|1.MEANING OF MONEY|
- Money is a commonly accepted medium of exchange.
- Money is anything that can be generally accepted as payment for goods and services or settlement of debts.
- Money is the most liquid (it is easy to sell in the market like gold, silver etc.) of all assets in the sense that it is universally acceptable and hence can be exchanged for other commodities very easily.
|2.FUNCTIONS OF MONEY|
|Functions Of Money||Primary Function||
- Measure of value – Money serves as a common measure of value or unit of account so, the relative comparison of goods is possible. This is possible because of Divisibility & Fungibility of money.
|Divisible – Money can be easily divided into small increments so that it can match commodity values more precisely. For example, 4 notes of Rs.500 have same value as 1 note of Rs.2000
Fungible – Fungibility is the ability of a good or asset to be interchanged with other individual goods or assets of the same type. For example, 1 note of Rs.500 can buy same amount of good as the other note of Rs.500
- Medium of exchange (transaction) – people can easily exchange goods and services with money. This is possible because money is:
- Readily acceptable as it is legal tender.
- Durable as it remains functional for a long time
- Recognizable by authorities and people as well.
- Hard to Counterfeit and duplicate.
- Deferred Payment – Money also serves as a standard mode of deferred payments. Time value of Money, for instance,Credit card, EMI etc. If a loan is taken today, it can be paid back in future using money.
- Transfer of Value – money has the same value throughout the country and has its value is transferrable.
- Store of Value – It can be kept as savings (in bank account) and could be used for investment purpose e.g. buying property. Its storage costs are also considerably lower.
|3. EVOLUTION OF MONEY|
|4.Paper money (Fiat money)|
|6.Virtual (Crypto) currency|
3.1 BARTER SYSTEM
- The Barter system is an exchange of goods for other goods. The exchange of commodities without the mediation of money is called Barter Exchange.
- It suffers from a problem of double coincidence of wants.
- The barter system does not provide for the direct purchase of goods since there was no common unit of account and medium of exchange (Money).
BARTER SYSTEM Vs MONEY
|Problem with perishable goods so they cannot be stored for a long time. E.g. Potatoes, rice.||It is not perishable so it can be stored. It will remain intact for a long time. E.g. Coins and paper currency|
Double coincidence of
|Double coincidence of wants is must to initiate a transaction.||Not needed to initiate a transaction.
Divisibility is difficult
|High divisibility, money can be divided into small increments that can be used in exchange|
|It has high storage cost given perishable nature of commodities.||Comparatively low storage cost.|
No universal acceptability
|Money facilitates exchanges by acting as a commonly acceptable medium of exchange|
|Temporary postponements of payment possible.|
|Convertibility to other
|Easy to convert into other commodities|
|Poor on account of exchangeability||Money can be exchanged easily|
|High Liquidity (Easily available and tradable in any market)|
Unit of Account
|Not act as standard unit of account||Money acts as standard unit of account.|
|High fungibility (replaceable by another identical item; mutually interchangeable)|
DIFFICULTIES UNDER BARTER SYSTEM
- Difficulties under Barter System
- Double coincidence of wants
- Lack of information about product quality
- Impossibility of sub divisions
- No unit of account to measure the worth of good
DOUBLE COINCIDENCE OF WANTS
It is an economic phenomenon where two parties each hold an item the other wants, so they exchange these items directly without any monetary medium.
E.g. – shoemaker wants to buy wheat and the farmer wants to buy shoes then they both can exchange their commodities.
3.2 COMMODITY MONEY
- Commodity money is money whose value comes from a commodity of which it is made.
- Commodity money consists of objects having value or use in themselves (intrinsic value) as well as their value in buying goods – for example gold not only use as medium of exchange but also for making jewellery as well.
- IndiaàCowries were used to make exchanges during earlier times.
PROBLEMS OF COMMODITY MONEY-
- Face Value was not same throughout region.
- Generally commodities used were perishable in nature.
- Generally commodities are bulky to carry
- No fungibility (replaceable by another identical item; mutually interchangeable) and divisibility
3.3. METALLIC MONEY
- It is money made up of pure and superior metals like gold and silver.
- This type of metallic money has the face value just equal to the intrinsic value. The value inscribed in the coins is called face value of money. The value of metal used to mint the coin is called intrinsic value.
- Forged in Gold (Muhr) àHigh value (Because gold supply was relatively lower than silver and copper.)
- Forged in Silver (Rupaiya) àModerate value
- Forged in Copper/ Bronze (Dam, Paisa) àFor day to day purchases
|FACE VALUE||INTRINSIC VALUE|
|The face value is the legally defined value of the coin relative to other units of currency.||Intrinsic value refers to the market value of the constituent metal within a coin.|
|Fiat money has the face value.||Fiat money does not have intrinsic value.|
|Face value cannot be derived from selling of constituent metal/currency itself.||Intrinsic value can be derived from selling of constituent metal itself.|
|Positives of Metallic Money||Negatives of Metallic Money|
|Metallic money has intrinsic value and it has non-perishable nature – can be stored for long time.||Bulky to carry so difficult to move.
|Divisible– Item used as money can be easily divided into small increments so that it can match commodity values more precisely.||Smuggling for intrinsic value.
|Fungible–Replaceable by another identical item; mutually interchangeable.||High storage cost.
3.4 PAPER MONEY (FIAT MONEY)
- Paper money acted as money (Legal tender) because they are guaranteed by the national governments. Fiat money is legally recognized to settle all debts & payments within territorial jurisdiction.
- Fiat money gives central banks greater control over the economy because they can control how much money is printed.
- When fiat money is backed by gold or silver standard, it’s called “representative money”, and when central bank promises “to pay bearer the sum of this many rupees”, currency becomes an “anonymous bearer bond with zero interest”.
- ExamplesàUS dollar, Indian Rupee, Euro, etc.
- In India, two entities issue fiat money –
- Government of India under the coinage act 1909 issues all coins and Rs.1 note; while
- RBI Act 1934 empowers RBI to issue the remaining bank notes and RBI central board is empowered to make recommendation to government of India to withdraw any notes from circulation. This is called “Demonetization” and was done thrice in India after independence.
WHAT IS NOT FIAT MONEY?
- Money without government legal backing
- Superstores plastic coins, cards & coupons
- Shares, Bonds, Debentures, G-Sec, T-bill
- DD, Cheques, Credit Card, ATM card
- Bitcoin & other Digital currency
PROBLEMS OF FIAT MONEY-
- Reduction in value of money by monetary policies leads to over printing of currency which could result in
- Still Bulky to carry, so reduces its movability
- Risk of theft and prone to counterfeit (duplicate/fake currency)
- Change problem–money cannot be easily divided into small increments so that it can match commodity values more precisely, leads to rounding off problem.
- g. petrol pumps not returning 60 paise per customer due to change problem.
Hyper-inflation is a situation when inflation rises at an extremely faster rate. The rate of inflation can increase from 50 times to 300 times.
3.5 BANK MONEY
- Backed by Central bank of the country viz.
- Cheque, Bank Draft, NEFT, RTGS
- Credit cards & Debit cards
BENEFITS OF BANK MONEY
- Transaction could be settled on the spot, result in time saving.
- Option of the Deferred payment
- Easy to transfer over long distance
- Exact amount can be transferred (No change problem)
- Hard to counterfeit or make duplicate
- Can be freezed if card is stolen via. KYC (Know Your Customer) norms
- Legally recognized for high value payment.
Deferred Payment – It is temporary postponement of the payment of an outstanding bill or debt, usually involving repayment by instalments.
3.6 VIRTUAL MONEY
- Virtual currency is a type of unregulated digital currency that is only available in electronic form.
- Virtual currency is currency held within the blockchain network that is not controlled by a centralized banking authority.
- It is stored and transacted only through designated software, mobile or computer applications, or through dedicated digital wallets, and the transactions occur over the internet through secure, dedicated networks.
- Virtual currency is considered to be a subset of the digital currency group, which also includes cryptocurrencies, which exist within the blockchain network.
- Virtual currency is different than digital currency since digital currency is simply currency issued by a bank in digital form.
3.7 FIDUCIARY MONEY
- Fiduciary money is that money which is accepted as a medium of exchange because of the trust between the payer and the payee.
- Example of Fiduciary money is Cheques, Banknotes, etc.
3.8 CREDIT MONEY
- Credit Money refers to that money, in which money value is more than the commodity value.
- Money value > Commodity value.
Money is the most liquid of all assets. Liquidity Order is as following –
- Demand deposits in Banks
- Savings deposits in Banks
- Term (Time) deposits in Banks
|Q. Consider the following liquid assets: (UPSC 2013)
The correct sequence of these assets in decreasing order of liquidity is
|4. CREATION OF MONEY|
- Money supply– It is all the currency and other liquid instruments in a country’s economy on the date measured.
- The money supply is roughly composed of both cash and deposits that can be used almost as easily as cash.
- Money supply will change if the value of any of its components such as Consumer Unit (CU), Demand Draft (DD) or Time Deposits changes.
- For simplicity, use the most liquid definition of money, viz. M1 = CU + DD, as the measure of money supply in the economy.
- Various actions of the monetary authority, RBI, and commercial banks are responsible for changes in the values of these items.
- The preference of the public for holding cash balances vis- ́a-vis deposits in banks also affects the money supply.
