TUTOR MARKED ASSIGNMENT
Course Code: ECO - 09
Course Title: Money, Banking and Financial
Institutions
Assignment Code: ECO – 09/TMA/2015-16
Coverage: All Blocks
Maximum Marks: 100
Attempt all the
questions.
1.
Why is money demanded? How is the Keynesian approach different from the
classical approach in this regard? (20)
2.
Explain the establishment, structure and functions of the State Bank of India. (20)
3.
What is meant by money market? Discuss the significance of money market in a
modern economy. (20)
4.
Describe the working of the IMF. How does it help member countries in dealing
with their temporary balance of payments problems? (20)
5.
Write short notes on the following: (4×5)
(a)
General Leading Principal of World Bank
(b)
Regional Rural Banks
(c)
Economic Significance of Banking
(d)
Branch Banking
Answer of Question No.1.
Demand for Money: Classical
view of demand for money contributes that money can not satisfy the holder
directly. It is demanded for its purchasing power or its use as medium of
buying goods and services which satisfy the holder of money. It is therefore
obvious that the demand for money arises from the demand for goods and services
to meet the society's requirements. Hence demand for money may be termed as
'derived demand'. The demand for money in a country depend on the volume of
transactions taken place in the country; more specially, depends upon the
supply of goods and services available in the market. The larger the amount of
tradable goods and services in the economy, large is the volume of demand for
money.
Comparative analysis of Classical theory and Keynesian
approach
Classical theory: The
classical theory of demand for money is presented in the classical quantity
theory of money and has two approaches: the Fisherman approach and the
Cambridge approach.
1. Fisherian Approach: To the classical economists, the demand for money is
transactions demand for money. Money is demanded by the people not for its own
sake, but as a medium of exchange. Thus, the demand for money is essentially to
spend or for carrying on transactions and thus is determined by the total
quantity of goods and services to be transacted during a given period.
2. Cambridge Approach: While Fisher's transactions approach emphasized the medium
of exchange function of money, the Cambridge cash-balance approach is based on
the store of value function of money. According to the
Cambridge economists, the demand for money comes from those who want to hold it
for various motives and not from those who want to exchange it for goods and
services. This amounts to the same thing as saying that the real
demand for houses comes from those who want to live in them, and not from those
who simply want to construct and sell them. Thus, in the Cambridge approach,
the demand for money implies demand for cash balances.
In the end, the classical theory of demand for money may be
summarised as under:
(i) Money is only a medium of exchange.
(ii) The ratio of desired money balances to nominal income is
assumed to be constant at its minimum, or, in other words, velocity of money is
constant at its maximum (because K = 1/V).
(iii) The public holds a constant fraction of its nominal
income in non-interest-earning cash balances for transactions and precautionary
motives.
(iv) Hoarding, i.e., holding money above the minimum desired
for transaction purposes, is considered irrational because money in itself has
no value.
(v) Quantity of money demanded is directly related to the
price level.
Keynesian theory of
Money demand: The modem concept of demand for money is associated
with the Keynesian analysis of the demand for money. In his General Theory of
Employment, Interest and Money (1936), J.M. Keynes expounded his theory of
demand for money. Essentially, Keynes' theory of demand for money is an
extension of the Cambridge cash-balances approach and stresses the asset role
(i.e., the store of value function) of money. In contrast to the Fisherian view
of what people 'have to hold', the Keynesian view stated that the demand for
money is determined by what people 'want to hold'. To Keynes, demand for money
does not mean the actual money balances held by the people, but what amount of
money balances they want to hold. Keynes states that the demand for money means
demand for money to hold the demand for cash balances.
Money is not just meant for spending. It can be held as a
form of wealth or asset which commands other forms of wealth in exchange, all
the time. Thus, money being the most liquid asset, can serve as an efficient
store of value; so it is demanded for its own sake. In this sense, the demand
for money is the inverse of the velocity of circulation. In short, the
Keynesian approach to the demand for money stresses the public's need for cash
or money balances as a store of value at a particular point of time.
In this context, it involves evidently the reason for the
people's preference to hold liquid cash or money, rather than other assets, as
a store of value. This desire for money is described by Keynes as liquidity
preference. Thus, the demand
for money, in the Keynesian sense, is a demand for liquidity or "liquidity
preference." Hence the modern approach to the demand for money has been
designated as the cash balance or liquidity preference approach. Keynes
distinguished three such motives which induce people to hold money. These are:
(1) the transactions motive; (2) the precautionary motive, and (3) the
speculative motive.
