ECO 09 Solved Assignment 2021 – 22
IGNOU Free Solved Assignment 2021 – 22
TUTOR MARKED ASSIGNMENT
COURSE CODE: ECO-09
COURSE TITLE: Money, Banking and Financial Institutions
ASSIGNMENT CODE: ECO-09/TMA/2021-22
COVERAGE: ALL BLOCKS
Maximum Marks: 100
Attempt all the questions:
1. What is money? Distinguish between money and near-money. Discuss the nature and functions of money. (20)
Ans: Meaning of Money: The word ‘money’ is derived from the Latin word ‘Moneta’ which was the surname of Roman Goddess of Juno. Money was coined in her Temple at Rome. Money is defined as anything that is generally acceptable as a means of exchange and that at the same time act as a measure and as a store of value. Money has three important functions i.e. medium of exchange, a standard value and a store value.
According to Coulborn, ‘Money may be defined as the means of valuation and payment”.
According to Hartley Withers, “Money is what money does”
Difference between money and near-money
Near-money can be distinguished from money on the following grounds:
1. Definition: Money consists of coins, currency notes and demand deposits of the banks. Near-money, on the other hand, includes the financial assets, like time-deposits, bills of exchange, bond, shares, etc.
2. Liquidity: Money possesses 100 per cent liquidity; i.e., it is perfectly liquid or can be readily acceptable as a means of payment. Near-money lacks 100 per cent liquidity, i.e., it involves time cost for its conversion into money.
3. Function: Money serves as a unit of account or a common measure of value. All prices are expressed in terms of money. Near-money on the other hand, does not perform such functions. Rather, its own value is expressed in terms of money.
4. Use in Transactions: Money is directly used for making transactions. Near-money, on the other hand, is an indirect medium of exchange; it has to be first converted into ready money and then used for transactions.
5. Income-Yielding Quality: Money is not an income-yielding asset. On the contrary, near-money assets are income yielding assets.
Nature of Money
Money is only a means and not an end in itself. It is demanded not for its own sake but because it helps us in buying goods and services to satisfy our wants. Money cannot directly satisfy human wants, but assists in production and exchange of goods and services. Its significance lies in its ability to command goods and services and liquidate business obligations. Money gives mobility Lo capital and aids division of labour and specialisation, thereby making large scale production possible. It has been rightly remarked that ‘we cannot eat money but we cannot eat without money either. To perform its functions well, money must possess the following characteristics.
1. General Acceptability: Money should be universally acceptable to all without any hesitation. Because of the general acceptability of money, we can use it widely as a medium of exchange.
2. Divisibility: Divisibility is one of the important characteristics of money. Money must be easily divisible into small parts to allow for the purchase of smaller units of the commodities.
3. Homogeneity: Money must be homogeneous. The units of money should be identical. They should be of equal quality.
4. Durability: Money must possess durability. It must be storable and should last for a long time without losing its value.
5. Cognoscibility: Money must have the quality of cognoscibility i.e. it must be easily recognised.
6. Stability: The value of money should remain stable. Because it has to serve as a measure of value, as a store of value, and as a standard of deferred payment.
7. Portability: Money must possess the portability characteristics. It should be easily carried or transferred from one place to another.
It is important to note that all the above characteristics must be present in money at one and the same time. If some of the characteristics are not present at one point of time it will not be money.
Functions of Money
Functions of money is divided into three categories: Primary functions, secondary functions and contingent functions.
A. Primary functions of money
1.Medium of Exchange: Money act as a medium of exchange. It has the quality of general acceptability. In modern days, exchange is the basis of entire economy and money makes this exchange possible. It was on account of the difficulties and inconveniences (lack of double coincidence of wants) of Barter system the money came into existence.
2.Measure of Value: Money act a unit of measure of value. In other words, it acts as a yardstick of standard measure of value to which all other things can be measured. Value of all goods and services is expressed in terms of money.
B. Secondary functions of money
1. Standard of Deferred Payments: Money has proved to be a suitable standard of deferred payment as it is more durable and stable compared to values of other commodities. It has the quality of general acceptability. Hence it is always desirable.
2. Store of Value: Money can be stored for future use. It has this merit because its utility is never lost. It serves as an excellent store of wealth, as it can be easily converted into other marketable assets, such as land, machinery, plant etc.
3. Transfer of Value: Money is a liquid means of exchange. Hence purchasing power of money can easily be transferred from one person to another and from one place to another.
C. Contingent functions
1. Basis of Credit: At present credit is used as money on the basis of money, Bank and Financial institutions create credit on the basis of money.
2. Basis of Distribution of Social Income: Total output of the country is jointly produced with the help of different factors of production (Land, Labor, Capital and Enterprises). So, the output should be distributed among them. Money helps in the distribution of the national product in the form of Rent, Wage, Interest and Profit, which are expressed in money terms.
