MONEY AND BANKING
1. BARTER SYSTEM :
A system where good and services are exchanged for other good and services without the use of money. It is an old method of exchange when concept of money was not evolved. In barter system, there should be double coincidence of wants, i.e. Person A should be willing to buy the commodity person B is offering and vice versa. In this system each sale is automatically a purchase and vice versa.
2. DOUBLE COINCIDENCE OF WANTS :
It occurs when a party is able to offer something that the other party wishes to have. This is one of the conditions for barter transaction. For example, when a party wants to trade amount ‘a’ of good X for amount ‘b’ of good Y, and another party is willing to trade amount ’b’ of good Y for the amount ‘a’ of good X. Economists refer to this as a double coincidence of wants -"double" because there are two parties and a "coincidence of wants" because the two parties have mutually beneficial wants that match up perfectly. The double coincidence of wants is also sometimes referred to as the dual coincidence of wants.
3. FUNGIBILITY :
The state of being interchangeable. For example, money has fungibility because there is no difference between one rupee and another rupee. For example, If Person A lends Person B a Rs 2000 note, it does not matter to Person A if he is repaid with a different Rs 2000 note, as the currency is mutually substitutable. In the same sense, Person A can be repaid with three Rs 500 note and 5 Rs 100 note, and still be satisfied since the summation of those notes equals Rs 2000. Conversely, as an example of non-fungibility, if Person A lends Person B a 50 carat diamond of a particular clarity level, it is not acceptable for Person B to return a different smaller diamonds pieces equaling 50 carat in total, even if it is of the same clarity level as lent by Person A as bigger diamonds commands more price as compared to smaller size diamonds of equal weight. Diamonds are not fungible with respect to ownership, on the other hand, gold is generally fungible as size of a gold piece does not matter in pricing as long as the weight remains the same.
4. LEGAL TENDER :
Different instruments recognized under the law of a country which can be used to make or accept payments. Currency notes and coins in India are legal tender money. It is only due to the backing of the central bank, i.e. RBI that we are willing to accept paper or metal (currency notes and coins) as a medium of payment. Legal tender can be limited or unlimited in character. In India, coins function as limited legal tender. Therefore, 50 paisa coins can be offered as legal tender for dues up to ₹10 and larger coins for dues up to ₹1000. Currency notes are unlimited legal tender and can be offered as payment for dues of any size.
5. FULL BODIED COINS :
A full bodied coin is one where the intrinsic value of the metal used to make that coin in equal to the representative value of the coin. For example, if in a Rs 10-coin, metal used is worth 10 rupees then it’s a full-bodied coin. Instead if the metal used is worth less than 10 rupees, say only 5 rupees worth of steel/aluminum/alloy required to make a Rs 10 coin, then it’s called a TOKEN COIN and not a full-bodied coin. In a token coin, the intrinsic value of the metal used is not equal to the face value of the coin. All paper currency is also token money since the value of paper used is much less than the face value of the currency note. All gold coins or gold-silver alloy coins are full-bodied, but silver coins can be full-bodied or token. Copper coins are almost always token, but there are historical examples of full-bodied copper money.
6. FIAT MONEY :
This is like token money but with government backing to make its status legal. Type of money with no particular intrinsic value. It circulates on authority of the government. They are legal tender. Currency notes and coins are called fiat money as they do not have intrinsic value like gold or silver coins.
7. FIDUCIARY MONEY :
Fiduciary money refers to money backed up by trust between the payer and payee. Example: Cheques are fiduciary money as these are accepted as a means of payment on the basis of trust but not on the basis of any order of the government. Fiduciary money can be legal and non-legal (not illegal, but non-legal). Example of legal fiduciary money – fiat money like currency notes and coins. Example of non-legal fiduciary money – cheques, bank draft, postal order, bonds, shares etc.
8. DEBASEMENT :
Debasement means either reducing the amount of precious metal in a coin or mixing more of a common metal with the precious metal (usually gold or silver) that gave the coins its worth, while maintaining the face value of the coin. The reasoning behind debasing the coinage can be to be able to make more coins and therefore create more money. However, the side effect could be inflation and people hoarding the older coins that contains more of the precious metals.
