What is Money?
Money is any item that everyone accepts as a medium of exchange. It is widely recognized as a means for purchasing goods and services and repayment of debts. It allows people to receive anything that they need for a livelihood.
In ancient times, people used to obtain things through the barter system. Here, two individuals or parties would exchange goods and services that the other needs. But the earlier method of bartering did not have the ease of transferability that eventually led to the invention of Money.
For Example- if anyone has rice but needs milk, he/she must find someone who not only has milk but also has the requisite of preparing meals. What if anyone finds a person who can offer milk but needs clothes?
A trade cannot occur in such a situation. Due to such recurring hassles, a relatively more straightforward medium of exchange came into existence, and now it has worldwide recognition.
As per the meaning of Money in economics, it is a medium of exchange, a unit of accounting that allows people to make any transaction.
In terms of exchange, traders accept Money as a medium for buying or selling commodities, and employees consider it a means of remuneration for their labour. As a unit of accounting, it acts as a quick and easy method of calculation.
For Example- when someone inquires about the value of an item, it can be merely quoted in its monetary denomination.
What are the Properties of Money?
The concept of Money in economics is considered as a crucial element for the proper functioning of an Economy. It has become an essential means of exchange in the entire world. It has value, and people use it to obtain things that they wish to avail.
There are specific properties of Money that account for its worldwide usage. Some of these include:
Interchangeability: Money has a universal application as one can interchange it with other things.
Repeated Usage: One can use it again and again to purchase anything. It does not lose its value with time.
Transferable: Anyone can carry Money from one place to another due to its portability.
Define Banking
A Bank is a financial institution that allows people to make deposits and receive credit. In India, Banks are licensed by the Reserve Bank of India. It operates to provide financial assistance to borrowers and allow cash transactions.
Similarly, Banking is an industry that allows credit, handles deposits, and provides financial help to borrowers. More broadly, it is a network that facilitates the Money flow in the Economy. Banks also facilitate companies with an adequate amount of funds to finance their operations.
Money and Banking are the two most essential components that drive the Economy. Money allows people to make transactions, whereas Banks play a vital role in circulating the Money supply in the Market.
What are the Different Types of Banks?
Banks provide long-term credit opportunities such as credit cards, Business loans, mortgages, etc. Similar to other Businesses, the goal of any Bank is to earn Profits.
They earn profits from the difference in interest rates charged from borrowers and offered to depositors.
For instance, a Bank gains 4% Profit by charging 6% interest from its borrowers and paying 2% interest to savings account holders.
There are different types of Banks operating in the Market. They are listed out below as:
Retail Banks: These Banks offer services to the public, and they deal with the retail Market. Their services are known as general Banking as they provide facilities such as savings accounts, current accounts, short-term loans, credit cards, personal loans, etc. Most retail banks offer wealth management facilities to their customers. They also provide foreign exchange facilities to their NRI customers.
Commercial Banks: They are also known as corporate Banks, and these institutions provide specific services to the companies. Apart from its daily Banking functions, they offer cash management, trade finance, real estate, and employer services to their corporate clients.
Exchange Banks: These Banks mainly facilitate foreign trade in a country. They accept, collect, and allow discounting of bills of exchange. These Banks also deal in buying and selling of foreign currencies along with general Banking activities.
Co-operative Banks: The primary function of these banks is to provide loans at a relatively lower rate of interest to farmers. They offer both short-term and long-term loan facilities to their customers. Short-term loans include credit for purchasing fertilizers, seeds, etc. whereas long-term funds include credit offerings to farmers for purchasing lands, etc.
Central Banks: A central Bank is considered as a lender of last resort. It does not directly deal with the general public; instead, it regulates the functions of the other Banks. They are responsible for controlling inflation, rate of interest, and monetary policy, among other necessary functions in an Economy.
Why is Banking Essential?
The primary purpose of a Bank is to keep customers Money secured. People find it safe to save Money in Banks as they provide protection.
Apart from security, it allows interest on savings to their customers. Instead of keeping Money at home, people find it more convenient to save in Banks.
Banking has become an integral part, as it facilitates advancing loans to different entities. For instance, they offer loans and credit cards to individuals to inflate their purchasing power. They also provide financial advice to its borrowers to aid Business decisions.
There has been a constant evolution of Money and Banking with time. With the ever-increasing demand of customers, new regulations have been implemented in the Banking industry. The value of Money always changes with time, and Banks ensure a smooth flow of Money in the Market.
To get a better and in-depth insight into the Money and Banking project, visit Vedantu’s official website today.
Vedantu is an online learning app that helps students to understand detailed concepts with ease. Money and Banking are essential topics in the CBSE Curriculum of schools. In Class 11th and 12th, this Chapter is categorized under the Commerce stream. It is an important Chapter. In addition, it helps in laying a strong foundation for the students who want to pursue their careers in the field of commerce and Banking.
In order to understand the complex topics included with the Chapters of CBSE Class 12th Economics, students are advised to consider the introductory Chapters equally important. For instance, if you will comprehend the definition of Money at a deeper level then it will be much easier to understand the related topics like Money supply in the upcoming Chapters.