- These influences on money supply can be summarised by the following key ratios-
4.1 CURRENCY DEPOSIT RATIO (cdr)
- The currency deposit ratio (cdr) is the ratio of money held by the public in currency to that they hold in bank deposits (cdr = CU/DD)
- It reflects people’s preference for liquidity. It is a purely behavioural parameter which depends, among other things, on the seasonal pattern of expenditure.
- For example, cdr increases during the festive season as people convert deposits to cash balance for meeting extra expenditure during such periods.
|CREATION OF MONEY
4.2 RESERVE DEPOSIT RATIO
- Reserve deposit ratio (rdr) is the proportion of the total deposits commercial banks keeps as reserves.
- Reserve money consists of two things –
- Vault cash in banks and
- Deposits of commercial banks with RBI.
- Banks hold a part of the money, that people keep in their bank deposits as reserve money and loan out the rest to various investment projects.
- Banks use this reserve to meet the demand for cash by account holders.
- However, RBI requires commercial banks to keep reserves in order to ensure that banks have a safe cushion of assets to draw on when account holders want to be paid.
- RBI uses various policy instruments to bring forth a healthy rdr in commercial banks.
- The first instrument is the Cash Reserve Ratio which specifies the fraction of their deposits that banks must keep with RBI.
- There is another tool called Statutory Liquidity Ratio which requires the banks to maintain a given fraction of their total demand and time deposits in the form of specified liquid assets.
- Apart from these ratios RBI uses a certain interest rate called the Bank Rate to control the value of rdr.
- Commercial banks can borrow money from RBI at the bank rate when they run short of reserves. A high bank rate makes such borrowing from RBI costly and, in effect, encourages the commercial banks to maintain a healthy rdr.
|Q. When the Reserve Bank of India announces an increase of the Cash Reserve Rate, what does it mean? [CSE -2010]
4.3 COMMERCIAL BANKS
- Commercial Banks accept deposits from the public and lend out this money to interest earning investment projects.
- The rate of interest offered by the bank to deposit holders is called the ‘borrowing rate’ and the rate at which banks lend out their reserves to investors is called the ‘lending rate’.
- The difference between the two rates, called ‘spread’, is the profit that is appropriated by the banks.
- Deposits are broadly of two types – demand deposits, payable by the banks on demand from the account holder, e.g. current and savings account deposits, and time deposits, which have a fixed period to maturity, e.g. fixed deposits.
|Q. Which of the following is not included in the assets of a commercial bank in India?
(d) Money at call and short notice
|Function of Commercial Banks|
|Primary||Accepting deposit and Providing loans|
|Collection and payment of various items e.g. Cheques, Bills
Purchase and sell of securities & remittance of money
Purchase and sell of foreign exchange
Acting as executors and trustees of wills & underwriting of shares
Lockers facility & Travellers’ cheque and letter of credit
|Q.The main functioning of the banking system is to________ (CDS-2013)
|5. VALUE OF MONEY|
- By value of money, we mean the purchasing power of money.
- Purchasing Power is the amount of goods or services that can be purchased with a unit of currency.
- When the value of money rises i.e. its purchasing power increases, the general price level falls and vice versa. This means the value of money is inverse of the general price level.
- For instance, at a point of time, Rs. 10 were able to purchase 2 packets of biscuits, but on another times it can buy only one packet because of erosion of purchase power of that currency. This also results in increased purchase power of biscuit packet, it became Rs.7.
|6. DEMAND FOR MONEY|
- Money is the most liquid of all assets in the sense that it is universally acceptable and hence can be exchanged for other commodities very easily.
- On the other hand, it has an opportunity cost. If, instead of holding on to a certain cash balance, you put the money in a fixed deposits in some bank you can earn interest on that money.
- Total demand for money in an economy is composed of transaction demand and speculative demand. Demand for money balance is thus often referred to as liquidity preference.
- People desire to hold money balance broadly for following motives-
6.1 TRANSACTION MOTIVE
- The principal motive for holding money is to purchase goods and services in day to day life and carry out transactions
- The transaction demand for money in the economy is fraction of the total volume of transactions in the economy over the unit period of time.
- The total value of annual transactions in an economy includes transactions in all intermediate goods and services and is clearly much greater than the nominal GDP.
- An increase in nominal GDP implies an increase in the total value of transactions.
6.2 SPECULATIVE MOTIVE
- When people wish to hold money rather than buying assets/bonds/risky investment. An individual may hold her wealth in the form of landed property, bullion, bonds, money
- Different people have different expectations regarding the future movements in the market rate of interest based on their private information regarding the economy.
- Speculative demand for money is inversely related to the rate of interest can be thought of as an opportunity cost or ‘price’ of holding money balance.
- g. If interest rates are high, and people expect interest rates to fall, then there is likely to be greater demand for buying bonds and less demand for holding money. If interest rates fall, then the price of bonds will rise.
6.3 PRECAUTIONARY MOTIVE
- The precautionary demand for money is the act of holding real balances of money for use in an emergency situation.
- As receipts and payments cannot be perfectly foreseen, people hold precautionary balances to minimize the potential loss arising from a contingency.
- The precautionary demand is dependent on the size of income, the availability of credit, and the rate of interest.
|7. OPPORTUNITY COST OF MONEY|
- Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made. Opportunity cost is also called the economic cost.
- Opportunity Cost = Return of Most Lucrative Option – Return of Chosen Option.
- As per microeconomics, opportunity cost is zero for free goods such as Air and common goods such as fish / grazing land.
- For public goods such as street light and defence, opportunity cost is involved (Government could have spent that much money on street lights rather than on military). Opportunity cost is not zero in case of public goods.
- If a commodity is provided free to the public by the government, then:
- The opportunity cost is zero.
- The opportunity cost is ignored.
- The opportunity cost is transferred from the consumers of the product to the taxpaying public.
- The opportunity cost is transferred from the consumers of the product to the government.
|8. DETERMINANTS OF MONEY DEMAND|
- The prevalent price level – High interest rate or price level will reduce demand for money and vice versa.
- Inflation level in an economy–Inflation level reduces demand for money because people prefer to save instead of expenditure because of price rise.
- Real income (Real GDP) – Real income is how much money an individual or entity makes after accounting for inflation.
- Disposable income–Higher the disposable income, there will be higher tendency to spend more.
- Innovation level in an economy.
|9. MONEY SUPPLY (MONETARY AGGREGATES)|
- The supply of money is a total stock of money in circulation among the public at a particular point of time.
- The measures of money supply in India are classified into four categories M1, M2, M3 and M4 along with M0.
- The classification of money supply was introduced in April 1977 by Reserve Bank of India.
- The term ‘the supply of money’ is synonymous with such terms as ‘money stock’, ‘stock of money’, ‘money supply’ and ‘quantity of money’. The supply of money at any moment is the total amount of money in the economy.
- The supply of money is the product of Money Multiplier (m) and the amount of high-powered money or the reserve money.
|Q. Which of the following measures would result in an increase in the money supply in the economy? [CSE -2012]
Select the correct answer using the codes given below:
9.1 RESREVE MONEY (M0)
- Reserve Money (M0): It is also known as High-Powered Money, monetary base, base money etc.
- Reserve Money is the monetary base of the economy.
Reserve Money (M0) = Currency in circulation + Bankers’ Deposits with the RBI + ‘Other’ deposits with the RBI.
- ‘Other’ deposits with RBI comprise mainly:
- deposits of quasi-government; other financial institutions including primary dealers,
- balances in the accounts of foreign Central Banks and Governments,
- Accounts of international agencies such as the International Monetary Fund.
9.2 NARROW MONEY (M1)
- In banking terminology, M1 is called narrow money as it is highly liquid and banks cannot run their lending programmes with this money.
- 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
9.3 BROAD MONEY (M3)
- The money component M3 is called broad money. With this money (which lies with banks for a known period) banks run their lending programmes.
- M3 = M1 + Time Deposits with the Banking System.
M4 = M3 + All deposits with Post Office Savings Banks (excluding National Savings Certificates).
- M3 and M4 are known as broad money.
|Q. Consider the following:
Which of these are included in Broad Money (M3)
|Q.Following are some components of money supply in India:
Which of the aforesaid items are components of narrow money (M1) in India?
HIGHEST LIQUIDITY TO LOWEST LIQUIDITY
- M1 ⇒ CURRENCY + DEMAND DEPOSITS + OTHER DEPOSITS
- M2 ⇒ M1 + POST OFFICE (ONLY SAVINGS)
- M 3⇒ M1 + TIME DEPOSITS
- M4 ⇒ M3 + POST OFFICE (TOTAL)
9.4 HIGH POWER MONEY
- The total liability of the monetary authority of the country, RBI, is called the monetary base or high powered money.
- It consists of currency (notes and coins in circulation with the public and vault cash of commercial banks) and deposits held by the Government of India and commercial banks with RBI.
- If a member of the public produces a currency note to RBI the latter must pay her value equal to the figure printed on the note.
- Similarly, the deposits are also refundable by RBI on demand from deposit-holders. These items are claims which the general public, government or banks have on RBI and hence are considered to be the liability of RBI.