3. Basis of Maximum Satisfaction and Production: A Consumer maximizes his satisfaction by equating the prices of each commodity (in terms of money) with its marginal utility. Similarly, a Producer maximizes his satisfaction by equating the marginal productivity of a factor with price of that factor.
4. Helpful in Making Capital Liquid and Mobile: Money makes capital liquid and mobile.
5. Guarantee of Solvency: Money acts as a guarantee of solvency for an individual or institution. Every individual or institution prefers to keep some money ready as cash deposits. Money deposits serve as a guarantee against solvency.
6. Bearer of Option: Money serves as a bearer of option which implies that accumulating wealth in the form of money, any individual can change their decision regarding the goods and services as and when the situation demands.
2. Differentiate between quantitative and qualitative methods of credit control and discuss the effectiveness of quantitative methods to control quantum of credit in an economy. (20)
Ans: Credit control is the most important function of the RBI. The capacity of the banks to create credit depends on the cash reserves available with banks which increase with rise in the deposits of the banks or vice-versa. The regulation of credit creation capacity of the commercial banks and other banking institutions by the Central Bank to achieve some definite objectives is known as Credit Control.
The principle methods or instruments of Credit Control used by the Central Bank are:
1) Quantitative or General Methods.
2) Qualitative or Selective methods.
1) Quantitative or General Methods: These are the traditional or general methods of credit control. These methods one used by Central Bank to have control over the total volume of credit in the economy neglecting the purpose for which it is used. These methods are:
a) Variation in the bank rate.
b) Open Market operations.
c) Variation in cash reserve ratio.
d) Variation in the statutory liquidity ratio.
e) Repo transactions.
2) Qualitative or Selective Methods: These are basically the selective and general methods of credit control. These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in economy. These methods are :
b) Margin requirement.
c) Consumer Credit Regulation.
e) Credit Rationing.
f) Moral suasion.
g) Direct action.
Difference between Quantitative Credit Control Measures Qualitative Credit Control
These methods one used by Central Bank to have control over the total volume of credit in the economy neglecting the purpose for which it is used.
These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in economy.
Quantitative credit control Instruments of have an effect on the entire economy.
Qualitative credit control Instruments have an effect only on some individuals or parties and not on the entire economy.
These measures do not restrict the flow of credit to some specific sectors of the economy.
These measures control the flow of credit to specified areas of economic activity.
Techniques of credit control
Techniques of credit control are – Variation in the bank rate, Open Market operations, Variation in cash reserve ratio, Variation in the statutory liquidity ratio and Repo transactions.
Techniques of credit control – Directions, Margin requirement, Consumer Credit, Regulation, Publicity, Credit Rationing, Moral suasion and Direct action.
These measures mainly affects lenders.
These measures affects both lenders and borrowers.
Effectiveness of Quantitative or General Methods
These are the traditional or general methods of credit control. These methods one used by Central Bank to have control over the total volume of credit in the economy neglecting the purpose for which it is used. These methods are:
a) Variation in the bank rate:
b) Open Market operations:
c) Variation in cash reserve ratio:
d) Variation in the statutory liquidity ratio:
e) ‘Repo’ Transactions:
a) Variation in the bank rate: Bank rate or discount rate is the rate at which the Central Bank of a country makes advances to the banks against approved securities or rediscounts the eligible bills. The purpose of change in the rate is to make the credit cheaper or expensive depending upon whether the purpose is to expand or control credit. An increase in bank rate result, in increase in lending rate of commercial banks’ which leads to contraction of credit while a decrease in bank rate leads to decrease in lending rates of commercial banks’ which leads to expansion of credit. This measures is mainly used when RBI wants to reduce the supply of money in the economy to control inflation.
b) Open Market operations: Open market operations means deliberate and direct buying and selling of securities and bills in the market by the Central Bank. The open market operations of the RBI are mostly limited to government securities. In order to increase money supply in the market, the RBI purchases securities in the open market. On the other hand, in order to contract credit, the RBI starts selling the securities in the open market.
c) Cash reserve ratio: Every scheduled bank in India is required to maintain a minimum percentage of their deposits with the RBI. Larger the reserve, lesser is the power of the banks to create credit and smaller the reserves, greater is the power of the banks to create credit. In case of high inflation situation, RBI increases CRR and in order to increase supply of money in the economy RBI reduces CRR.
d) Statutory liquidity ratio: Statutory liquidity ratio is another reserve requirement used by the RBI to control money supply. In India, besides maintaining the cash reserve, every bank has to maintain a statutory reserve of liquid assets in terms of cash, gold or unencumbered securities. This is termed as statutory liquidity ratio. In increase in the liquidity ratio implies a transfer of banking funds to Government and corresponding reduction in credit available to the borrowers.