He further holds that, the total demand for money implies total
cash balances. Analytically, total cash balances may be classified into two
parts: (i) Active Cash Balances; and (ii) Idle Cash Balances.
Answer
of Question No.2.
Establishment of State Bank of
India: State Bank of India (SBI), state-owned
commercial bank and financial services company, nationalized by the Indian
government in 1955. SBI maintains thousands of branches throughout India and
offices in dozens of countries throughout the world. The bank’s headquarters
are in Mumbai. The oldest commercial bank in India, SBI originated in 1806 as
the Bank of Calcutta. Three years later the bank was issued a royal charter and
renamed the Bank of Bengal. Along with the Bank of Bombay (founded 1840) and
the Bank of Madras (founded 1843), it was one of three so-called presidency
banks, each of which was jointly owned by the provincial government and private
subscribers. In 1921 the presidency banks were merged to form the Imperial Bank
of India (IBI), which then became the largest commercial enterprise in the
country.
In 1955 the government of India and the country’s central bank,
the Reserve Bank of India (founded 1935), assumed joint ownership of IBI, which
was renamed the State Bank of India. Four years later, by the State Bank of
India (Subsidiary Banks) Act, banks earlier operated by individual princely
states became subsidiaries of SBI. The Reserve Bank’s share of SBI was
transferred to the government in 2007. Since nationalization, SBI has served
the needs of Indian economic development through rural-development initiatives
and microcredit programs and by financing major agricultural and industrial
projects and raising loans for the government.
Organisational
Structure: The
organisational structure of the State Bank of India is somewhat different from
the other nationalized banks. It has a well defined system of decentralisation
of authority. The whole country has been divided into nine circles for
administrative control purposes The Head Offices of each circle is known as
Local Head Office with a Local Board of Directors which has a statutory status.
Each circle has been further divided into a number of Regions. There is a Chief
General Manager (formerly known as the Secretary and Treasurer) for each Circle
He is the Chief Executive for his circle and has under him Regional Managers
for the different regions in his circle.
The Chief General
Manager enjoys vast powers for control over branches and has also extensive
discretionary powers regarding loans and advances. All this has resulted in
taking the operational control nearer to the area of operation. The Bank is
further trying to strengthen the Regional Offices so as to reduce the span of
control of the controlling authority (i.e., the Chief General Manager), leading
to further decentralisation.
Functions
of SBI: The functions of SBI can be grouped under two categories, viz.,
the Central Banking functions and ordinary banking functions.
A. Central Banking Functions: The SBI
acts as agent of the RBI at the places where the RBI has no branch. Accordingly,
it renders the following functions:
(1) Banker to the Government: The SBI
functions as the banker to the central and state governments. It receives and
pays money on behalf of the governments. Especially it renders the following
functions as directed by the RBI in this regard.
(a) Collection of charges on behalf of the government e.g.
collection of tax and other payments
(b) Grants loans and advances to the governments
(c) provides advises to the government regarding economic
conditions, etc.
(2) Banker's Bank: Commercial Banks have accounts with
SBI. When the banks face financial shortage, the SBI provides assistance to
them as it is considered a big brother in the banking industry. It discounts
the bills of the other commercial banks. Due to the functions on this line the
SBI is considered in a limited sense as the banker's bank.
(3) Currency Chest: The RBI maintains currency chests at
its own offices. But RBI Offices are situated only in big cities. SBI, buy its
wide network of branches operate in urban as well as rural areas. RBI
therefore, in such places keeps money at currency chests with SBI. Whenever
needs arise, the currency is withdrawn from these chests under proper
accounting and reporting to RBI. Presently RBI entrust currency chest to other
Public Sector Banks and a few Private Sector Banks also.
(4) Acts as Clearing House: In all the places, where RBI has no
branch, the SBI renders the functions of clearing house. Thus, it facilitates
the inter bank settlements. Since, all the banks in such places have accounts
with SBI; it is easy for the SBI, to act as clearing house.
(5) Renders Promotional Functions: State
Bank of India also renders various promotional functions. It provides various
facilities to the following priority sectors: (i) Agriculture (ii) Small - Scale Industries (iii) Weaker sections of the society (iv) Co-operative sectors (v) Small – traders (vi) Unemployed Youth (vii) Others. In this respect SBI is like
any other commercial bank.