- In general, therefore, this liability must be backed by an equal value of assets consisting mainly, gold and foreign exchange reserves. In practice, however, most countries have adopted a ‘minimum reserve system’
- By definition, money supply is equal to currency plus deposits –
M = CU + DD = (1 + cdr)DD
where, cdr = CU/DD.
- Assume, for simplicity, that treasury deposit of the Government with RBI is zero. High powered money then consists of currency held by the public and reserves of the commercial banks, which include vault cash and banks’ deposits with RBI. Thus,
H=CU+R=cdr.DD+rdr.DD=(cdr + rdr)DD
- The currency issued by the central bank is called ‘high power money’ because it is generally backed by supporting ‘reserves’ and its value is guaranteed by the government and it is the source of all other forms of money.
- In India, there are two sources of high power money supply:
- Sources of high power money supply
- Government of India
- The RBI issues currency notes of rupees 2, 5, 10, 20, 50, 100, 200, 500, and 2000 denominations which RBI calls as the ‘Reserve Money’.
- The RBI issues currency of one rupee notes and coins including coins of smaller denominations on behalf of the Government of India which accounts for around 2 per cent of the total high power money.
|RESERVE BANK OF INDIA|
|Notes in circulation||Foreign currency assets|
|Notes held in banking dept||Bill purchases and discounts|
|Deposits||Collaterals by commercial banks|
|Other liabilities||Loan and advances|
Gold coin bullion
|Supply of money remaining the same when there is an increase in demand for money, there will be (CSE-2013)
9.5 MINIMUM RESERVE
- The RBI is required to maintain a reserve equivalent of Rs. 200 crores in gold and foreign currency with itself, of which 115 crores should be in gold.
- Against this reserve, the RBI is empowered to issue currency to any extent. This is being followed since 1957 and is known as the Minimum Reserve System (MRS).
|10. MONEY MULTIPLIER|
- The money multiplier is maximum amount of broad money that could be created by commercial banks for a given fixed amount of base money and reserve ratio.
- Its value is determined in ratio of total money supply to the stock of the high-powered money in an economy.
- M– stock of money, H-stock of high powered money
- Clearly, its value is greater than 1.
- The Currency Deposit Ratio (cdr) and Reserve Deposit Ratio (rdr) plays an important role in determining money multiplier.
- cdr = C/DD ratio of the total deposit kept by commercial banks.
- rdr is the proportion of the total deposit kept by commercial banks.
- The money multiplier (M) is the inverse of the Reserve Requirement (R)
- M = 1/R
- Monetary base is the sum of currency in circulation and bank reserves.
|Q. The money multiplier in an economy increases with which one of the following?
VELOCITY OF MONEY CIRCULATION
- The number of times a unit of money changes hands during the unit period is called the velocity of circulation of money.
- It is the average number of times money passes from one hand to another, during given time period.
- g. you bought pen worth Rs.10 from shopkeeper, he uses same 10 rupee note to buy Coca-Colaàthen same currency note performed function of TWENTY Rupees. This is called “Velocity of money”
|11. FACTORS AFFECTING VELOCITY OF MONEY|
- Income distribution – Poor people immediately use their money. So, money in the hands of poor money has higher velocity.
- Business cycle – During booming period, production of goods and services increases, so there is higher demand for goods and services which leads to higher economic transactions so, higher velocity and vice versa
- If more people use EMI loans for purchase, it will result in higher velocity of money.
- Developed countries have higher velocity of money, because of higher spending pattern and confidence in Government social-security.
A boom refers to a period of increased commercial activity within a business, market, industry, or economy as a whole.
|12.FACTORS AFFECTING MONEY SUPPLY|
- Monetary Base – A monetary base is the total amount of a currency that is either in general circulation in the hands of the public or in the commercial bank deposits held in the central bank’s reserves. If there is more of reserve money in the system, money supply would increase and vice versa.
- Monetary policy – RBI’s dear (tight) money policy reduces money supply in market. However, RBI’s cheap money policy increases money supply in market.
- People’s choice–When people deposit higher portion of their income in banks, it results in decreased money supply.
- Fiscal policy– Fiscal policy deals with the government policy concerning changes in the taxation and expenditure overheads and components.
- Business cycle–In boom cycle, money supply increases and in depression cycle, the money supply decreases.
- Money multiplier
- Money supply will decrease if: –
- Higher Taxation – as it will reduce money in the market.
- Sale of Government Securities (G-sec) –peoples will purchase this, so it will reduce money supply.
- Deficit financing by government will increase money supply, so the level of inflation also increases.
Business cycle is fluctuations in economic activity that an economy experiences over a period of time. Business cycles are generally measured using the rise and fall in the real gross domestic product (GDP) or the GDP adjusted for inflation. It is also known as the economic cycle or trade cycle.
|Q. Which of the following measures would result in an increase in the money supply in the economy? (CSE-2012)
|13. DETERMINANTS OF MONEY SUPPLY|
- Reserve Ratio–higher reserve ratio (e.g. CRR, SLR, Repo rate) reduces the available money with bank to lend, so it reduces money supply and vice versa.
- The Level of Bank Reserves–higher bank reserves reduces the available money with bank.
- Public’s Desire to Hold Currency and Deposits–higher deposits by public reduces money supply in the market.
- Money Multiplier – this refers to how an initial deposit can lead to bigger final increase in the total money supply.
- Interest rates– higher interest rates discourages the borrowings by people from the bank. So it reduces money supply.
|Q. With reference to inflation in India, find correct statement:
WHY IS SAVINGS/CURRENT ACCOUNT BALANCE TREATED AS MONEY?
- This is because to settle a transaction, you can draw a cheque against these accounts. These deposits are also called demand deposits because they are payable by the bank on demand from the account holder.
- However, cheques drawn on savings or current accounts can be refused by anyone as a mode of payment. Thus they are not legal tenders. This is because cheques (or drafts) are just an instrument for transacting but it has no value of its own.
|14. CREDIT CREATION IN INDIA|
- A situation in which banks make more loans available to consumers and businesses, which results in creation of credit in the overall economy.
- Credit is created by commercial banks in two ways-
- Advancing loans
- By purchasing securities.
- Banks maintain some part of deposits as liquid cash, termed as cash reserve. This is in minimum requirement as specified by RBI. The excess or surplus is given out as loans and advances.
- When giving a loan, banks open deposit account in the name of the borrower. This is known as secondary or derivative deposit.
- The deposit left after giving out loans is known as credit multiplier. Thus, credit is created from secondary deposits.
- Credit multiplier indicates the number of times primary deposits multiplies and is the inverse of CRR.
Primary deposits refer to that sum of money which is deposited in the bank accounts while opening such accounts.
Secondary deposit or derivative deposit is the deposit of credit created by the bank to the borrower while lending loan.
TYPES OF CREDIT CREATION
The need for credit comes from demand and supply side of the economy. The consumers of demand side require credit to acquire simple assets like consumer durables. The demand for credit from supply side corporate houses arises due to their needs for long-term investments. Types of loans:
- Commercial loans: Loans which are given to supply side. These are given for 2 purposes:
- For acquiring fixed assets
- For maintaining the business
- Individual loans: Loans which are given to demand side. These are given for:
- Acquiring durables
- Installment credit: Credit amount is decided in advance and the amount is disbursed either in stages or all at once. It is however, repaid in installments.
- Operating credit: This is given to meet the daily credit requirements for operations. Banks decide the credit limit and provide a current account from which money can be withdrawn.
- Receivable finance: Credit is in form of bills of finance.
|Types of loans|
- Banks are able to diversify the operational risks with the help of credit creation.
- The loans and advances are generally done from excess or surplus reserves.
- This money which is lying passive joins the active process of credit creation.
- It is directly dependent on the volume of excess reserves available with the banks.
- Cash Reserve Ratio (CRR) – CRR is the quantum which bank should keep with RBI as safety measure. The minimum cash limit of the bank which varies from 3-15%. Any increase in CRR leads to less availability of the credit.
- Risk – Averse nature of customers which makes them keep some cash with them for emergencies while banks prefer giving more loans to keep credit creation going.
- Periods of economic recessions call for less loan demands from the customers.
|15. MONETARY POLICY OF RBI|
- Monetary policy refers to all those operations, which are used to control the money supply in the economy.
- RBI reviews its monetary policy every two months (Six times in a year)
- The RBI implements the monetary policy through open market operations, bank rate policy, CRR, SLR, reserve system, credit control policy, moral persuasion etc.
15.1 OBJECTIVE OF MONETARY POLICY
- To maintain economic and financial stability – by targeting healthy inflation range.
- To ensure adequate financial resources for the purpose of development.
- Ensuring price stability in market by maintaining optimum inflation level.
- Adequate flow of credit to productive sectors.
- Promotion of productive investments & trade by ensuring conducive monetary policy, E.g. by credit rationing tool.
- Promotion of exports and economic growth – by providing timely credit and favourable monetary stimulus through various monetary policy tools.
|Q. An increase in the Bank Rate generally indicates that_____(2013)
15.2 TOOLS OF MONETARY POLICY
- TOOLS OF MONETARY POLICY
- Quantitative Instruments
- Qualitative Instruments
(NOTE- details of monetary policy tools have been discussed in Banking chapter)
|Q. Consider the following: (CSE-2015)
Which of them is/are part of Monetary Policy?
|16. MONETARY POLICY COMMITTEE (MPC)|
- Monetary policy refers to the credit control measures adopted by the central bank of a country. RBI is the sole monetary authority which decides the supply of money in the economy.