e) ‘Repo’ Transactions: ‘Repo’ stands for repurchase. Repo or repurchase transactions are undertaken by the Central Bank in the money market to manipulate short term interest rates and to manage liquidity levels. Under repo, buying and selling of securities takes place with the condition that at the end of the specified fixed period the buyer shall sell the securities at the predetermined rate. The difference between the repurchase price and the original sale price will be earning for the lender. An increase in repo rate means the commercial banks will get more interest on their reserve with RBI which leads to shortage of funds in the economy. On the other hand, decrease in repo rate means the commercial banks will earn less return on their balance with RBI which increases withdrawal of funds by commercial banks from RBI and thus increases liquidity.
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3. What is a non-bank financial intermediary? What are its features? The UTI has brought professionalism to the non-bank financial intermediation sector in India. Comment. (20)
Ans: Financial intermediation is the modern term used for ‘Financial Institutions’. The financial intermediaries act as mediators to bring together the savers and users of capital. They mobilize money from the savers by selling securities to them, and lend the same to the borrowers. Broadly, the term financial intermediaries can be applied to a variety of institutions, some of which are listed below:
– Commercial Banks.
– Insurance Companies.
– Provident Fund Organizations etc.
The following are the features of non-bank financial intermediaries.
a) Non-bank financial institutions generally pay back the money taken from the public only after a specified time.
b) Non-banking financial institutions lend funds mainly on term basis to business firms only. They also subscribe for the shares and debentures of industrial concerns.
c) The non-bank institutions, undertake many promotional activities for the rapid industrial development of the country.
d) The non-bank financial intermediaries, on the other hand, come under the categories of both organized and un-organized sectors.
4. Describe the working of the IMF. How does it help member countries in dealing with their temporary balance of payments problems? (20)
Ans: The IMF is an international monetary institution established by 44 nations under the Bretton woods agreement of July 1944. It came into existence in December 1945 and started functioning in March, 1947. It is an autonomous organization and is affiliated to the U.N.O. It has its main office in Washington. Initially, the IMF had 30 countries as its members. At the end of 2000, the membership of the IMF was 183. It was established to promote economic and financial co-operation amongst member countries.
Workings of IMF (Objectives and
The objectives of I.M.F are:
a) To promote international economic and financial co-operation amongst member countries.
b) To promote exchange stability and avoid currency devaluation.
c) To promote the international trade by removing all obstacles.
d) To promote investment of capital in backward and undeveloped countries.
e) To make financial resources available to members.
f) To seek reduction on payment imbalances.
g) To elimination or reduction of existing exchange control.
The functions of IMF are:
a) It functions as a short credit institution.
b) It provides machinery for the orderly adjustments of exchange rates.
c) It keeps reserves of the currencies of all member countries.
d) It lends to the borrowing countries in the currencies which they require.
e) It promotes the expansion of International Trade for the mutual benefits of member countries.
How does it help member countries in dealing with their temporary balance of payments problems?
IMF lending aims to give countries breathing room to implement adjustment policies in an orderly manner, which will restore conditions for a stable economy and sustainable growth. These policies will vary depending upon the country’s circumstances. For instance, a country facing a sudden drop in the prices of key exports may need financial assistance while implementing measures to strengthen the economy and widen its export base. A country suffering from severe capital outflows may need to address the problems that led to the loss of investor confidence perhaps interest rates are too low; the budget deficit and debt stock are growing too fast; or the banking system is inefficient or poorly regulated.
5. Write short notes on the following: (4 x 5) = 20
(a) Inflationary gap
Ans: An inflationary gap is a macroeconomic concept that describes the difference between the current level of real gross domestic product (GDP) and the anticipated GDP that would be experienced if an economy is at full employment. This is also referred to as the potential GDP. For the gap to be considered inflationary, the current real GDP Must be the higher of the two metrics. The inflationary gap exists when the demand for goods and services exceeds production due to factors such as higher levels of overall employment, increased trade activities or increased government expenditure. This can lead to the real GDP exceeding the potential GDP, resulting in an inflationary gap. The inflationary gap is so named because the relative increase in real GDP causes an economy to increase its consumption, which causes prices to rise in the long run. Due to the higher number of funds available within the economy, consumers are more inclined to purchase goods and services. As the demand for goods and services increases but production has not yet compensated for the shift, prices rise to restore market equilibrium. When the potential GDP is higher than the real GDP, the gap is referred to as a deflationary gap. According to macroeconomic theory, the goods market determines the level of real GDP, which is shown in the following relationship:
Y = C + I G+ NX
Y = real GDP
C = consumption expenditure
I = investment
G = government expenditure
NX = net exports
An increase in consumption expenditure, investments, government expenditure or net exports causes real GDP to rise in the short run. Real GDP provides a measure of economic growth while compensating for the effects of inflation or deflation. This produces a result that accounts for the difference between actual economic growth and a simple shift in the prices of goods or services within the economy.