B. General Banking Functions: Besides
the above specialized functions, the SBI renders the following functions under
Section 33 of the Act.
1. Accepting deposits from the public under current, savings,
fixed and recurring deposit accounts.
2. Advancing and lending money and opening cash credits upon the
security of stocks, securities, etc.
3. Drawing, accepting, discounting, buying and selling of bills of
exchange and other negotiable instruments.
4. Investing funds, in specified kinds of securities.
5. Advancing and lending money to court of wards with the previous
approval of State Government.
6. Issuing and circulating letters of credit.
7. Offering remittance facilities such as, demand drafts, mail
transfers telegraphic transfers, etc.
Answer of Question No.3.
Meaning of
Money Market: The financial system of any country is the backbone of the economy
of that country. The financial systems of all economies are broadly sub-divided
into money market, capital market, gilt-edged securities market and foreign
exchange market. The money market, capital market and the gilt securities
market provides avenues to the surplus
sector such as household institutions in the economy to deploy their funds to
the deficit sector such as corporate and government sectors to mobilize funds
for their requirements. The operations in the money market are generally
short-term (upto 1 year) in nature, in capital market short-term to long term
and in gilt securities market generally long-term. However, in an integrated
financial system, the occurrence of an event in one market of the financial
system will have an impact on the other market system.
The Indian money market is a market
for short-term money and financial asset that are close substitutes for money,
which are close substitute for money, with the short-term in the Indian context
being for 1 year. The important feature of the money market instruments is that
it is liquid and can be turned quickly at low cost. The money
market is not a well-defined place where the business is transacted as in the
case of capital markets where all business is transacted at a formal place,
i.e. stock exchange. The money market is basically a telephone market and all
the transactions are done through oral communication and are subsequently
confirmed by written communication and exchange of relative instruments.
The money market consist of
many sub-market such as the inter-bank call money, bill discounting, treasury
bills, Certificate of deposits (CDs), Commercial paper (CPs), Repurchase
Options/Ready Forward (REPO or RF), Inter-Bank participation certificates
(IBPCs), Securitized Debts, Options, Financial Futures, Forward Rate Agreement
(FRAs), etc. which collectively constitute the money market.
Role and
Functions of Money Market
A well-developed
money market is essential for a modern economy. Though, historically, money
market has developed as a result of industrial and commercial progress, it also
has important role to play in the process of industrialization and economic
development of a country. Importance of a developed money market and its
various functions are discussed below:
1. Financing Trade: Money Market plays crucial role in
financing both internal as well as international trade. Commercial finance is
made available to the traders through bills of exchange, which are discounted
by the bill market. The acceptance houses and discount markets help in
financing foreign trade.
2. Financing Industry: Money market contributes to the
growth of industries in two ways:
(a) Money market helps the industries in securing short-term loans
to meet their working capital requirements through the system of finance bills,
commercial papers, etc.
(b) Industries generally need long-term loans, which are provided
in the capital market. However, capital market depends upon the nature of and
the conditions in the money market. The short-term interest rates of the money
market influence the long-term interest rates of the capital market. Thus,
money market indirectly helps the industries through its link with and
influence on long-term capital market.
3. Profitable Investment: Money market enables the commercial
banks to use their excess reserves in profitable investment. The main objective
of the commercial banks is to earn income from its reserves as well as maintain
liquidity to meet the uncertain cash demand of the depositors. In the money
market, the excess reserves of the commercial banks are invested in near-money
assets (e.g. short-term
bills of exchange) which are highly liquid and can be easily converted into
cash. Thus, the commercial banks earn profits without losing liquidity.
4. Self-Sufficiency of Commercial Bank: Developed
money market helps the commercial banks to become self-sufficient. In the
situation of emergency, when the commercial banks have scarcity of funds, they
need not approach the central bank and borrow at a higher interest rate. On the
other hand, they can meet their requirements by recalling their old short-run
loans from the money market.
5. Help to Central Bank: Though the central bank can function
and influence the banking system in the absence of a money market, the
existence of a developed money market smoothens the functioning and increases
the efficiency of the central bank. Money
market helps the central bank in two ways:
(a) The short-run interest rates of the money market serves as an
indicator of the monetary and banking conditions in the country and, in this
way, guide the central bank to adopt an appropriate banking policy,
(b) The sensitive and integrated money market helps the central
bank to secure quick and widespread influence on the sub-markets, and thus
achieve effective implementation of its policy.
