MONEY AND BANKING
Features of Money
Functions of Money
Money is something which people generally accept in exchange for a good or a service. Money performs four main functions:
a medium of exchange for buying goods and services;
a unit of account for placing a value on goods and services;
a store of value when saving;
a standard for deferred payment when calculating loans.
Properties or Characteristics of Money
Any item which is going to serve as money must be:
acceptable to people as payment;
scarce and in controlled supply
stable and able to keep its value
divisible without any loss of value
portable and not too heavy to carry.
Origins of Money
The earliest method of exchange was barter in which goods were exchanged directly for other goods. Problems arose when either someone did not want what was being offered in exchange for the other good, or if no agreement could be reached over how much one good was worth in terms of the other.
Valuable metals such as gold and silver began acting as a medium of exchange. Governments then decided to melt down these metals into coins.
By the seventeenth century people were leaving gold with the local goldsmith for safe keeping. Receipts of £1 and £5 were issued which could then be converted back into gold at any time. Soon these receipts were recognised as being 'as good as gold' and were readily taken in exchange for goods. Goldsmiths became the first specialist bankers and their receipts began to circulate as banknotes.
Only the Bank of England can now issue banknotes in England and Wales. However, notes are not usually used to buy expensive items such as cars. The buyer is more likely to write out a cheque, which instructs his bank to transfer money from his account into the account of the seller. Hence bank deposits act as money.
Commercial Banks
Banks are authorised institutions and perform four functions. They accept deposits, make loans, arrange payment of bills and provide a number of customer services. The four main high street or clearing banks in the UK are Barclays, Lloyds, Midland and National Westminster.
Types of Bank Account
Banks provide different types of account for different needs. Customers can open:
A current account which provides a cheque book but usually pays no interest. Current accounts are mainly used to pay bills.
A deposit account which does pay interest but money can only be taken out by visiting the bank. Deposit accounts are mainly used for short term saving.
An investment or savings account which pays a higher rate of interest but written notice of withdrawal must be given. Accounts of this type are used mainly for long-term saving.
Types of Bank Loan
An overdraft is when the bank allows a customer to take out more money than is in his account. Overdrafts are up to an agreed limit, and must be paid off whenever the bank asks. Interest is charged daily on any outstanding balance.
A loan account is when a customer borrows a fixed sum of money to be repaid in monthly instalments over a number of years. A fixed rate of interest is charged.
Methods of Payment
These include:
Cheques when the bank is ordered to pay money to someone else. The people involved in writing a cheque are:
The person writing out the cheque (drawer).
The bank ordered to pay the money (drawee)
The person receiving the money (payee).
A cheque card is issued to trusted customers which guarantees payment by the bank of any cheque up to the sum of £50, though some will now go up to £100.
Standing orders when a fixed sum is paid out on set dates.
Direct debits when a variable sum is paid out on set dates.
Credit cards when customers have a special card (eg Visa or Access) which can be used to buy goods. Cardholders receive a statement every month and no interest is charged if the account is settled in full. Interest is changed monthly on any outstanding balance.
EFTPOS.
Other Services
Banks have cash points; exchange foreign currency and issue travellers' cheques; provide night safes and store valuables; execute (carry out) wills and trusts; and factor (collect) debts.
Commercial Bank Balance Sheet
A balance sheet shows the present position of a company. One for a commercial bank is shown here.
The balance sheet of a commercial bank
Liabilities |
|
Assets |
|
(a) Current a/c |
£100 |
(e) Cash in tills |
£20 |
(b) Deposit a/c |
£200 |
(f) Money at the Bank of England |
£40 |
(c) Savings a/c |
£100 |
(g) Money at call and short notice |
£40 |
|
|
(h) 91-day bills |
£50 |
|
|
(i) Government securities with less than 1 year to maturity |
£50 |
|
|
(j) Investments |
£50 |
|
|
(k) Loans |
£150 |
(d) Total liabilities |
£400 |
(l) Total assets |
£400 |
In the balance sheet the liabilities column shows the origin of the money held by the bank. Items (a) to (c) show the amount of money held in each type of account. Item (d) states the total value of the deposits held by the bank.
The assets column shows what the bank has done with the money. Note that only a small percentage of total liabilities is kept as cash in tills (item (e)). Item (f) is the bank's own current account for settling debts. Item (g) is money lent out to discount houses for a few days. Items (i) and (j) are IOUs issued mainly by the government. Items (e) to (I) are the bank's liquid or reserve assets and can easily be turned into cash.
Items (j) and (k) are illiquid (not easily turned into cash) but highly profitable. By definition, the amount of total assets (item (l) must equal total liabilities.
Credit Creation
Some customers leave money in the bank earning interest. A bank can use these idle deposits to make loans to people who then buy goods. Shopkeepers receive extra money which they redeposit with the bank. Some of this redeposited money is left to earn interest and can be re-lent. The bank has therefore created money. If all customers were to try to cash their deposits at once, their would not be sufficient cash. The amount of money the bank can create therefore depends on the ratio of cash to liabilities that they hold. The higher this cash ratio the less money the bank can re-lend or create.
Money Supply
Definition
The money supply is the total amount of assets in circulation which are acceptable in exchange for goods. In modern economies people accept either notes and coins or an increase in their current account as payment. Hence the money supply is made up of cash and bank deposits. There are five main measures of the money supply known as M0 to M5.
Control of the Money supply
The Bank of England is responsible for controlling the money supply and this involves limiting the amount of cash, and bank deposits in circulation.
As the Bank of England actually issues notes and coins, it can easily control the amount of cash in the money supply.
However, the major part of the money supply is not created by the Bank of England. Commercial banks decide the amount of bank deposits in circulation using the equation:
D = 1x A
where D = total deposits
A = liquid assets
and = the percentage of deposits held in liquid form.
The Bank of England can:
Place a limit on the amount of deposits a bank can have.
Force up interest rates to discourage customers from taking out loans.
Reduce the amount of liquid assets held by a bank selling bills to the public. The public then write out cheques to the government and money leaves the bank.