9. DEMONATISATION :
Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins. Sometimes, a country completely replaces the old currency with new currency. For example, withdrawal of Rs. 500 and Rs. 1000 currency notes from circulation in November 2016. After the announcement, these currency notes ceased to be legal tender. In other words, the notes lost their value as a currency.
10. CRYPTO CURRENCY :
A cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency. Essentially, any cryptocurrency network is based on the absolute consensus of all the participants regarding the legitimacy of balances and transactions. If nodes of the network disagree on a single balance, the system would basically break. E.g. Bitcoins, Ethereum, Lite coin etc.
11. MONETARY POLICY :
The policy of central bank of the country (such as Reserve bank of India) aimed at controlling the money supply/credit in the country with a view to achieve a desired policy objective such as – controlling inflation, higher rate of growth, correcting the unfavorable balance of payments, employment generation etc. The central bank uses instruments like bank rate, cash reserve ratio (CRR), statutory liquidity ratio (SLR), open market operations etc. to implement the monetary policy.
When RBI increases the money supply in the country using above tools, it is called Expansionary Monetary/Credit Policy which may generally be adopted during a period of slow economic growth. On the other hand, when inflation threatens the economy, the central bank may adopt Contractionary Monetary Policy to reduce the available money supply in the economy. The tool used by RBI to control this money supply are classified as qualitative and quantitative tools.
12. CASH RESERVE RATIO (CRR) :
Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. CRR is set according to the guidelines of the central bank of a country. The amount specified as the CRR is held in cash, is stored in bank vaults or parked with the Reserve Bank of India. The aim here is to ensure that banks do not run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy tool and is used for controlling money supply in an economy. At present, this rate is fixed at 4%.
13. STATUATORY LIQUIDITY RATIO (SLR) :
It is that ratio/percentage of its total deposits which a commercial bank has to maintain with itself at any given point of time in the form of liquid assets like cash in hand, gold or first class securities (generally government securities). This mean the banks can earn some amount as 'interest' on these investments as against CRR where they do not earn anything. At present, this rate is fixed at 19.5%.
14. BANK RATE :
Rate of interest which a central bank charges on the loans and advances made to commercial banks. In this case, there is no repurchasing agreement signed, no securities sold or collateral involved. Banks borrow funds from the central bank and lend the money to their customers at a higher interest rate, thus, making profits. Bank rates influence lending rates of commercial banks. Higher bank rate will translate to higher lending rates by the banks. Bank Rate is usually higher than Repo Rate. At present, this rate is fixed at 6.75%.
15. REPO AND REVERSE REPO RATE :
Repo stands for Repurchase Obligations when commercial banks wants short term liquidity (7,14 or 21 days), they can keep their securities with the ncentral bank and get the funds. However, they are obliged to buy back these securities at a later date. The consequent rate of interest charged by the central bank is called repo rate. Repo Rate is different than Bank Rate. At present, this rate is fixed at 6.50%. Essentially therefore, Repo implies short term lending to banks by RBI against government securities. These securities should however be over and above the SLR. Reverse Repo Rate on the other hand, is the rate at which commercial banks can put their surplus funds with the central bank temporarily for a short period of time by buying securities from the central bank. In other words, RBI borrows from banks by selling government securities with an in-built clause of repurchase by RBI after a specified period. At present, this rate is fixed at 6.25%.
16. OPEN MARKET OPERATIONS (OMO) :
Purchase and sale of government securities by the central bank (here, RBI) to the public (open market). OMO is a major instrument adopted by central banks to change money supply in an economy. These operations are generally conducted by ways of options.
17. MARGINAL STANDING FACILITY (MSF) :
In May 2011, the RBI introduced a new instrument called Marginal Standing Facility under which all scheduled Commercial Banks can avail overnight funds from RBI against approved government securities. MSF, being a penal rate, is always fixed above the repo rate. The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging government securities, where the rates are lower in comparison with the MSF. The MSF would be a penal rate for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio. At present, this rate is fixed at 6.75%.