MPC is a statutory body created under Monetary Policy Framework Agreement 2015 between the RBI and Government in 2016
- MPC is entrusted with the responsibility of fixing the benchmark repo rate (policy rate) required to contain inflation as defined in the Monetary Policy Framework Agreement.
- The meetings of the MPC are held at least 4 times a year and it publishes its decisions after each such meeting.
- MPC is 6-member body including 3 members from RBI and 3 members to be nominated by the Central Government.
- Chairperson of MPC – RBI Governor
- Quorum for meeting – 4 members
- Decisions are taken by majority with the Governor having the casting vote in case of a tie.
- To ensure transparency – Govt can send message only in writing.
- Committee must publish its proceedings of the meeting on the 14th day, and “Monetary policy report” at every 6 months.
|RBI SIDE||GOVT. SIDE|
|3 members – RBI Governor, Dy. Governor, One nominated person -will be from RBI side.
RBI Governor (Shri Shaktikanta Das), as the Ex-officio Chairman.
|3 members will be selected from government side.|
|Their tenure tied with their ex-officio job tenure.||Tenure: 4 years, no reappointment.|
|RBI Governor & Dy. Governor are selected by Financial Sector Regulatory Appointment Search Committee (FSRASC), headed by Cabinet Secretary (IAS)||They’re selected by Search-cum-Selection Committee headed by Cabinet Secretary (IAS)|
- Inflation target is decided by Union Government after consulting with the RBI Governor.
- The present mandate of the committee is to maintain 4% annual inflation (until March 31, 2021) with bandwidth of ceiling 6% and a floor of 2%.
- If Target fail: If inflation not kept in 4% +/-2% zone for 3 consecutive quarters then the Committee must send report to Govt. with reasons and remedies.
- It is a monetary policy where a central bank follows an explicit target for the inflation rate for the medium-term and announces this inflation target to the public.
- The Government of India has notified a medium-term inflation target of 4 %, with a band of +/- 2 %
16.1 OBJECTIVE OF MPC
- Price Stability for promoting economic development through ensuring optimum inflation level which will drive economic growth in long run.
- Controlled Expansion of Bank Credit with special attention to seasonal requirement (E.g. for agricultural purposes) for credit without affecting the output.
- Promotion of Fixed Investment to increase the productivity of investment by restraining non-essential fixed investment.
- Promotion of Exports and Food Procurement Operations by paying special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.
- Desired Distribution of Credit – Monetary policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.
- Equitable Distribution of Credit to all sectors of the economy and all social and economic class of people.
- To promote economic efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
- Reducing the Rigidity and encouraging more competitive environment and diversification.
The Chakravarty committee has emphasized that price stability, growth, equity, social justice, promoting and nurturing the new monetary and financial institutions have been important objectives of the monetary policy in India.
(NOTE – Detailed topic has been discussed in Banking chapter)
|Q. Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? [CSE-2017]
Select the correct answer using the code given below:
|17. FINANCIAL LIQUIDITY|
- Liquidity refers to the amount of liquid assets that are available to pay expenses and debts as they become due. It is availability of cash or cash equivalents to meet short-term operating needs.
- Bank leverages the deposits for lending in the economy which is known as ‘credit creation’ by banks. This credit creation is almost like fresh money injected in the economy and contributes to inflationary pressures.
- Liquidity in the economy should strike a balance between requirements of growth and at the same time keep the prices under check. Managing liquidity is a major aspect of the RBI functions.
- Money deposited in the bank is a source of liquidity. Money deposited could either be ‘demand’ deposits (payable by the bank on demand by a customer. Like, money retained in your savings account in the bank can be withdrawn by you at any time) or, ‘time’ deposits (can be withdrawn after a fixed period only like fixed deposits). Both demand as well as time deposits are the liabilities of the bank as the bank has to pay it back to the customer.
- These demand and time liabilities of the banking system are the source of increasing liquidity.
|18. LIQUIDITY TRAP|
- A liquidity trap is when monetary policy becomes ineffective due to very low interest rates combined with consumers who prefer to save rather than invest in higher-yielding bonds or other investments.
- A liquidity trap means consumers’ preference for liquid assets (cash) is greater than the rate at which the quantity of money is growing.
- While a liquidity trap is a function of economic conditions, it is also psychological since consumers are making a choice to hoard cash instead of choosing higher-paying investments because of a negative economic outlook.
18.1 REASONS FOR LIQUIDITY TRAP
- Expectations of deflation by the public
- Preference for saving – Liquidity traps occur during periods of recessions and a gloomy economic outlook.
- Credit Crunch – Banks lost significant sums of money in buying sub-prime debt, which defaulted. Therefore, they are seeking to improve their balance sheets by restricted lending activities.
- Banks don’t pass Base Rate cuts onto consumers
- Ineffective monetary policy transmission
- Unwillingness to hold bonds – If interest rates are zero, investors will expect interest rates to rise sometime. If interest rates rise, the price of bonds falls.
|19. VARIOUS TERMS FOR CURRENCIES|
19.1 HARD CURRENCY
- It is the international currency in which the highest faith is shown and is needed by every economy.
- It is strongest currency of the world, one which has a high level of liquidity. Basically, the economy with the highest as well as highly diversified exports, that are compulsive imports for other countries (high-level technology, defence products, lifesaving medicines and petroleum products) will also create high demand for its currency in the world and becomes the hard currency. It is always scarce.
- Meanwhile, by late 2015, the IMF allowed the SDR to be denominated in the Chinese ‘Yuan’–paving the way for a new hard currency to be implemented in 2016.
19.2 SOFT CURRENCY
- A term used in the foreign exchange market which denotes the currency that is easily available in any economy in its forex market.
- For example, rupee is a soft currency in the Indian forex market. It is basically the opposite term for the hard currency.
19.3 HOT CURRENCY
- Hot currency is a term of the forex market and is a temporary name for any hard currency.
- Due to certain reasons, if a hard currency is exiting an economy at a fast pace for the time, the hard currency is known to be hot.
- As in the case of the South East Asian crisis, the US dollar had become hot.
19.4 HEATED CURRENCY
- A term used in the forex market to denote the domestic currency which is under enough pressure (heat) of depreciation due to a hard currency’s high tendency of exiting the economy (since it has become hot).
- It is also known as ‘currency under heat’ or ‘under hammering’.
19.5 CHEAP CURRENCY
- A term first used by the economist M. Keynes (1930s). If a government starts re-purchasing its bonds before their maturities (at full-maturity prices) the money which flows into the economy is known as the cheap currency, also called cheap money.
- In the banking industry, it means a period of comparatively lower/softer interest rates regime.
19.6 DEAR CURRENCY
- This term was popularised by economists in early 1930s to show the opposite of the cheap currency. when a government issues bonds, the money which flows from the public to the government or the money in the economy in general is called dear currency, also called as dear money.
- In the banking industry, it means a period of comparatively higher/costlier interest rates regime.
19.7 HELICOPTER MONEY
- It is a hypothetical concept put forward by the economist, Milton Friedman.
- This involves the central bank of the country printing currency notes and distributing it to the people free of cost.
- The idea here is to promote demand in the economy during recession.
|20. CURRENCY IN INDIA|
- In India, the paper currency was first issued during British East India Company rule.
- The first paper currency issued in India was the Rs. 1 note. The first paper notes were issued by the private banks such as Bank of Hindustan and the presidency banks during late 18th century.
|21. CURRENCY CIRCLE|
- After the 1861 act, the Government of India had the monopoly to issue paper notes in India.
- The lack of mobility, lack of development and lack of education resulted in a major issue in redemption of these notes.
- Consequently, there were only some areas (such as major cities and nearby areas) in various parts of country, where the paper notes of Indian government were legal tenders. These areas were called “Currency Circles”.
|22. CURRENCY CONTROLLER IN INDIA|
- Section 22 of the RBI Act 1934 provided that RBI has the sole right to issue Bank notes of all denominations.
- Thus, on 1 April 1935, the currency function moved from Controller of Currency to RBI.
- Today, Reserve Bank is responsible for the design, production and overall management of the nation’s currency, with the goal of ensuring an adequate supply of clean and genuine notes.
|23. DECIMALIZATION OF COINAGE|
- During time of independence, the basic unit of Indian currency was 1 Rupee which could be divided into 16 Annas or 64 pice (pice was old spelling of paise)
- This 16 Anna or 64 Pice structure remained till 1957, when decimalization of the coinage was done.
- Henceforth, spelling of “pice” was changed to “Paisa” and 1 Rupee was divided into 100 Paise. This is called Decimalization of Coinage and it took place in 1957. The 100th part of Rupee was now called Naya Paisa. The term “naya” was dropped in 1964.
|24. ROLE OF RBI W.R.T. COINS IN INDIA|
- The distribution of Coins is undertaken by RBI as an agent of the Government, (coins are minted by the Government and not by RBI).
- However RBI is the only source of legal tender money because distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government.
|25. CURRENT PAPER NOTES IN CIRCULATION|
- At present, paper currency notes in India are issued in the denomination of Rs.5, Rs.10, Rs.20, Rs.50, Rs.100, Rs.200, Rs.500 and Rs.2,000.
