Currency and Financial Institutions
Currency:- Currency is a medium of exchange used commonly. Currency has a unique characteristic of being accepted in the form of currency or as a medium of exchange. Therefore, currency is any such item which is commonly acceptable for payment of goods and services.
Exchange: Exchange is the give and take of goods or services in lieu of currency or any other goods or services.
There are various forms of currency which are used as medium of payment –
Origin and Development of Currency
In English language, currency is known as money. The term money in English language has originated from Moneta which is a word from Latin language. The first Currency mint of Rome was established in the temple of goddess Moneta and gradually, the term money started to be used for currency in common form.
· First ‘rupee’ in India was issued by Sher Shah Suri (1540-45 CE).
Demonetization is the process of abolishing the legal validity of the prevailing currency and removing it from circulation.
i. In order to provide financial education, Reserve Bank of India has started ‘Project Financial Literacy’. It aims at providing information regarding the central bank and common banking concepts to target groups.
ii. If we want to gain expansive knowledge about the financial system, we can visit the website http://rbi.org.in/financialeducation/home.aspx on the internet. This is a very effective and attractive step taken by the Reserve Bank of India to provide financial literacy.
Development of Currency
a. Barter Exchange System:
In this system, goods and services are exchanged in direct form through other goods and services.
Problems of Barter Exchange System –
· Problems associated with double coincidence of wants existed in barter exchange. Double coincidence of wants means that the item which one individual wants to sell should be required by another individual who should possess that item which is required by the first individual.
· Barter exchange system also lacked a standard measure of value.
· In this system, collection of money or wealth or transfer of money was also very inconvenient.
· Transfer or money or value in the form of goods was very risky.
· In barter exchange, another major problem which aroused was in context to indivisible goods.
Example:- If an individual possessed a horse and he wished to purchase a sheep, then neither he could give one entire horse nor he could divide the part of his horse in exchange of the sheep. If such goods were divided, then these would lose their entire importance.
b. Metallic Currency:
Metallic currency replaced goods currency. In the beginning, metallic goods and metallic pieces were used in the form of currency.
It is believed that the use of metallic coins started in China, India and Egypt.
Problem of Metallic Currency –
· Transfer of metallic currency was difficult.
· Their production was expensive and it was not possible to fulfill the increased requirement of currency through metallic currency.
c. Paper Currency:
Due to limitations of metallic currency, paper currency was developed. Paper currency is free from all those problems which existed in metallic currency.
Benefits of Paper Currency –
· Production of paper currency is cost effective and its transfer is also easy.
· Availability of paper currency can be easily increased in order to fulfill its increasing demand.
· Paper currency is free from all those problems which existed in metallic currency.
Functions of Currency and Role of Currency in the Economy
Mainly, currency acts as a medium of currency exchange, measure of value, a measure of delayed payments and storage of value. Along with this, it fulfils various developmental functions and plays an important role in the economy.
Various Functions of Currency
a. Medium of exchange:
In an economy, the basic role of currency is to function in the form of medium of exchange or as a mode of payment. This function of currency eliminates the problem of double coincidence of wants present in system.
b. A Unit of Account or a Measure of Value:
This means that currency acts is a common measure of value. With its help the exchange value of various goods and services can be expressed in the form of currency. However, the ever changing value of currency is the most important setback of currency in the form of measure of value.
c. Measure of Delayed Payments:
Those payments which are not done instantly and are scheduled to me made in the future are known as delayed payments. As loan is also a form of delayed payment, thus loans can also be easily paid off in the form of currency.
d. Store of Value:
· This means that people can keep their money or assets in the form of currency. Currency also functions in the form of store of value.
· The value of currency refers to the purchasing power of currency. Currency is not the only store of value.
· Other goods and assets also act as store of value and in this context they compete with currency.
e. Other Functions of Currency and its Role in Economy:
· Transfer of value is facilitated with the help of currency.
· Currency provides a basis of credit to an economy.
· People deposit a part of their income in the form of currency in banks. Banks create credit through this deposited money.
