Assignment Code: ECO-09/TMA/2021-22

Course Code: ECO-09

Assignment Name: Money, Banking and Financial Institutions

Year: 2021-22

Verification Status: Verified by Professor

Marks: 100

Q1) What is money? Distinguish between money and near-money. Discuss nature and functions of money.

Ans) Money is a medium of trade that enables individuals to obtain the goods and services they require to live. Money is a commodity that is widely acknowledged as a means of economic exchange. It is the vehicle through which prices and values are communicated. It is the primary measure of wealth and circulates from person to person and country to country, promoting trade.

Differences

Nature of Money

Money is merely a tool, not an end in and of itself. It is desired not for its own sake, but because it assists us in purchasing things and services to meet our needs. Money does not directly satisfy human desires, but it does facilitate the production and exchange of products and services. Its importance stems from its power to compel products and services as well as settle corporate debts. Money allows for the mobility of capital, as well as the division of labour and specialisation that allows for large-scale production. 'We can't eat money, but we can't eat without money, either' as the saying goes.

Functions of Money

Primary Functions:

Money as a Medium of Exchange : It is money's most essential and unique feature that distinguishes it from near-money items. The adoption of money as a common medium of exchange has made the process of buying and selling products and services easier. Without money, trading could only take place through the barter system, whose fundamental flaws were explored previously in this Unit. The use of money as a medium of exchange, on the other hand, avoids most of the drawbacks of a barter exchange. Although the use of money divides exchange into two halves, namely selling and buy, it does not result in time and energy waste.

Money as a Measure of Value : Money is used to assess the worth of all other commodities and services in terms of their monetary value. Without money, the worth of an item could only be expressed in terms of other goods and services. As previously stated, if there are one hundred items on the market, then the value of each product must be described in terms of the remaining 99 goods, resulting in a total of.4950 values. If money is used as a measure of value, however, we must measure the value of each commodity only in terms of money, i.e. 100 values for 100 commodities. There are other items that are measured in distinct physical units, such as a metre of fabric, a kilogramme of wheat, a litre of milk, and so on.

It is also possible to compare the values of such things if we know their monetary value. One metre of cloth, for example, is comparable to 6 kg of wheat or 3 lives of milk because they are both the same price. Money prices are also useful for calculating national income because they allow us to sum up the values of a wide range of commodities and services that are measured in distinct physical units and thus cannot be lumped together to estimate national revenue. Furthermore, the use of money allows for the comparison of the worth of products over time and between different areas. Money, on the other hand, can only function as a sufficient measure of worth if its own value remains steady throughout time. Money has become a poor indicator of worth due to the continuous rise in global price levels.

Secondary Functions:

Money as a Standard of Deferred Payment: Money facilitates not only gods' and services' current transactions, but also their credit transactions. When current items are swapped for future payments, it facilitates credit transactions. In today's society, the majority of deferred payments are made in monetary terms solely. Repayment of a debt, including interest, pensions, rents, salaries, and insurance premiums are all examples of this. Only if the value of money does not change can money be an appropriate benchmark for deferred payments. Money becomes a poor standard of deferred payments if prices rise or fall abruptly, resulting in substantial swings in the value of money.

Money as a Store of Value: People can save a portion of their current earnings as money to spend in the future. Money is a completely liquid asset that represents generalised purchasing power. Furthermore, it has a longer lifespan and a more consistent value. 1 is simple to store because it is low in weight and takes up little room. As a result, accumulating wealth in the form of money, which can be changed into any asset at any time, is convenient. Money acts as a bridge between the present and the future in this sense, as money saved today allows families to shift their purchasing power from the present to the future.

Money as a Means of Transferring Purchasing Power : Money is the most practical means of transferring value from one person to another and from one location to another. Money is widely accepted, and the cost of transferring it from one location to another is inexpensive due to its great worth and light weight when compared to other items. For example, with the use of a bank draught or a cheque, a person can transfer crores of rupees to another person in a remote location for absolutely no cost. However, transmitting this value in terms of, say, rice is obviously difficult, expensive, and wasteful.

Contingent Functions:

Distribution of National Income : Money facilitates the allocation of national output among those who contributed to its creation. People in a contemporary society labour together to generate commodities as workers, capital owners, landlords, and so on. As a result, the output will be split among them in the form of earnings and salaries, interest, rent, and so on. It would not always be possible to share such an output in the absence of money, particularly in the case of indivisible items, such as a machine. We can solve such an issue with the aid of money.

Basis of Credit System : Credit, or the promise to pay, is the foundation of the modern economy. The current money (coins, currency notes, checks, bank draughts, and so forth) is! 1btfiSng, but only on the condition that you pledge to pay. This money, on the other hand, assists banks in creating new money through the credit creation process, when banks expand secondary deposits with the support of cash deposits. Money is used as a basis for banks to create credit in this way.