- The printing of Rs. 1 and Rs. 2 denominations has been discontinued, though the notes in circulation are valid as per the Coinage Act 2011.
- RBI has been authorized to issue notes of Rs. 5000 and Rs. 10000 also. In fact, as per RBI act, RBI can issue any note of any denomination but not exceeding Rs. 10,000. The notes denomination is notified by Government and RBI acts accordingly.
|26. SIGNATURE ON CURRENCY NOTES|
- Under Section 22 of the Reserve Bank of India Act, RBI has sole right to issue currency notes of various denominations except one rupee notes.
- Signature on currency notes is of the incumbent RBI Governor.
- The One Rupee note is issued by Ministry of Finance and it bears the signatures of Finance Secretary.
|27. PROPORTIONAL RESERVE SYSTEM|
- Originally, the assets of the Issue department were to consist of not less than 2/5th of the Gold or sterling securities, provided Gold was not less than Rs. 40 Crores in value.
- Remaining 3/5th of the assets might be rupee coins. This was called “Proportional Reserve System”. In 1956, this system was changed.
- Now, RBI is required to maintain a Gold and Foreign Exchange Reserves of 200 Crore, of which at least Rs. 115 Crore should be in Gold.
- Against minimum reserve, the RBI is empowered to issue currency to any extent. This is being followed since 1957 and is known as the Minimum Reserve System (MRS).
|28. CURRENCY CHESTS|
- Currency chests are storehouses where bank notes and rupee coins are stocked on behalf of the Reserve Bank.
- The currency chests have been established with State Bank of India, six associate banks, nationalized banks, private sector banks, a foreign bank, a state cooperative bank and a regional rural bank.
- Deposits into the currency chest are treated as reserves with the Reserve Bank and are included in the Cash Reserve Ratio.
|29. PRINTING PRESS IN INDIA FOR BANK NOTES|
- Note Press (CNP), Nasik (Maharashtra) established in 1928, was the first printing press for banknotes in India.
|No. of press||Four printing presses print and supply banknotes|
|Owned by Govt.||The presses in Madhya Pradesh and Maharashtra are owned by the Security Printing and Minting Corporation of India (SPMCIL), a wholly owned company of the Government of India.
SPMCIL is the only PSU under the Department of Economic Affairs (MoF)
|Owned by RBI||The presses in Karnataka and West Bengal are owned by the Bharatiya Reserve Bank Note
Mudran Private Limited (BRBNMPL), a wholly owned subsidiary of the Reserve Bank. The Government of India is the issuing authority of coins and supplies coins to the Reserve
|Coins||The Government of India is the issuing authority of coins and supplies coins to the Reserve Bank on demand
The Reserve Bank puts the coins into circulation on behalf of the Central Government.
|30. LANGUAGES ON CURRENCY NOTES|
- The amount of a banknote is written on it in 17 (15 in panel on backside + Hindi + English) languages.
- The 15 languages in the panel are Assamese, Bengali, Gujarati, Kannada, Kashmiri, Konkani, Malayalam, Marathi, Nepali, Oriya, Punjabi, Sanskrit, Tamil, Telugu and Urdu.
|31. ISSUE DEPARTMENT AND CURRENCY DEPARTMENTS OF RBI|
- RBI has a separate department called issue department whose assets and liabilities are kept separate from the Banking Department.
- Currency Management function of Reserve Bank is carried out at the “Department of Currency Management” located at Central Office Mumbai.
- There are 19 Issue offices. RBI authorizes selected branches of Banks to establish Currency Chests and Coin Deposits.
MONEY PART – 2
|1. LEGAL TENDER MONEY|
- The ‘Legal tender’ is the money that is recognised by the law of the land, as valid for payment of transactions and debts.
- Denomination of a country’s currency by law, must be accepted as a medium of exchange and payment for a money debt.
- While usually all denominations of the circulating paper money are legal tenders, the denomination and amount in coins acceptable as legal tender varies from country to country. This is also called lawful money.
- The RBI Act of 1934, which gives the Central Bank the sole right to issue bank notes, states that “Every bank note shall be legal tender at any place in India in payment for the amount expressed therein”.
- The recognition or cancellation of the legal tender status is important because paper money derives all its value from the Government’s recognition of it.
- The legal tender money is of two types:
- Limited Legal Tender Money
- Unlimited Legal Tender Money
|Q. Which one of the following statements correctly describes the meaning of legal tender money?
|Limited Legal Tender Money||Unlimited Legal Tender Money|
|This is a form of money, which can be paid in discharge of a debt up to a certain limit, and beyond this limit, a person may refuse to accept the payment and no legal action can be taken against.
Coins are limited legal tender in India.
|In this form of money, this can be paid in discharge of a debt of any amount.
A person who refuses to accept this money a legal action can be taken against.
Paper notes/currency are unlimited legal tender in India.
|2. BLOCK CHAIN AND DISTRIBUTED LEDGER TECHNOLOGY (DLT)|
- Blockchain, sometimes referred to as Distributed Ledger Technology (DLT), makes the history of any digital asset unalterable and transparent through the use of decentralization and cryptographic hashing.
- Blockchain Technology was invented by Satoshi Nakamoto in 2008 for use in the crypto-currency bitcoin, as its public transaction ledger.
- Satoshi Nakamoto’s aim in creating the decentralized Bitcoin ledger – the blockchain – was to allow users to control their own money so that no third party, not even the government, would be able to access or monitor it.
- Blockchain consists of three important concepts: blocks, nodes and miners.
- Blocks – Blocks are files where data pertaining to the bitcoin network are permanently recorded. A block is like a page of a ledger or record book.
- Nodes can be any kind of electronic device that maintains copies of the blockchain and keeps the network functioning.
- Miners create new blocks on the chain through a process called mining.
- A Cryptocurrency is an internet-based medium of exchange which uses cryptographical functions to conduct financial transactions.
- It leverages blockchain technology to gain decentralization, transparency, and immutability (ability of a blockchainledger to remain unchanged, unaltered and indelible)
- The most important feature of a cryptocurrency is that it is not controlled by any central authority – the decentralized nature of the blockchain makes cryptocurrencies theoretically immune to the old ways of government control and interference.
3.1 EVOLUTION OF CRYPTO CURRENCY
- The first decentralized cryptocurrency, bitcoin, was created in 2009 by presumably pseudonymous developer Satoshi Nakamoto.
- Subprime crisis and recession in 2008-2009 leads to Quantitative Easing (the introduction of new money into the money supply by a central bank) of dollar in US which increased dollar supply and led to erosion of purchasing power dollar
- Banks charge fees on online transfer, credit card, ATM
- It is an electronic or digital currency that works on a peer-to-peer basis. It is decentralized and has no central authority controlling it.
- Bitcoins can be sent digitally to anyone who has a bitcoin address anywhere in the globe. One person could have multiple addresses for different purposes – personal, business and the like.
- Satoshi Nakamotoproposed bitcoin, which was an electronic payment system based on mathematical proof.
- A bitcoin is not printed currency but is a non- reputable (assurance that someone cannot deny the validity of something) record of every transaction that it has been through. All this is part of a huge ledger called the blockchain.
- Since no authority controls the generation of the coins or tracks them, the system itself is designed in such a way that the network maintains a foolproof system of the record of every transaction as well as tracking issuance of the currency sent without either side knowing the identity of the other
- Bitcoins are ‘mined’ using computing power in a distributed network.
- It’s the first example of a growing category of money known as cryptocurrency.
|Q. With reference to ‘Bitcoins’ sometimes seen in the news, which of the following statements is/are correct? (CSE-2019)
Select the correct answer using the code given below.
- There’s a new cryptocurrency called Libra to be rolled out by Facebook by 2020.
- It wants to be a ‘global currency’, one that can be used to transfer money anywhere in the world without any transaction fees.
- It is the asset-backed cryptocurrency meant to revolutionize international money.
Asset-backed cryptocurrencies are crypto coins that have a link to an object with economic value.
|6. CRYPTO-CURRENCIES VS DIGITAL CURRENCIES|
|Cryptocurrencies are decentralized, and the regulations inside the network are governed by the majority of the community.||Digital currencies are centralized, meaning that transaction within the network is regulated in a centralized location, like a bank.|
|Cryptocurrencies are transparent. Anyone and everyone is able to see any and all transactions made and received by any user, as all revenue streams are placed in a public chain – the blockchain.||Digital currencies are not transparent. With digital currencies, you cannot choose the address of the wallet and see all money transfers since the beginning of time. This information is kept strictly confidential and private.|
|Cryptocurrencies are regulated by their respective communities.
Most countries have some legal framework surrounding digital currencies.
|Digital currencies have a central authority that can deal with any problems or issues. This central body can, for example, freeze or cancel transactions on the request of the participant or the authorities.|
|An Encrypt Form Of Digital Currency.||A Unified Electronic Cash-form.|
|7. RBI BANNED CRYPTOCURRENCIES IN 2018|
- Cryptocurrencies are a poor unit of account, as demonstrated by their frequent and high fluctuation in value.
- They pose several risks, including anti-money laundering and terrorism financing concerns for the state and liquidity, credit, and operational risks for users.
- On the perspective of consumers, issues linked to crypto-currencies are heightened by the striking paucity of information on their design, use and operation and indications of market manipulation.