(b) Branch Banking
Ans: Branch Banking: Branch Bank is a type of banking system under which the banking operations are carried with the help of branch network and the branches are controlled by the Head Office of the bank through their zonal or regional offices. Each branch of a bank will be managed by a responsible person called branch manager who will be assisted by the officers, clerks and sub-staff. In England and India, this type of branch banking system is in practice. In India, State Bank of India (SBI) is the biggest public sector bank with a very wide network of 16000 branches.
Merits of Branch Banking
1. Benefits of large Scale Production: Due to large scale production, the cost per unit of operation is very low in case of this system.
2. Distribution of Risks: There is a distribution of risks because the losses incurred by one branch are made up by the profits earned by other branches.
3. Effective Central Bank control: Due to presence of few big banks in the banking system, the RBI can effectively and easily regulate the activities of banks.
4. Public Confidence: Branch banking system gains greater public confidence because of its large scale operations and huge financial resources.
5. Easy transfer of funds: Since the branches of bank under branch banking are spread all over the country, it is easier and cheaper, for it to transfer funds from one place to another.
Demerit of branch banking
1. Problems of Management: The effective management and control of bank under branch banking system is difficult due to large network of branches.
2. Delay in Decision Making: Decision making is delayed because the branch manager has to consult with the head office before taking decision.
3. Ignorance of local heads: Branches follows the policies framed by the head office. The head office and the branch may not be aware of the local conditions.
4. Monopolistic tendencies: Branch banking encourages monopolistic tendencies. A few big banks can dominate and control the whole banking system.
5. Regional imbalances: Under branch banking system the financial resources collected in smaller and backward regions are transferred to the bigger industrial centre. This encourages regional imbalances in the country.
(c) State Finance Corporations
Ans: Industrial Finance Corporation of India (IFCI) was established in 1948 at all India level to provide finance exclusively to large scale industrial units. Financial needs of medium and small size industries were not covered by IFCI. The government, therefore, felt the need for starting development hanks at the regional level to provide assistance to small scale industries. Consequently, State Financial Corporation’s (SFCs) and State Industrial Development Corporations (SIDCs) were established in all the states.
State Financial Corporations Act, 1951 was brought into force to enable all State Governments (except Jammu and Kashmir) to set up State Financial Corporations as regional development banks. They are to meet the financial requirements of small and medium size industrial units in the respective States. The first State Financial corporation was established in Punjab in 1953. Subsequently Andhra Pradesh and Bihar State Governments took the lead to set up SFCs in 1960 followed by Uttar Pradesh, Karnataka, Gujarat, Maharashtra and Orissa. At present, there are 18 SFCs operating in different States and Union Territories in the country.
Financial Resources: Capital structure of an SFC is determined by the concerned State Government with a minimum of Rs. 50 lakh and maximum of Rs. 5 crores. They are also authorised to raise funds by issue of share capital, and issue of bonds and debentures guaranteed by State Governments. They can also accept medium and long-term deposits from public. In addition, they can borrow from other financial institutions.
Management: Every SFC is managed by a 12-member Board of Directors. The State Government concerned appoints the-Chairman and the Managing Director, and nominates three directors. IFCI and IDBI nominate one director each. Three directors are elected by financial institutions. The rest will be chosen on the basis of one each from schedule banks, cooperative banks and other financial institutions. One director is elected by non-institutional shareholders.
(d) Foreign Exchange Market
Ans: Foreign Exchange Market: Most counties in the present day world have open economies which means that some residents of these countries are engaged in international transactions. These transactions can be in the form of commodity exports and imports, services exports and imports inter-country unilateral transfers, capital flows and exports and imports of gold. Most of these international transactions have one special characteristic which distinguishes them from purely domestic transactions. They require use of foreign currency by the participants in the transaction. For example, an Indian firm importing goods from the USA will have to acquire dollars for meeting payments obligation. Similarly, a Canadian visiting India will have to obtain rupees in exchange of dollars which he may be carrying. The international transactions thus require exchange of one currency for another. This buying and selling of currencies take place in the foreign exchange market.
The term foreign exchange in a narrow sense refers to foreign currencies. In broad sense the term foreign exchange includes not only foreign currencies, but also bank deposits denominated in a foreign currency and short-term claims on foreigners expressed in foreign currencies. Most foreign exchange transactions, deposits denominated in foreign currencies.