Chapters :

Money & Banking - 02

MEASURES OF MONEY SUPPLY                       

The RBI in 1977 published monetary aggregates based on the recommendation of Second working group on money supply. The following 4 components were given:

M1 = Currency With Public (Coins, Currency Notes) and demand deposits of the   public in banks and other deposits with RBI.

M2 = MI + Post Office Savings Deposit.

M3 = M1 + Time Deposits Of The Public With Banks.

M4 = M3 + Total Post Office Deposits (savings and fixed deposits).

The RBI 2nd revision in aggregates was suggested by Y.V. REDDY COMMITTEE IN 1998. It was based on the balance sheet of banking sector in conformity with norms of progressive liquidity. Hence the following classification was done:

RESERVE MONEY (M0):

It is the Monetary Base of the economy. It is also called as Primary Money Or Basic Money. The ability of banks to create deposit money is dependent on how much reserve money is available and the portion of that with the public in form of currency. It consists of:

  • Currency In Circulation
  • Bankers Deposit With RBI
  • Other Deposits With RBI
  • RBI’s Net Credit To Government, Banks
  • Net Forex With RBI. 
  • Government’s Currency Liability To Public
  • Net Non-Monetary Liabilities Of RBI

NARROW MONEY:

IT is the currency with public + demand deposits with banking system + other deposits with RBI.

M1 is narrow money as it is highly liquid and banks cannot run their lending programme with this money.

M2 = M1 + savings with post office

Note: M1 M2 Called narrow money

BROAD MONEY:

M1 + Time Deposits With Banks. This M3 is known as Broad Money. It is the money which lies with the bank for running their lending programme. The financial assets included in the category of M3 are more than those included in the category of M2.

The basic difference between M1 and M3 is the treatment of time deposits with bank. Narrow money (M1) Excludes time deposit while M3 – Include time deposit.

M3 – is the most commonly used measuring of money supply. It is also known as aggregate monetary resources. 

M4

M4 = M3 + All deposits with Post Office Savings Banks (excluding National Savings Certificates).

M3+M4 – Known as broad money.

The Narrow Money (M1, M2) and Broad Money (M3, M4) this classification based on their decreasing under of liquidity.

M1 = Highly Liquid

M4 = Least Liquidity of all

Liquidity of money – as we move from M1 to M4, the liquidity (Inertia, Stability, Spend Ability) of the money goes on decreasing and in opposite direction, the liquidity increases.

HIGH POWERED MONEY

HIGH POWERED MONEY OR POWERFUL MONEY refers to that currency that has been issued by the Government and Reserve Bank of India. Some portion of this currency is kept along with the public while rest is kept as funds in Reserve Bank.

H = C + R

Where H = High Powered Money

C = Currency with the public (Paper money + coins)

R = Government and bank deposits with RBI

Thus the sum total of money deposited with the public and the funds of banks is termed as powerful money. It is mainly created by the central bank.

FACTORS OFFERING MONEY SUPPLY IN INDIA

Money supply with the public in influenced mainly by the RBI and its commercial bank.

THE CURRENCY DEPOSIT RATIO (CDR)-The ration of money held by public currency to that gold in bank deposit. If reflects peoples preference of liquidly if behaviour permeates.

The RESERVE RATIO (RDR) – it is the proportion of total deposit commercial banks keeps as reserve. Bank hold a part of the people money keep in their bank deposit as reserve money and loan out the rest to various investment projects.

STATUTORY LIQUID RATIO – This requires the bank to maintain a given fraction of their total demand and time deposits in the form of spectated liquid assets.

CASH RESERVE RATIO –it specifies the fraction of their deposits that banks must keep with RBI.

MONEY MULTIPLIER

It is the ratio of the stock of high power money in an economy. It is the ratio between board money (M3) and Reserve money (M0).

BANKING

A bank is a type of financial intermediary as it mediates between the savers and borrowers. It does so by accepting deposits from the public and lending money to businesses and consumers. Its primary liabilities are deposits and primary assets are loans and bonds. It performs the function of regulation of money supply in the economy. This banking system acts as a bridge between demand and supply of finances between various players in the economy like Household, Business Firms, Government and even external sector. Let us closely examine the various functions and roles of the banking system and its problems.

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