Maximisation of Utility and Profits : Money aids consumers in achieving their highest levels of enjoyment. The customer maximises his utility by allocating money among various items and services. Similarly, producers can determine the money cost of production and then set a price that maximises profits. 4) Money gives assets liquidity and consistency: Money is the most liquid of all assets, thus it's convenient to keep wealth in it. Money can be used to purchase any item, and every asset can be transformed into money. As a result, money provides liquidity to all assets. Furthermore, a person's or a country's overall wealth can be calculated by adding up the dollar values of all assets. As a result, money adds a level of consistency to the nation's riches.

Q2) Differentiate between quantitative and qualitative methods of credit control and discuss the effectiveness of quantitative methods to control quantum of credit in an economy.

Ans) Quantitative Methods

Under this category, there are four distinctive methods:

Bank Rate Policy

When member banks approach the central bank for accommodation to supplement their liquid funds, the bank rate is the rate of interest at which the central bank rediscounts the qualifying securities of the member banks. They require these funds to increase credit privileges for their customers, particularly during the busiest season. As a result, the bank rate is also known as the rediscount rate.

The following assumptions underpin the bank rate policy:

1. Commercial bank lending rates are strongly linked to the bank rate. When banks raise their lending rates in response to a rise in the bank rate, businessmen will borrow and invest less.

2. Banks only retain the bare minimum of cash reserves on hand, forcing them to seek the central bank for additional cash as needed.

3. The banks have sufficient volumes of suitable securities.

4. Prices, employment, salaries, and output are all flexible enough to expand or contract in response to changes in industrial and corporate borrowing and investment.

Workings of the Bank Rate Policy: The central bank indirectly controls credit volume by creating suitable adjustments in the bank rate, which influences commercial bank lending rates of interest. When the economy is in an inflationary state, it is a result of excessive credit creation. As a result, the central bank boosts the bank rate in order to keep inflation under control. An increase in the bank rate leads to an increase in commercial banks' 1 lending rates. A rise in the cost of bank loans may discourage borrowers from seeking additional loans, putting a stop to commercial banks' excessive credit creation.

Businessmen, on the other hand, may be forced to liquidate some of their assets in order to repay their debts. This will increase the supply of items on the market and help to slow the price rise. When faced with a deflationary crisis, the central bank lowers the bank rate, making borrowing less expensive and thereby stimulating investment. However, in recent years, the bank rate policy has lost a lot of its clout.

The effectiveness of the bank rate policy may be harmed if:

1. Commercial banks may have sufficient cash reserves and hence may not need to seek extra funding from the central bank.

2. It is likely that the bank may be able to collect funds from other sources and will not need to seek accommodation from the central bank.

3. Commercial banks may not have enough approved first-class bills and securities to have the central bank rediscount them.

4. In less developed countries with a substantial unorganised sector, interest rates on loans may not climb in tandem with the bank rate.

5. When investment profitability is very high due to inflationary conditions in the economy, a bank rate hike will just increase borrowing costs and may not reduce demand for money for investments. In India, for example, despite rising interest rates, there has been a steady increase in demand for bank borrowing.

Bank rate policy is regarded as an indirect technique of credit control, and its success requires that either the assumptions on which it is founded be true or that it be used in conjunction with other credit control tools such as open market operations.

Open Market Operations

To manage the volume of credit, the central bank uses open market operations to purchase and sell securities and bills in the money market directly and deliberately. The Open Market Operations are as follows: When the economy is experiencing inflation, the central bank sells securities on the open market. This diminishes banks' cash reserves directly to the extent that these securities are purchased. Furthermore, this reduces the amount of customers' deposits with commercial banks to the extent that these customers purchase the central bank's securities.

As a result, the central bank's selling of securities on the open market reduces the credit-creating 'base of the. As a result, credit is tightened and the supply of money in circulation is reduced by commercial banks. This aids in the regulation of rising demand for goods and services, as well as the rising trend in their prices. In contrast, the central bank purchases securities to supplement commercial banks' cash reserves in order to boost lending volume and battle deflation.

The mis approach of credit management is thought to be superior to bank rate policy since it directly impacts banks' credit-creating potential by lowering their cash holdings. However, even this strategy has some drawbacks that make it less effective at times.

They are as follows:

1. Only a large, powerful, and active securities market can support open market operations. However, in less developed countries such as India, such a market may not exist, rendering this strategy ineffectual.

2. The sale of securities may not have a negative impact on commercial banks' liquidity because they can refill reserves using the central bank's rediscounting capabilities.

3. It's possible that open market operations won't be enough to keep deflation at bay. It's because, even if the central bank adds to the money supply by purchasing assets on the open market, it can't force borrowers to borrow and invest more during the defining period because prices fall and investments lose money.