· Currency has mobilized capital and has played an important role in the economy. Due to currency, it has become possible to transfer capital from one industry to another and from one place to another.
Investment: Investment refers to such expense which increased the stock of actual productive assets in an economy.
Benefits of Currency:
(i) Currency also allows freedom of choice of goods to the consumers.
(ii) Currency also plays an important role in production sector.
(iii) Due to adoption of labour distribution and specialization through currency, production on large scale has become possible.
(iv) Specialization takes place when an economic resource produces a specialized product or service.
· When production work is subdivided into various workers and when every unit plays a specialized role in production of a product or service, then it is known as division of labour.
· It is not always possible to divide the total produce or goods obtained, but it is possible to divide production into various productive units following appropriate financial rules through currency. Due to currency, rapid increase in domestic and international trade has become possible.
· At present time, the form of welfare state has become very important. The state or government runs various schemes for the welfare of its citizens. The government has to incur huge expenditure on these schemes.
Savings and Credit
Saving: The part of income which remains unconsumed is known as saving.
Credit: The term credit refers to a party providing loan or finance to another party.
Financial intermediaries are such institutions and firms which act as an anchor or middleman between those who provide credit and those who require it.
Features of Financial Intermediaries –
· These institutions obtain money from those individuals who spend less than their earnings, i.e. they save and then they provide credit to such individuals or institutions which require money for consumption or production.
· These financial intermediaries always have availability of money.
· They provide credit on reasonable interest rates and reasonable and acceptable
Institutional and Non Institutional Sources of Credit
Financial institution is such an institution which performs the work of deposits, loans, investments, etc. For example, banks, cooperative committees, money lenders, local bankers, etc.
These financial institutions are classified into institutional and non institutional sources.
Institutionswhich provide institutional credit are registered with the government and Reserve Bank of India.
· Their regulation, control and direction is done by the government and Reserve Bank of India.
· They inform about all their activities to their regulating institutions.
· These institutions do not operate only with the motive of earning profits.
· They also have to fulfill various important social obligations.
· These institutional credit to economically weaker sections also.
· They play an important role in establishing economic equality by financial inclusion of economically weaker sections.
Financial inclusion refers to join the poor, weak, backward and lower income group of the society with financial services by providing them financial services at reasons cost.
A commercial bank is such a financial institution which provides functions such as accepting deposits, providing commercial loans, etc. Banks are important financial intermediaries to perform the function of savings and credit.
Functions of Commercial Banks:
· These banks accept deposits from those people who save money and lend them to those people who are in need of money for consumption or production.
· Bank acts as an anchor between people who use capital and those who save money.
· Banks also provide an important facility, i.e. at times of need, the depositor can easily take his money deposited in the bank easily, therefore this type of deposit is known as demand deposit.
· For payment through cheque, the payer who has an account in a bank draws a cheque of a fixed amount.
Cheque is such an order form which gives an order to the bank to pay a fixed amount to the person nominated in the cheque from the account of an individual.
If we look at the cheque carefully, then we find that there are seven entries in the crossed cheque:
1. Two parallel slanting lines
2. Date of issue
3. Name of the payee
4. Amount of payment in numbers
5. Amount of payment in words
6. Account number of the payer who issues the cheque
7. Signature of the payer
In exchange of demand deposits, the facility of drawing cheques facilitates direct payment without the use of cash.
Question: What do the banks do with the money which they accept as deposits in accounts? Answer: Banks keep a small amount of the deposited money in the form of cash. Provision of this part is done on the basis of possibility of withdraw of deposits in a single day.
Role of Commercial Banks –
The importance of commercial banks in context to economic development can be understood from the following points:
1. High rate of deposit is necessary for economic development.
2. Deposits received by people are mobilized through banks and provided to various producers and investors in various sectors of the economy.
3. Banks make optimum allocation of resources.
Functions of Commercial Banks –
a. Accepting Deposits:
The foremost and most important function of commercial banks is to accept deposits.
In broad form, these deposits are of three types:
a. Deposits of current account.
b. Deposits of savings account.
c. Permanent deposits.