- It is possible that the business models of commercial banks may be seriously disrupted.
|8. RBI’ STAND ON DECENTRALISED DIGITAL CURRENCY (VIRTUAL) CURRENCY|
- No central bank has authorized Bitcoins.
- Not traded through BSE, NSE or Commodity exchange (SEBI, FMC)
- No Forex dealers under FEMA can convert Fiat currency into Bitcoin or vice versa
- Bitcoin Exchange websiteàLegal status unclear
- Danger of Hacking, Phishing, Malware, Password lost
- Consumer courts cannot help in this regard
- Poses high risk of speculation & volatility
- Mere digital code, no intrinsic value, not backed by Gold, silver or crude oil etc.
- Media reports on use for illegal drug, money laundering, terror-financing.
- Unintentionally breaching anti-money laundering / Anti-terror laws
- Same for all Digital currencies / virtual currencies
|9. BAN OR REGULATE? – INDIA’S POLICY ON CRYPTOCURRENCIES|
- The recommendation of an inter-ministerial committee that India should ban all private cryptocurrencies, that is, Bitcoin and others like it, hardly comes as a surprise.
- Finance Minister, in his Budget speech in 2018, said the government doesn’t consider them legal tender.
- The RBI has repeatedly warned the public of the risks associated with cryptocurrencies.
|10. CONCERNS WITH CRYPTO -CURRENCIES|
- A May 2019 article by Bloomberg, citing data from blockchain analysis firm Chainalysis, said “speculation remains Bitcoin’s primary use case”.
- Its use in illegal online marketplaces that deal with drugs and child pornography is well-documented.
- There have been cases of consumers being defrauded, including in India.
- Given all this, it is understandable that the committee, under the chairmanship of Subhash Chandra Garg, the former Economic Affairs Secretary, has come across as being cautious of private cryptocurrencies even while advocating a central bank-issued cryptocurrency.
|11. CRYPTO-CURRENCY PANEL FOR BAN ON PRIVATE DIGITAL CURRENCIES|
- The committee headed by finance secretary Subhash Chandra Gargset up to look into the legality of cryptocurrencies and blockchain has submitted its report to the Finance Ministry and recommended that private cryptocurrencies be banned completely in India.
- The committee notes with serious concern mushrooming of cryptocurrencies almost invariably issued abroad and numerous people in India investing in these.
- The Committee, however, leaves the door open for the central bank issued cryptocurrencies, adding that it endorsed the RBI’s stance of banning any sort of interface of cryptocurrencies with the banking system in India.
- The Committee recommends that all private cryptocurrencies, except any cryptocurrency issued by the state, be banned in India.
- It endorses the stand taken by the RBI to eliminate the interface of institutions regulated by the RBI from cryptocurrencies.
- However, the report goes on to say that it would be advisable to “have an open mind” regarding the introduction of an official, government-backed cryptocurrency in India.
- But it also added that it is currently unclear what the advantages of such a currency in India would be.
|12. BANNING OF CRYPTOCURRENCY & REGULATION OF OFFICIAL DIGITAL CURRENCY BILL, 2019|
- The Subhash Chandra Garg committee has drafted a law which mandates a fine and imprisonment of up to 10 years for offences.
- The draft law says that anybody who mines, generates, holds, sells, deals in, transfers, disposes of or issues cryptocurrencies with will face a fine and/or jail time of between 1 and 10 years.
- All the cryptocurrencies have been created by non-sovereigns.
- They do not have any intrinsic value of their own and lack any of the attributes of a currency.
- That is, they neither act as a store of value nor are they a medium of exchange in themselves.
- These cryptocurrencies cannot serve the purpose of a currency.
- The private cryptocurrencies are inconsistent with the essential functions of money/currency, hence private cryptocurrencies cannot replace fiat currencies.
|13. ADVANTAGES OF DLT AND BLOCKCHAIN|
- Distributed ledger technology (DLT) is a digital system for recording the transaction of assets in which the transactions and their details are recorded in multiple places at the same time.
- Unlike traditional databases, distributed ledgers have no central data store or administration functionality.
- While the committee has taken a strong stance against cryptocurrencies, it has highlighted the benefits of the DLT technology and blockchain.
- The Committee recommends that blockchain based systems may be considered by MEITY for building a low-cost KYC system that reduces the need for duplication of KYC requirements for individuals.
- DLT-based systems can be used by banks and other financial firms for loan tracking, collateral management, fraud detection, claims management in insurance
- Similarly, DLT can be beneficial for removing errors and frauds in land markets if the technology is implemented for maintaining land records.
- The Committee therefore recommends that various state governments may examine the feasibility of using DLT for land-records management.
|14. SUPREME COURT ON CRYPTOCURRENCY (2020)|
- Recently, the Supreme Court struck downa circular of RBI, which bans financial institutions from enabling deals in digital or cryptocurrencies.
- The ban that came into force in April 2018, had crippled the Indian cryptocurrency industry.
- This ban was challenged by the Internet & Mobile Association of India (IAMA)in the Supreme Court, the IAMA pleaded that dealing and trading in cryptocurrency was a legitimate business activity and that the RBI did not have jurisdiction over it as these assets could be classified as commodities rather than currency.
- Economic Dimension: While the RBI had the power to take note of and deal with virtual currencies, the prohibition was excessive since it cut off the lifeline of otherwise legitimate trade.
- Administrative Aspect: An outright ban on virtual currencies would be a disproportionate measureby the government since many less intrusive measures are available.
- Constitutional Aspect: Theban was unconstitutional. It is in violation of the freedom to carry on trade guaranteed by Article 19(1)(g) of the Indian Constitution.
14.2 WAY FORWARD
- Rather than impose bans, it would be more pragmatic to institute awareness campaigns to alert investors to specific risks, and to monitor trades for fraud and scams.
- There is a need for RBI to formulate a detailed regulatory frameworkto license virtual currency intermediaries like exchanges.
- These local cryptocurrency exchanges could be asked to adhere to the KYC normsfollowed by stock exchanges.
- A vibrant cryptocurrency segment could add value to India’s financial sector. Thus, in the face of growing technological innovation in the financial sector, it is critical to strengthen the supporting regulatory frameworks of India that operate regardless of the nature of an instrument.
|15. NATIONAL PAYMENT CORPORATION OF INDIA (NPCI)|
- It is an umbrella organisation for operating retail payments and settlement systems in India. It is an initiative of RBI and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007.
- It has been incorporated as a “Not for Profit” Company under the provisions of Section 25 of Companies Act 1956 (now Section 8 of Companies Act 2013).
- National Financial Switch (NFS) is the largest network of shared automated teller machines (ATMs) in India.
- The ten core promoter banks are State Bank of India, Punjab National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Bank of India, ICICI Bank, HDFC Bank, Citibank and HSBC. In 2016 the shareholding was broad-based to 56 member banks to include more banks representing all sectors.
|Q. Which one of the following links all the ATMs in India? (CSE -2018)
|Q. Consider the following statements: (CSE-2017)
Which of the statements given above is/are correct?
|16. DIGITAL PAYMENTS|
- Recently various steps have been taken to promote digital payments in India.
- RBI has removed charges for payments via NEFT and RTGS and asked banks to pass on the benefits to customers.
- The merchant discount rate(MDR)charges applicable on payment via RuPay and UPI have been removed.
- All business companies with an annual turnover of ₹50 crore or more have been mandated to offer RuPay & UPI modes of payment to customers.
- RuPay and UPI are products of National Payments Corporation of India (NPCI).RuPay is the first domestic Debit and Credit Card payment network of India.
PAYMENT AND SETTLEMENT SYSTEMS IN INDIA: VISION-2018
Document published by RBI. The Vision-2018 aims at building best of class payment and settlement systems for a ‘less-cash’ India. The broad contours of Vision-2018 revolve around 5 Cs – coverage, convenience,
confidence, convergence and cost. To achieve these, Vision-2018 will focus on four strategic initiatives such as responsive regulation, robust infrastructure, effective supervision and customer centricity.
16.1 DIGITAL MODES OF PAYMENT SETTLEMENT
|Settlement type||Half- hourly batches||One on one settlement||One on one settlement|
|Min transfer limit||Rs.-||Rs. 2 lakh||Rs. 1|
|Max transfer limit
|No limit (Rs. 50,000 per transaction)||No limit
|Rs. 2 lakh
|Funds Transfer Speed||2 hours
|Available on certain days of week between stipulated time period (till 6PM)||24/7
|Online/ offline||Online/ offline||Online
DIGITAL PAYMENTS INDEX (DPI)
- The Reserve Bank shall construct and periodically publish a composite DPI to capture the extent of digitisation of payments effectively.
- The DPI would be based on multiple parameters and shall reflect accurately the penetration and deepening of various digital payment modes.
- The DPI will be made available from July 2020 onwards.
Committees related to Digital Payment in India
- Ratan Watal (2016)
- Nandan Nilekani (2019)
16.2 TRENDS IN DIGITAL PAYMENTS
Digital payments witnessed a Compounded Annual Growth Rate (CAGR) of 61% and 19% in terms of volume and value, respectively over the past 5 years. This demonstrates a steep shift towards digital payments.
ACCEPTANCE DEVELOPMENT FUND
- Recently, RBI announced setting up of Acceptance Development Fund to improve the last- mile payments network in rural India to transact digitally.
