Money and Banking Overview

Money and Banking Notes

The Meaning of Money

  • Definition: Money is any commodity that serves as a medium of exchange for purchasing goods and services.
    • Examples include:
    • Banknotes and coins (legal tender)
    • Gold
    • Bank account deposits

Forms of Money

  • Main forms of money in modern economies:
    • Cash:
    • Includes physical banknotes and coins.
    • Accounts for less than 3% of the UK's total money supply.
    • Convenient for small transactions but risky for larger amounts.
    • Bank Deposits:
    • Represents majority of money supply in electronic form.
    • Involves using credit/debit cards or online transfers.
    • Central Bank Reserves:
    • Money held by central banks for inter-bank payments, typically electronic.

Functions of Money

  1. Medium of Exchange:
    • Facilitates trade by being widely accepted for goods and services.
  2. Measure of Value (Unit of Account):
    • Standardizes the market value of goods and services, making price comparison easier.
    • Example: Expressing prices in dollars is more efficient than using commodities.
  3. Store of Value:
    • Maintains purchasing power over time, allowing flexibility in spending.
    • Example: Businesses can hold onto money for future needs instead of immediate spending.
  4. Standard of Deferred Payment:
    • Used as a basis for future payments, such as loan repayments.

Characteristics of Money

  • Durability:
    • Must last long enough to be practical for everyday use.
    • US dollar bills can be folded around 4000 times before ripping; last up to 9 years.
  • Acceptability:
    • Widely recognized as a valid medium of exchange.
    • Legal tender varies by country.
    • Gold is universally accepted.
  • Divisibility:
    • Must be split into smaller units for different transactions.
  • Uniformity:
    • Money must be recognizable and consistent in appearance.
  • Scarcity:
    • Limited availability ensures value; regulated by central banks.
  • Portability:
    • Easy to carry and use; physical cash weighs about 1 gram per note.

Bartering

  • Definition: The direct exchange of goods and services without money.
  • Problems:
    • Requires a double coincidence of wants (both parties must want what the other offers).
    • Issues with divisibility (e.g., cannot split livestock efficiently).
    • Portability concerns with physical items.

Functions of Central Banks

  • Central Bank Definition: The primary monetary authority in a country managing money supply and banking system.
  • Examples: Federal Reserve (USA), Bank of England, European Central Bank.

Key Functions of Central Banks

  1. Sole Issuer of Banknotes and Coins:
    • Only entity allowed to produce legal tender, enhancing public trust.
  2. Government's Bank:
    • Maintains government accounts and manages public sector debt.
  3. Bankers' Bank:
    • Oversees commercial bank reserves and ensures efficient liquidity management.
  4. Lender of Last Resort:
    • Provides financial support to prevent bank failures during crises, safeguarding the economy.
    • Example: Financial bailouts during the 2008 crisis.

Commercial Banks

  • Definition: Retail banks providing financial services (savings, loans, etc.).
  • Example banks include: ICBC, JPMorgan Chase, HSBC.

Primary Functions of Commercial Banks

  1. Accepting Deposits:
    • Includes sight deposits (on demand) and time deposits (fixed periods).
  2. Making Advances:
    • Providing loans, overdrafts, and mortgages to clients.
  3. Credit Creation:
    • Increases money supply by lending from deposit base.

Secondary Functions of Commercial Banks

  • Collecting and clearing cheques.
  • Providing financial services (tax advice, insurance, transfers).
  • Offering safety deposit boxes and credit card facilities.
  • Facilitating online banking transactions.

Summary and Review

  • Money is crucial for economic transactions, evolving from barter systems to complex banking systems.
  • Central banks regulate the economy's money supply, while commercial banks provide essential financial services to individuals and businesses.
  • Key Concepts:
    1. Understanding the definitions and differences between money, central banks, and commercial banks.
    2. Recognizing the various forms and functions of money.
    3. Knowing the characteristics that make money effective as a medium of exchange and store of value.