Note:- Deposits of current and saving accounts are jointly known as demand deposits. Banks provide maximum interest on permanent deposits.
b. Providing Loans:
Commercial banks provide loans to all sectors of the economy such as agriculture, industries, businesses, etc.
Note:- This loan is provided in various forms such as cash credit, overdraft, etc.
Overdraft: This refers to providing loan by giving the freedom to the depositors to withdraw funds exceeding the amount deposited in their accounts.
Note:- The rate of interest on loans given by the banks exceeds the rate of interest which the banks give on deposits. This difference in the rate of interest taken by debtors and given to depositors is the primary source of income for banks.
c. Other Functions:
· Banks collect bills and cheques.
· They also make regular payments of insurance premiums.
· They provide facility of lockers and keep the costly belongings of their customers safe.
· Banks collect various statistical data and provide them to various agencies.
· They provide the facility of money transfer.
Non Institutional Sources of Credit
Definition: Non institutional sources are such sources of finance which are not registered with the government and Reserve Bank of India and these do not follow the guidelines laid down by them.
Example: Local bankers, moneylenders. landlords, their relatives, etc, are usually included in non- institutional financial sources.
· These institutions are very flexible.
· Their activities are not time bound.
· The process provision of credit of these institutions is very easy and quick.
· They do very less paper work.
· These institutions keep very less record of their transactions.
Few Non institutional financial sources are discussed below:
a. Local Bankers:
These are private firms or individuals which function just like a bank. These have been an important source of non-institutional credit.
Following are the major functions performed by local bankers:
1. Accepting deposits by people.
2. Mortgaging various types of properties of their customers.
3. Transferring money from one place to another.
4. Conducting their business along with banking operations.
5. Providing services to small traders and businessmen.
6. Providing loans to debtors.
7. Serving the customers not only as bankers but also as friends and advisors.
Moneylenders provide credit purely on the basis of their own capital. They do not accept deposits from people. They usually provide petty personal loans. They charge high rate of interest from their customers.
c. Self Help Groups:
Even today, banks are not present in various rural regions India.
Question: what is the importance of self help groups in economic development?
1. Obtaining loan from banks is also difficult obtaining loan from banks is also difficult as compared to obtaining loan from personal sources.
2. Collateral and specific documents are required to obtain loan from banks.
3. Unavailability of collateral is one major reason due to which poor people are unable to obtain loan from banks.
4. On the other hand, non institutional credit providers such as moneylenders, etc.
5. Moneylenders charge a very high rate of interest.
6. Do not perform complete paper work and exploit the poor debtors.
In recent years, people have employed new ways of providing credit to poor people. One such step is based on organizing small self help groups.
Question: what activities are performed by the members of self help groups?
1. Most of the important decisions regarding the activities of saving and loans are taken by the members of the group.
2. The group decides about the loan to be given, its objective, its amount, rate of interest, tenure of repayment, etc.
3. The group is responsible for repayment of the loan.
4. If even a single member is unable to repay the loan, then other members take this issue seriously.
d. Chit Fund:
Chit fund play a significant role in promoting the habit of saving and in providing loans. A company which manages, operates and directs chit plans is known as a chit fund company.
Note: Chit fund is a unique saving and loan plan run in India. This is a mutual benefit program.
Characteristics of Chit Fund:
· Under this, all the members of the plan form part of a contract in which they deposit their predetermined amount of money.
· The total amount deposited in this way is given to any one member of the plan through a draw or by auction.
· All the members participate in the draw or auction and the member who is ready to take the amount after deduction of maximum amount is declared as the winning member.
· Every month, one member gets the amount of prize in the form of winner.
· The member who becomes a winner once is not included again in the draw or auction. This means that only non-winning members can participate in the forthcoming draw or auction under this plan.
· The amount of deduction is the profit which is divided equally between all the members. Next installment amount is fixed after deducting the amount of profit.
· The chit fund company obtains a fixed commission from the members as per the contract in exchange of operating, managing and directing the plan.
· Under the plan, the winner also has to deposit his installment per month within the fixed time period of the chit fund plan.