- It will be operationalized as a bank- sponsored development fund solely to improve payment infrastructure in Indian small towns and villages especially in Tier III to Tier VI centers, where most daily transactions are in cash.
DIGITAL COMPETITIVE INDEX
- Released by- IMD World Competitiveness Center.
- It was started in 2017 and measures the capacity and readiness of 63economies to adopt and explore digital technologies as a key driver for economic transformation in business, government and wider society.
- To evaluate an economy, WDCR examines 3 factors: Knowledge– capacity to understand and learn the new technologies; technology– competence to develop new digital innovations; and future readiness– preparedness for coming developments
|17. PLATFORMS FOR DIGITAL PAYMENTS|
17.1 UPI and UPI 2.0
- UPI is a payment system that allows money transfer between any two bank accounts by using a smartphone. It was launched in April 2016
- UPI allows a customer to pay directly from a bank account to different merchants, both online and offline, without the hassle of typing credit card details, IFSC code, or net banking/wallet passwords.
- It also caters to the “Peer to Peer”(P2P) collect request which can be scheduled and paid as per requirement and convenience.
- NPCI has upgraded the UPI as UPI 2.0 with enhanced features such as-
- Linking of overdraft account – Apart from the savings and current accounts, the UPI users can now link their overdraft account to it.
- One-time Mandate (account blocking) – It allows customers or merchants to pre-authorize a transaction and pay at a later date.
- Security Layer in QR – The app allows the users to scan the QR code and check the authenticity of the merchants through notification to the user to ascertain the information.
- Increased Transaction Limit From 1 lakh/day to 2 lakh/day.
- Signed intent and QR (Quick Response code): This feature helps customers to check the authenticity of merchants while scanning QR. It notifies the user with information to ascertain whether the merchant is a verified UPI merchant or not. This provides an additional security.
|Q. Which of the following is a most likely consequence of implementing the ‘Unified Payments Interface (UPI)’? [CSE-2017]
17.2 BHIM AND BHIM 2.0
- Bharat Interface for Money (BHIM)is a mobile payments application based on NPCI’s Unified Payments Interface (UPI).
- BHIM is developed by National Payments Corporation of India (NPCI)
- The BHIM app was launched in December 2016 by NPCI.
- A new and modified version of Bharat Interface for Money (BHIM), BHIM 2.0 has been launched under the Ministry of Electronics and Information Technology.
- Under BHIM 2.0, the existing cap of 20,000 has been increased to Rs. 1,00,000, from verified merchants.
- BHIM provides an easy and secure mode of money transfer for the users on a mobile platform. It provides the facility to easily send or receive money from other customers using the UPI.
17.3 BHARAT QR
- A QR code consists of black squares arranged in a square grid on a white background, which can be read by an imaging device such as a camera.
- Bharat QR is P2M (Person to Merchant) Mobile payment solution. This solution is mutually derived among NPCI, Visa and Mastercard payment networks.
- Once the BQR codes are deployed on Merchant locations, user can pay the utility bills using BQR enabled mobile banking apps without sharing any user credentials to the merchant. It is a quick method of payment.
- Bharat QR transactions are different from POS In POS transaction, POS terminal is required whereas in Bharat QR transaction, QR Code is required.
- Aadhar Enabled Payments System is bank led model which allows online interoperable financial inclusion transactions at Point of Sale through the business correspondent of any bank using Aadhaar authentication.
17.5 EMV CARDS (EUROPAY-MASTERCARD-VISA)
- Debit card security standard that includes a small micro-chip in the debit card.
- The microprocessor chip embedded in the card prevent card skimming or cloning that is possible in magnetic stripe cards
ADVANTAGE OVER MAGNETIC STRIPE CARDS
- The magnetic stripe credit and debit cards store the data on the magnetic stripe found on the reverse side of the card.
- Fraudsters place a skimmer device inside the card swipe slot in ATMs or PoS terminals to read the customer data stored in the magnetic stripe.
- EMV chip cards prevent such skimming because they do not reveal the user data to the terminal at the time of swiping the card.
MOBILE MONEY IDENTIFIER (MMID)
MMID is a 7 digit number, issued by banks. Every bank account has only one MMID. Different MMID’s can be linked to same Mobile Number. MMID is one of the input which when clubbed with mobile number facilitates fund transfer. Combination of Mobile no. & MMID is uniquely linked with an Account number and helps in identifying the beneficiary details.
|18. MERCHANT DISCOUNT RATE (MDR)|
- MDR is the cost paid by a merchant to a bank for accepting payment by digital means from their customers, which is usually recovered from the customer.
- MDR also called as the Transaction Discount Rate (TDR)
- MDR is user-fee charged by the banks to merchants for facilitating card-based or digital transactions. It is charged as a percentage of the transaction amount.
- Recently the government has done away with MDR altogether for large-retails clearing the way for adoption of low-cost digital payments like BHIM UPI, UPI-QR Code, Aadhaar Pay etc.
|Q. Which one of the following best describes the term “Merchant Discount Rate” sometimes seen in news? (CSE-2019)
|19. PAYMENTS AND SETTLEMENTS SYSTEM|
- System that facilitates transfer of money from a payer to the beneficiary.
- The payment and settlement systems act, 2007provide for the regulation and supervision of payment systems in India and to designate the Reserve Bank of India as the authority for that purpose and for matters connected therewith or incidental thereto.
- It includes both paper based payments such as cheques, drafts as well as electronic payments such as Real Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT), immediate payment Service (IMPS), UPI etc.
|20. LABLES OF ATM IN INDIA|
The ATM entered India by late 1980s and have evolved into three of its types by now –
Bank’s own ATMs
|These are owned and operated by the concerned bank and carry the bank’s ‘logo’. They are the costliest way to provide such service to bank’s customers.|
Brown Label ATMs (BLAs)
|These are owned by third party (a non-banking firm). The concerned banks only handle part of the process that is ‘cash handling’ and ‘back-end server’ connectivity. These are ‘owned’ and ‘operated’ by a third party (a non-banking firm).|
White Label ATMs (WLAs)
|They do not bear ‘logo’ of the banks they serve. They are interconnected with the entire ATM network in the country. The Tata Communications Payment Solutions became the first such firm to get permission of the RBI – Brand name was “Indicash”.|
The 3rd parties have a mandate to deploy –
- 67% ATMs – Rural location
- 33% ATMs – Urban location
- g. – Tata communications payment solutions – first firm to get permission from RBI (‘Indicash’)
|21. CARD TYPES BASED ON PAYMENT MODALITY|
21.1 CREDIT CARDS (PLASTIC MONEY)
- It allows holder to make purchase on credit (loan), even if he may / may not have sufficient balance in his bank account at the time of purchase.
- Customer does shopping using credit cardà bank transfers concerned amount to merchant from bank’s own funds and later bank recovers same amount from customer.
- Customer can pay entire due amount at once or convert it into Equated Monthly Installments (EMI).
- Interest rate may be charged depending on billing cycle, grace period and other terms and conditions
- If Credit card used for withdrawing money from ATM, then it’s a type of ‘borrowing’, so, bank levies interest rate.
21.2 DEBIT CARDS (PLASTIC MONEY)
- It allows holder to make purchases upto the extent of the amount lying in own his bank balance.
- Customer does shopping using debit card àbank transfer concerned amount from customer’s own bank account to merchant.
- If he has insufficient balance, he may not be able to make purchase. Although nowadays e- commerce sites allow debit- card based EMIs.
- Debit card can be used to withdraw money from ATM from your existing bank balance. So, it’s not ‘borrowing’.
21.3 HYBRID CARD / DUO CARD
- Single card containing two chips for –
- credit card
- debit card.
- So, you don’t have to carry two separate cards. E.g. Indus bank Hybrid card.
21.4 PRE -PAID CARD
- It’s a subtype of debit card. While debit card is linked to a given bank account, a person can buy pre-paid card even without having account in the given bank e.g. IRCTC’s UBI prepaid card which can be used for buying rail tickets, meals etc.
|22. DIGITAL PAYMENT REGULATORY BODIES|
22.1 DIGITAL TRANSACTIONS OMBUDSMAN (2019)
- RBI designates senior RBI officials at 21 places across India as Digital Transactions Ombudsman (DTO)
- They will hear customer complaints upto ₹ 20 lakh against prepaid payment instruments, Mobile wallets, Apps, NEFT/RTGS and other digital transactions.
- They can order the company / bank to revert /settle the transaction and pay upto additional ₹ 1 lakh for mental agony of customeràHigher Appeal to Dy.Gov of RBI.
- If amount involved is more than ₹ 20 lakh, then matter outside his jurisdiction. Victim has to approach ordinary courts/consumer courts depending on the case matter.
In line with the recommendations of the report of the “committee on deepening of digital payments” chaired by Nandan Nilekani, RBI announced creation of a Payments Infrastructure Development Fund (PIDF). The 500 crores PIDF seeks to encourage acquirers to deploy Points of Sale (PoS) infrastructure for both physical and digital modes.
22.2 PAYMENT REGULATORY BOARD (PRB) (PROPOSED)
- 1998: Narasimhan-II Committee on Banking Reforms suggested regulatory framework for e-banking, card payment etc.