For the students who wish to appear for the competitive exams in the future, Money and Banking is specifically important for them.
Types of Money
Once you are familiar with the definition of the term- Money the next step involves learning the types of Money that come with it. It is an important question that is apparent in its repetition among the previous year's question papers.
According to the Economists, Money can be categorized into four types-
Fiat Money- It consists of the type of currency that is legally issued by the government. In simpler terms, it does not involve physical commodities like gold and silver. Examples of fiat Money include- the US dollar, the euro, and the pound.
Commercial Money- It is the type of currency that is generated by commercial Banks. Commercial Banks are responsible for making Money by providing loans. It can be in any form like personal loans, mortgages, etc. In simpler terms, the amount of Money that is produced by the commercial Banks is called commercial Money.
Fiduciary Money- Are you aware of what a cheque is? Well, it is one of the primary examples to understand fiduciary Money. A cheque is defined as a means of payment between the payer and the payee which is based on the trust between these people rather than any official involvement of the government. To put it simply, Fiduciary Money is the type of currency that involves Money based on the trust between the payer and the payee.
Commodity Money- As the term describes, is defined as the type of Money that is based on the value of a commodity. These commodities hold an inner value of their own. It varies from commodity to commodity. Instances of Commodity Money include- Gold, silver, copper.
FAQs on Money and Banking: Functions and Importance
1. What are the primary functions of money in an economy?
Money serves four main functions that help an economy run smoothly:
- Medium of Exchange: It acts as an intermediary for buying and selling goods and services, eliminating the need for a barter system.
- Measure of Value: It provides a common unit to measure the value of different goods and services, making it easy to compare prices.
- Store of Value: Money can be saved and used for future purchases because it holds its value over time, unlike perishable goods.
- Standard of Deferred Payment: It allows for contracts and loans to be made, with payments settled in the future using a standard value.
2. What is a commercial bank and what is its main purpose?
A commercial bank is a financial institution that accepts deposits from the public and provides loans to individuals and businesses. Its main purpose is to earn a profit by charging a higher interest rate on loans than it pays on deposits. Examples in India include the State Bank of India (SBI) and HDFC Bank.
3. What is the main difference between a commercial bank and a central bank?
The main difference lies in their roles and who they serve. A commercial bank deals directly with the public for profit-making activities like accepting deposits and giving loans. A central bank (like the Reserve Bank of India) is the apex institution that does not deal with the public; instead, it regulates the entire banking system, issues currency, and acts as the government's banker.
4. How did the invention of money solve the main problem of the barter system?
The main problem of the barter system was the need for a 'double coincidence of wants,' where two people each had to have what the other wanted at the same time. Money solved this by acting as a universally accepted medium of exchange. This breaks the transaction into two parts: you can sell what you have for money, and then use that money to buy what you need from someone else, anytime.
5. What are the key functions of a country's Central Bank?
A country's Central Bank, such as the RBI in India, performs several crucial functions:
- Issuing Currency: It is the sole authority for issuing currency notes.
- Banker to the Government: It manages the government's accounts, funds, and debts.
- Banker's Bank and Supervisor: It holds the cash reserves of commercial banks and supervises their operations to ensure stability.
- Controller of Money Supply: It uses tools like the repo rate to manage the amount of money in the economy to control inflation and promote growth.
6. Why is the banking system often called the 'backbone' of a modern economy?
The banking system is called the 'backbone' because it supports the entire economic structure. It channels money from people who save (households) to those who need it for investment (businesses). This process, known as capital formation, is essential for economic growth, job creation, and industrial development. Banks also facilitate trade and commerce through a reliable payment system.
7. What are the different components of the M1 measure of money supply?
The M1 measure of money supply is one of the most liquid measures. As per the CBSE 2025-26 syllabus, it includes three main components:
- C: Currency and coins held by the public.
- DD: Demand Deposits held by the public in commercial banks.
- OD: Other Deposits with the RBI (which includes deposits of public financial institutions, foreign central banks, etc.).
8. How do commercial banks create credit or 'make' money?
Commercial banks create credit through a process called the credit multiplier. Based on the assumption that not all depositors will withdraw their money at once, banks are required to keep only a fraction of their deposits as reserves (as per the Cash Reserve Ratio). They can lend out the rest. This loan money is then deposited in another bank, which again keeps a fraction as reserves and lends out the rest. This cycle continues, creating credit that is a multiple of the initial deposit.
9. What does it mean when the Central Bank is called the 'lender of last resort'?
The term 'lender of last resort' means that if a commercial bank is facing a severe financial crisis and cannot get a loan from any other source, it can approach the Central Bank for a loan as a final option. This function is crucial for preventing bank failures and maintaining public confidence in the banking system.
10. Can you give a real-world example of how the Central Bank controls the money supply?
Certainly. To reduce inflation, the Reserve Bank of India (RBI) might increase the repo rate. This is the rate at which it lends money to commercial banks. When this rate goes up, borrowing becomes more expensive for banks like SBI or HDFC. They, in turn, increase the interest rates on their loans for cars, homes, and businesses. This discourages people and companies from borrowing, reducing the overall money supply and helping to control rising prices.