Answer
of Question No.4.
Introduction
of IMF
The International Monetary Fund (IMF) is an
international organization created for the purpose of standardizing global
financial relations and exchange rates. The IMF generally monitors the
global economy, and its core goal is to economically strengthen its member
countries. The work of the IMF is of three main types. Surveillance involves
the monitoring of economic and financial developments, and the provision of
policy advice, aimed especially at crisis-prevention. The IMF also lends to
countries with balance of payments difficulties, to provide temporary financing
and to support policies aimed at correcting the underlying problems; loans to
low-income countries are also aimed especially at poverty reduction. Third, the
IMF provides countries with technical assistance and
training in its areas of expertise. Supporting all three of these activities is
IMF work in economic research and statistics.
In recent years, as part of its efforts to
strengthen the international financial system, and to enhance its effectiveness
at preventing and resolving crises, the IMF has applied both its surveillance
and technical assistance work to the development of standards and codes of good
practice in its areas of responsibility, and to the strengthening of financial
sectors. The IMF
also plays an important role in the fight against money-laundering and
terrorism
Balance
of payments and IMF helps it members in dealing with this problem
Bad luck, inappropriate policies, or a
combination of the two may create balance of payments difficulties in a
country—that is, a situation where sufficient financing on affordable terms cannot
be obtained to meet international payment obligations. In the worst case, the
difficulties can build into a crisis. The country's currency may be forced to
depreciate rapidly, making international goods and capital more expensive, and
the domestic economy may experience a painful disruption. These problems may
also spread to other countries.
The causes of such difficulties are often
varied and complex. Key factors have included weak domestic financial systems;
large and persistent fiscal deficits; high levels of external and/or public
debt; exchange rates fixed at inappropriate levels; natural disasters; or armed
conflicts or a sudden and strong increase in the price of key commodities such
as food and fuel. Some of these factors can directly affect a country's trade
account, reducing exports or increasing imports. Others may reduce the
financing available for international transactions; for example, investors may
lose confidence in a country's prospects leading to massive asset sales, or
"capital flight." In case, diagnoses of, and responses to, crises are
complicated by linkages between various sectors of the economy. Imbalances in
one sector can quickly spread to other sectors, leading to widespread economic
disruption.
How IMF
lending helps
IMF lending aims to give countries
breathing room to implement adjustment policies and reforms that will restore
conditions for strong and sustainable growth, employment, and social
investment. These policies will vary depending upon the country's circumstances,
including the causes of the problems. For instance, a country facing a sudden
drop in the price of a key export may simply need financial assistance to tide
it over until prices recover and to help ease the pain of an otherwise sudden
and sharp adjustment. A country suffering from capital flight needs to address
the problems that led to the loss of investor confidence: perhaps interest
rates that are too low, a large government budget deficit and debt stock that
is growing too fast, or an inefficient, poorly regulated domestic banking
system.
Before a member country can receive a loan,
the country's authorities and the IMF must agree on a program of economic
policies. A country's commitments to undertake certain policy actions
are an integral part of IMF lending. They are designed to ensure that the funds
will be used to resolve balance of payments problems. They would also help to
restore or create access to support from other creditors and donors. A
country's return to economic and financial health allows the IMF to
be repaid, making the funds available to other members.
In the absence of IMF financing, the
adjustment process for the country would be more difficult. For example, if
investors become unwilling to provide new financing, the country has no choice
but to adjust—often though a painful compression of imports and economic
activity. IMF financing can facilitate a more gradual and carefully considered
adjustment.
IMF loan programs are
tailored to the specific circumstances of individual countries. In recent
years, the largest number of loans has been made through the Poverty Reduction and Growth Facility
(PRGF), which provides funds at a concessional interest rate to
low-income countries to address protracted balance of payments problems.
However, the largest amount of funds is provided through Stand-By Arrangements
(SBA), which charges market-based interest rates on loans to assist with
short-term balance of payments problems. The IMF also provides other types of
loans including emergency assistance to
countries that have experienced a natural disaster or are emerging from armed
conflict.
Globalization has vastly increased the size of
private capital flows relative to official flows and IMF quotas, albeit
unevenly so. Many emerging market countries currently see an unmet need for
insurance against large and volatile capital flows. In recent years, the IMF
has been re-examining its instruments that help prevent and respond to crises
to ensure they continue to meet emerging-market members’ needs. Low-income
countries have differing needs. Some require debt relief, and others
concessional financing. Meanwhile, some no longer need financing, but seek the
reassurance of policy support and signaling.