- 2007: Payment & Settlement Systems Act established Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) in RBI. All payment system providers have to register with RBI’s BPSS- whether bank, non-bank, wallet/Prepaid Payment Instrument (PPI) etc.
- 2016: Ratan Watal Committee on digital payment suggested replacing this BPSS with a Payments Regulatory Board (PRB) in RBI, to look after Interoperability, Consumer protection, Innovation, R&D in digital payments.
- 2018: Draft Payment and Settlement System Bill to implement it. But, RBI vs Government difference of opinion about who should be chairman, how many members from Government side etc.
|23. RECOMMENDATIONS OF NANDAN NILEKANI PANEL ON REFORMING RBI AND NPCI|
- RBI should prepare area wise ‘Digital Financial Inclusion Index’ to monitor progress & take remedial steps.
- Ensure no user is more than 5 kms away from a banking access point.
- Local vendor should be made Banking Correspondent(BC).
- Setup an Acceptance Development Fund (ADF) to develop digital payment infrastructure in poorly served areas (e.g. subsidy on PoS devices). RBI and Banks should co-contribute fiscal amount in this fund.
- Reduce the MDR / card payment fees – Allow customer to do “n” number of digital payment transactions per month with no charges.
- RBI should make NEFT available 24/7 and review charges on its usage. (June 2019: RBI removed charges on both NEFT and RTGS and asked the banks to pass on the benefits to customers.)
- NPCI should offer RuPay and BHIM UPI in other countries to facilitate remittance to India.
- Encourage local language apps/ software for digital payments.
|24. DEMONETISATION – CRITICAL ANALYSIS|
- Demonetization is the act of stripping a currency unit of its status as legal tender.
- Demonetization has been used as a tool to stabilize a currency and fight inflation, to facilitate trade and access to markets, and to push informal economic activity into more transparency and away from black and grey markets.
24.1 EARLIER DEMONETIZATIONS IN INDIA
- The first demonetisation was implemented in 1946(RBI demonetised Rs 1,000 and Rs 10,000 notes)
- The Morarji Desai government demonetised these notes in 1978.
24.2 POSITIVE IMPACTS OF DEMONETISATION
- Increase in tax collection and considerable increase in the number of Income Tax Returns (ITRs) filed. ITR registered an increase of 24.7%.
- Tackling Black Money – The government has identified more than 37000 shell companies which were engaged in hiding black money and hawala
- Impacts on terrorism, Naxalism, and trafficking – Due to demonetisation, terrorist and Naxalite financing has stopped almost entirely.
- The note ban had led to a huge fall in sex trafficking. Since demonetisation, no high-quality fake currency notes were found/seized by intelligence operations.
- Increase in digital transactions – digital transactions have increased by around 50-55% points since demonetisation.
- Increase in digital transactionsàRBI has to print fewer notes which save printing costs of the government.
Cash – to – GDP ratio – gives the ratio of cash currency available in the market to the total monetary value of GDP. Currency-to-GDP ratio as of March 2019 was 11.23% which is highest in three years.
Tax-to-GDP ratio represents the size of a country’s tax kitty relative to its GDP. It is a representation of the size of the government’s tax revenue expressed as a percentage of the GDP. Higher the tax to GDP ratio the better financial position the country will be in.
24.3 NEGATIVE IMPACT OF DEMONETISATION
- Poor Planning – At the time of demonetisation, the high-value notes constitute 87.5% of the currency value.
- Impacts on Jobs – As people ran out of money, they could not be able to pay which results into economic slowed down & supply-chain of informal sector gets affected.
- Impacts on Savings – Households are now holding far more of their savings in cash than in the year prior to demonetisation.
- Impacts on Government expenditure: by RBI cost the government around Rs 8000 crore during the period between July 2016-June 2017.
- Impacts on GDP – country’s growth rate, which was 7.5% in September 2016 declined to5.7% in June 2017 – reduction of 1.5%.
- It is still apparent that the corruption has not yet suppressed since demonetisation.
- The cash-GDP ratio has reached levels similar to the period before demonetisation.
- Stress in agriculture have begun to appear because of demonetization pertains to cash as the dominant mode of transaction in the agriculture sector.
- Banks are not in a position to considerably increase lending; their net interest income has decreased. Worsening their capital situation and their NPA situation got worse.
|25. MEASURES TO PROMOTE LESS CASH ECONOMY|
- Ratan Watal Committee to Finance Ministry for medium term recommendations to strengthen digital payment ecosystem.
- Chandrababu Naidu chief ministers’ Committee to PM to promote digital payment.
- HRD ministry’s Vittiya Saksharta Abhiyan wherein college students explain people about digital transactions.
- NITI and NPCI jointly launched lottery / cash back schemes for customers (Lucky Grahak) and merchants (Digi Dhan Vyapar). Government itself launched further referral bonus, cashback schemes for using UPI-BHIM.
- Budget-2017: Imposed ceilings the cash transactions, provided tax incentives to companies for using digital transactions, reduced custom duties on ATM related devices.
- Digidhan Mission (2017) – Ministry of Electronics and Information Technology (MeitY), to create awareness about digital payments.
- MeitY also launched a DIGIDHAN DASHBOARD web portal to monitor the digital transactions in India.
- Budget-2018: promised to explore blockchain technology for promoting digital economy.
- Budget-2019: Imposed Tax Deduction at Source (TDS) on withdrawal of ₹1 cr or more from a single user account.
- Digital Payment Abhiyan (2019- Sept) –launched by MEITY along with Google India and Data Security Council of India (DSCI, a not-for-profit organization by NASSCOM).
|26. BLACK MONEY- CRITICAL ANALYSIS|
- An income which is not declared by a person or a group of persons in a nation is termed as black money. It is also termed as ‘illegitimate’ as it goes unrecognized for the tax declaration.
26.1 MEANING OF BLACK MONEY
- There is no universal definition for black money in economics. In layman’s language, it is money that has been acquired through illegitimate means or money which is unaccounted for, that is, for which tax is not paid to the government.
- Cash transactions without proper accounting are classified as black money.
- Black money is hidden from government authorities and is not reflected in the GDP of India, national income, etc.
- White money is money that is earned through legitimate means and is accounted for, for which income or other tax is paid.
- In an ideal economy, all money that is transacted should be accounted for. This would help the government to collect taxes.
26.2 GENERATION OF BLACK MONEY
|The illegal activities that can lead to black money generation are:
§ Non-compliance with tax requirements
§ Complex procedural regulations
§ Money laundering
|This is where an entity wilfully does not pay taxes that are due to the government.
|This is where an entity takes advantage of the existing loopholes in the system and avoids paying taxes. This is not illegal though.
26.3 SOURCES OF BLACK MONEY IN INDIA
- Sellers or traders who do not give bills or receipt create black money.
- Many people invest in bullion or jewellery to hide their actual income from the authorities.
- In the real estate sector, many people undervalue their real assets to refrain from paying the rightful tax.
- Some SHGs and trusts do not provide proper sources for their funds and donations received.
- Tax havens – Tax havens are generally small countries where foreigners don’t have to pay taxes. These countries generally have very liberal regulatory frameworks, which big corporations take advantage of.
- Setting up of shell companies and redirect all their profits to this entity, by which they can reduce their tax liabilities by a huge margin.
- Investments through innovative derivative instruments like participatory notes (P-Notes) also are a means to hide black money.
26.4 EFFECTS OF BLACK MONEY
- It affects the financial system of the country. The central bank is not able to control money supply in the economy causing higher inflation. This will lead to a fall in the value of the currency.
- Black money affects the credibility of a country negatively.
- It is most often used for illegal activities such as drugs and narcotics dealing, terrorism, etc.
- The government suffers a big loss in the form of taxes because of black money.
- Black money creates a parallel economy in the country, which is completely underground.
- Black money can also cause real estate prices to go up, which may lead to an asset bubble.
26.5 MEASURES TAKEN TO CURB BLACK MONEY
- Tax reforms have been initiated with a view to resisting black money. The tax base has been increased and rates have been slashed. Reforms are being made to incorporate tax deduction at the source itself.
- Through the Black Money Bill 2015, the government has allowed the reporting of black money generated through tax evasion in a given time frame.
- Demonetisation of Rs.500 and Rs.1000 was carried out in 2016 with the primary view of making black money useless.
- The government is encouraging cashless/digital transactions with a view to making things more transparent.
- Electoral reforms are also intended to curb black money as much of the black money generated in India is used in elections.
26.6 LEGISLATIVE FRAMEWORK TO DEAL WITH BLACK MONEY
- Prevention of Corruption Act, 1988
- Benami Transactions Prohibition Act, 1988
- Prevention of Money Laundering Act, 2002
- The Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015
- Lokpal and Lokayukta Act, 2013
|27. MONEY LAUNDERING|
- Money laundering is the process by which black money is converted into white money.
- People who possess black money cannot spend it publicly. They should either hide it or spend it on the underground economy.
- Through money laundering, people separate the money earned (illegally) from its source, mix it with white money, and then funnel it back into the source.
- Another associated term is round–tripping. In this, people send money to a tax haven like Mauritius or Cayman Islands (to avoid paying tax) and then invest that money into India, thus becoming a foreign investment.
- Accommodative stance is taken when a central bank (such as RBI) attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP).
- The policy is implemented to allow the money supply to rise in line with national income and the demand for money.