18. BANK RUN :
A panic situation in which customers try to withdraw their deposits simultaneously and the bank’s reserves are not sufficient to cover the withdrawals. A ‘bank run’ takes place when the customer of the bank fear that the bank will become insolvent and rush to the bank to take out their money as quickly as possible to avoid losing it.
19. BASE RATE :
Base rate is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers. Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of fund to their customers.
20. MARGINAL COST OF FUNDS BASED LENDING RATE (MCLR) :
The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank. MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank - on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower. This new methodology replaces the base rate system introduced in July 2010.
RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary policy. Prior to MCLR system, different banks were following different methodology for calculation of base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or blended cost of funds.
21. QUANTITATIVE EASING :
Quantitative easing is an occasionally used monetary policy, which is adopted by the government to increase money supply in the economy in order to further increase lending by commercial banks and spending by consumers. The central bank (Read: The Reserve Bank of India) infuses a pre-determined quantity of money into the economy by buying financial assets from commercial banks and private entities. This leads to an increase in banks' reserves. This has the same effect as increasing the money supply. Where do central banks get the credit to purchase these assets? They simply create it out of thin air. Only central banks have this unique power. This is what people are referring to when they talk about the Federal Reserve “printing money.”
22. SMALL FINANCE BANK :
Small finance banks are a type of niche banks in India. The objectives of setting up of small finance banks will be to further financial inclusion by (a) provision of savings vehicles, and (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganized sector entities, through high technology low cost operations. The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities. Small finance banks will be allowed to take deposits from customers. And as against payments banks, small finance banks will also be allowed to lend money to people.
23. PAYMENT BANK :
Small finance banks are a type of niche banks in India. Its operations are restricted. It can accept current and savings deposits up to a limit of ₹1 lakh. It can enable money transfers — both domestic and overseas — and direct benefit transfers, facilitate payments of utilities and other bills. It can also help channel savings by distributing insurance, mutual funds and pension products. While it cannot lend directly, it can act as a banking correspondent to other banks to provide credit in rural areas. The objectives of setting up of payment banks is to further financial inclusion.
24. ISLAMIC BANKING :
Islamic banking is a banking system in accordance with the Shariat. In Islam, money has no intrinsic value – money, therefore, cannot be sold at a profit and is permitted to be used as per shariat only. The Islamic Law or Shariat prohibits paying any fee for renting of money for specific periods of time. It also prohibits any sort of investment in businesses that are considered haraam or against the principles of Islam.
25. INSOLVENCY :
Insolvency is a state where the liabilities of an individual or an organization exceeds its asset and that entity is unable to raise enough cash to meet its obligations or debts as they become due for payment. Technically insolvency could be a financial state when the value of total assets of an individual or a group exceeds its liabilities. A person facing insolvency needs to take corrective actions to rectify its situation to avoid possible bankruptcy. This can be done in many ways like generating surplus cash or by minimizing the overhead cost. This can also be done by negotiating the repayment terms with your lenders.
26. BANKRUPTCY :
When an individual is unable to pay off his liabilities and debts then he generally files for bankruptcy. Here he asks for help from government to pay off his debts to his creditors. Bankruptcy could of two types, namely, reorganization bankruptcy and liquidation bankruptcy. Usually people tend to restructure the repayment plans to pay them easily under reorganization bankruptcy. And under liquidation bankruptcy, the debtor tends to sell of certain of their assets to pay off their debts for their creditors. One must follow a legal procedure to declare themselves bankrupt and get aid from government to deal with their creditors. To do this debtor must apply for bankruptcy in a relevant court. Or else one of his creditors files an application in a relevant court to declare that entity or person as bankrupt.
27. NON-PERFORMING ASSETS :
A non-performing asset (NPA) is referred to a loan amount for which the principal/ interest payment remained overdue for a time span of 90 days. But incase, a borrower fails to repay the loan (interest/principal/both) that loan becomes an NPA for the bank. Banks classify NPAs into three categories, which are Substandard assets, Doubtful assets and Loss assets.
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