Answer of Question No.5.
(a) General Leading Principles
of World Bank
The World Bank has formulated certain principles for advancing
loans, either directly or indirectly, which are to be fulfilled. These conditions as incorporated in the Article III of the
Articles of Agreements are as follows:
(i) The World Bank usually advances loan to the Government of its
member country and also satisfies itself about the repaying capacity of the
borrowing of its member country.
(ii) The competent committee of the Bank reports favorably on the
project.
(iii) The Bank is satisfied on the issue that the borrower is
almost unable to obtain the loan otherwise on reasonable terms.
(iv) The Bank should look into the feasibility of the project for
which the loan is sought by the member country.
(v) The World Bank should see that the rate of interest and other
charges are reasonable and along with it should see that such rate, charges and
the schedule of repayment are quite appropriate to the project.
(vi) The World Bank may guarantee a loan made by other investors
and accordingly the Bank must receive suitable compensation for such risk
beared by it.
(vii) The Bank should also insist upon a guarantee from the
government of the country to which the loan is extended by the Bank.
(b)
Regional Rural Banks
Regional Rural Banks were established under the provisions of an
Ordinance promulgated on the 26thSeptember 1975 and the RRB Act, 1976 with an
objective to ensure sufficient institutional credit for agriculture and other
rural sectors. The RRBs mobilize financial resources from rural / semi-urban
areas and grant loans and advances mostly to small and marginal farmers,
agricultural laborers and rural artisans. The area of operation of RRBs is
limited to the area as notified by Government of India covering one or more
districts in the State. The Regional Rural Banks (RRBs) have been set up to
supplement the efforts of cooperative and commercial banks to provide credit to
rural sector. The following were the reasons or need set up the RRBs:
1. To free the rural poor, small and marginal farmers from the
clutches of money lenders
2. To provide credit to small farmers, marginal farmers, rural
artisans, landless laborers who do not fulfill the criterion of
creditworthiness as per the banking principles.
3. To provide banking services to the rural community at a
relatively lower cost by adopting a different staffing pattern, wage structure
and banking policies.
(c) Economic Significance of
banking
Banks play an important role in the economic growth of a country.
In the modern set up, banks are not to be considered dealers in money but as
the leaders of development. The importance of bank for a country’s economy can
be explained in following ways:
a) Banks by
playing attractive interest rate on deposits try to promote thrift and savings
in an economy.
b) The
investment of these savings in productive channel results in capital formation.
c) The
scattered small savings in the country can be put to optimum use by commercial
banks. Banks utilize this amount by giving loans to industrial houses and the
government. By providing funds to the entrepreneurs, bank help in increasing
productivity of capital.
d) Banks help
in remitting money from one place to another. The cheque, bank draft, letter of
credit, bills, hundies enable traders to transfer large sums of money from one
place to another.
e) By their
ability to create credit, the banks have placed at the disposal of the nation a
large amount of money. The bank can increase the supply of money through credit
creation.
f) With the
growth of banking activity, employment opportunity in the country has increased
to a considerable extent.
g) The banks
help in capital formation in the country. A high rate of saving and investment
promote capital formation.
h) Money
deposited in the bank and other precious items are now absolutely safe. For
keeping valuables, banks are providing locker facilities. Now people are free
from any type of risks.
(d) Branch Banking
Branch banking is the act of doing one's banking
business at a location that is separate from the bank's central business
location. Many large and small banks use branch banking in order to extend the
reach of their services to different locations in a community, state, or
country. Smaller branches are also less expensive to operate, and often easier
for customers to access, while providing all of the features of a larger bank. Historically,
branch banks were part of a larger building, often found in strip malls or even
in grocery stores or discount stores, sharing the location with another
business. Today, however, branch banking can take place at a number of
different locations, and many banks build individual branch locations that are
independent of other businesses. Each type of location is still considered a
branch bank.
In general, most of the services offered at a large
bank can be completed at a branch banking location. Locations found in grocery
and discount stores often do not have as many options as other branch services;
it is often not possible to "drive-through" at these locations,
because the bank is located inside the store. In addition, though deposits can
be made at this type of bank branch, safe deposit boxes are typically never
available, because the security is simply not high enough. Otherwise, these
locations typically offer all other services, and generally include an
automated teller machine (ATM).