints owned by Govt of India (since
    intrinsic value & actual value are almost same)
    Note printing: at printing presses owned by RBI (since
    Govt can’t be trusted?!)
    It costs 50 paise for printing a note of Rs 5, 96 paise for Rs
    10, Rs. 1.81 for Rs 50 note, Rs 1.79 for Rs. 100
    Source:
    http://firstbiz.firstpost.com/economy/why-is-printin
    g-a-rs-50-note-costlier-than-a-rs-100-note-30849.ht
    ml
    Legal Tender

    Coin of any denomination not


    lower than one rupee is legal
    tender for any sum
    Half rupee coin is legal tender
    for any sum not exceeding ten
    rupees
    Every banknote issued by
    Reserve Bank of India is legal
    tender ("I promise to pay the
    bearer the sum of Rupees…”)
    Credit and Banks

    Bank = Banco (Italian for


    bench)

    Bankruptcy = Banca rotta


    (Italian for broken bench)

    Credo (origin of the word Credit) is


    Latin for “I believe”

    15
    Financial
    Institutions
    Types of Financial
    Institutions Commercial
    Regulatory
    Institutions Institutions

    RBI Banks Non-banks

    SEBI, IRDA,
    Retail banks NBFCs
    PFRDA

    Wholesale Insurance
    banks companies

    Cooperative Mutual funds,


    banks Pension funds
    Reserve Bank of India

    • RBI Act (1934), fully owned by Govt of India


    • The Preamble of the Reserve Bank of India describes the basic functions as:
    "...to regulate the issue of Bank Notes and keeping of reserves with a view
    to securing monetary stability in India and generally to operate the
    currency and credit system of the country to its advantage;
    to have a modern monetary policy framework to meet the challenge of an
    increasingly complex economy, to maintain price stability while keeping in
    mind the objective of growth."
    • Core Purpose: To foster monetary and financial stability conducive to
    sustainable economic growth and to ensure the development of an efficient
    and inclusive financial system.
    Main Functions of the RBI
    Monetary Authority: Conducts Monetary Policy to maintain price
    stability & credit availability
    Regulator & Supervisor: Maintain public confidence, protect depositors’
    interest & provide cost effective banking services
    Manager of Foreign Exchange: Manages foreign exchange to facilitate
    trade & maintain orderly conditions in forex market
    Issuer of Currency: Ensures adequate supply and in good quality
    Developmental Role: To support national objectives
    Banker to Government and to Banks
    Organizational Structure

    Departments such as Monetary Policy, Banking


    regulation & supervision, Non-banking regulation &
    supervision, Currency management, Foreign exchange,
    Economic Research, Statistics etc.
    Simplified Balance Sheet of RBI

    Liabilities Assets
    Currency in circulation (held by Domestic assets (government
    public & some by banks) bonds, loans to banks, other
    financial institutions)
    Reserves Foreign assets
    (deposits by banks with the RBI  (foreign government bonds,
    CRR of 3% & excess reserves) gold, forex reserves)
    Non monetary liabilities (paid up Other assets
    capital, surplus, employees PF etc.) (physical assets)

    • Is the currency in circulation backed by gold?


    • How does RBI decide how much ‘money’ to print?
    • Is it a policy decision or a demand decision?
    Role of Banks in ‘Creating’ Money

    Simplified balance sheet of a commercial bank:

    ASSETS LIABILITIES AND CAPITAL

    Reserves (cash with RBI) Deposits

    Loans Capital
    Other Assets Other Liabilities
    Role of Banks in ‘Creating’ Money
     Suppose RBI buys bonds worth Rs.1000 from a bond investor
     This is known as an Open Market Operation (OMO)
     Suppose the bond investor deposits the Rs.1000 in Firstbank
     Initially, Firstbank’s balance sheet is:
     Suppose CRR is 10%
    FIRSTBANK’S
    balance sheet  Firstbank will hold
    10% of deposits in
    Assets Liabilities
    reserves deposits reserve with RBI,
    making loans with
    Rs.100 Rs.1,000
    the rest.
    loans Rs.900
    Role of Banks in ‘Creating’ Money

     Suppose the borrower deposits the Rs.900 in


    Secondbank.
     Initially, Secondbank’s balance sheet is:

    SECONDBANK’S • Secondbank will hold


    10% in reserves with
    balance sheet RBI and loan 90% of
    Assets Liabilities this deposit.
    reserves Rs.90 deposits
    Rs.900
    loans Rs.810
    Role of Banks in ‘Creating’ Money

     If this Rs.810 is eventually deposited in Thirdbank,

    THIRDBANK’S
    balance sheet  Then Thirdbank
    Assets Liabilities will keep 10% of it
    deposits in reserve,
    reserves Rs.81 Rs.810
    and loan the rest
    loans Rs.729 out.
    Finding the total supply of money:
    Firstbank deposit = Rs.1000
    + Secondbank deposit = Rs. 900
    + Thirdbank deposit = Rs. 810
    + Fourthbank deposit = Rs. 729
    + subsequent deposits…

    Total money supply = 1000+ (1-crr)1000 + (1-crr)21000 +… = (1/crr ) 1000


    where crr = cash reserve ratio
    In our example, crr = 0.1, so M = Rs.10,000
    Rs. 1000 liquidity injection led to new money supply of Rs. 10,000!
    (1/crr) is the money multiplier. Not to be confused
    with Keynesian (expenditure) multiplier
    Money Supply
    • Currency is money
    • ‘Bank money’ can be used as medium of exchange, store of value, and is therefore money (demand
    deposits)

    • Money supply = currency + demand deposits with banks


    • Money Supply (M ) = C + D

    • Specifically,
     M1 = Currency with the public + Demand deposits with the banking system + ‘Other’ deposits with the
    RBI.
     M2 = M1 + Savings deposits of post office savings banks
     M3 = M1+ Time deposits with the banking system
     M4 =M3 + All deposits with post office savings banks (excluding National Savings Certificates).

    M1 and M2 are called narrow money whereas M3 and M4 are called Broad Money.
    Finding the total supply of money:

    Money Supply (M ) = C + D
    In this example we assumed there was no change in C as all bank
    customers deposited their funds with banks
    Therefore to know money supply, we need to track D i.e. the deposit
    creation (or credit creation) by banks

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