Variable Legal Cash Reserve Ratio

The variable cash reserve ratio is a relatively recent mechanism for central banks to manage credit. The Federal Reserve System of the United States was the first to embrace it. This type of credit control is most commonly used in nations where the money market is unorganised or underdeveloped. Currently, every commercial plank is required to retain a certain percentage of its total deposit liabilities with the central bank in the form of minimum legal cash reserves, either by law or by custom. ' Variations in this reserve ratio are likely to affect the amount of liquidity available to commercial banks and, as a result, their lending capabilities. The central bank boosts the cash reserve ratio when credit contraction is wanted and reduces it when credit expansion is necessary. This strategy is more direct and has an immediate impact on the amount of credit that commercial banks create.

The following formula is used to calculate the bank's cash-creating capacity:

∆D = C × 1/r

Where,

AD = Change in total deposits

C = Cash deposits

r = minimum cash reserve ratio

Secondary Reserve Requirements

Central banks now have the authority to impose not only a minimum cash reserve ratio but also a proportion of liquid assets to total assets on commercial banks. This reduces their ability to manufacture credit even further. Commercial banks should not be allowed to convert government securities and other liquid assets into company loans and advances, according to the basic premise. A larger secondary reserve requirement will result in fewer longer-term loans and advances, which will lead to inflation. Many countries, including India, have utilised this weapon to control inflation by limiting commercial banks' lending ability.

De Kock believes that this weapon may be developed to play an important role in limiting extreme inflationary pressures. To make it more effective, this type of credit control is usually combined with modifications in the minimum cad! reserve ratio.

Three truths emerge from the above consideration of generic credit control mechanisms. To begin with, no single credit management strategy can be proven to be truly effective unless it is supported by another one. Second, while these approaches may be good for controlling inflation, none of them are particularly effective for controlling deflation. Finally, these systems fail to give preferential treatment to priority areas of the economy with more pressing and socially acceptable needs for bank loans.

Qualitative Methods

Selective credit control approaches are sometimes known as qualitative credit control methods. Selective credit controls are thought to be superior to general credit controls since they are aimed at controlling not only the total volume of credit but also the precise uses for which credit is issued. In fact, selective controls distinguish between desired and essential applications and non-essential and undesirable uses for which credit is given. Its goal is to shift credit away from less desirable and productive usage and toward more significant, desirable, and productive ones. The following are examples of selective controls:

Variation in Margin Requirements: Banks use the practise of requiring a margin to estimate the loan value of a collateral security given by borrowers. The security's ban value is equal to the market value minus the margin. For example, at a 20% margin requirement, the loan value of an equity share with a market value of Rs. 125 is Rs. 125 - Rs. 25 = Rs. 100. As a result, the bank cannot lend more than Rs. 100 on this security.

The central bank has the authority to set the margin for various forms of collateral securities, hence influencing the loan's maximum limit. The amount of loan that can be issued against a security will be reduced if the margin requirement is increased. This will assist to control inflation by limiting the amount of credit available. Variation in margin requirements is a powerful tool for regulating credit in speculative domains while also reducing loan availability+ in more productive and socially desirable areas. Furthermore, if the central bank can recruit the help of commercial banks, this strategy is simple to implement.

Regulation of Consumer Credit: This credit control mechanism was originally utilised in the United States during World War 11 to limit customer demand for commodities in short supply. Consumer credit regulation is important in societies that have a large-scale consumer credit system based on instalment payments and hire-purchase. This procedure entails determining the minimal down payment and the number of instalments over which the loan can be repaid. The central bank supervises consumer credit by setting a maximum loan amount that commercial banks can give to buyers of listed durable goods. The central bank advises that the amount of down payment be increased and the number of instalments be decreased to restrict demand for goods and so regulate prices during inflation. However, in less developed countries where the hire buy system is not yet widely used, it has only limited application in monetary management.

Rationing of Credit: This strategy is particularly important in channelling financial resources into the planning authorities' designated channels. Rationing of credit is a strategy by which the central bank attempts to set a ceiling for loans and advances, as well as, in some situations, a limit for specific loan and advance categories. In this method, credit is restricted in non-priority segments, allowing credit to be diverted to the desired sectors of the economy. This strategy, on the other hand, is frequently disliked by member banks since it attempts to limit commercial banks' flexibility and initiative.

Issue of Directives: In recent years, central banks have begun providing directives to commercial banks in order to enlist their assistance and cooperation in implementing monetary policy effectively. Directives can take the form of oral or written declarations, appeals, or warnings, with the goal of limiting individual credit arrangements and total loan volume. The willingness of banks to collaborate with the central bank determines the success of directives. Despite the fact that disobeying directions is not illegal, commercial banks collaborate with the central bank because the former relies greatly on the latter for its smooth operation. Other credit control tools are generally used in addition to directives.

Moral Suasion: It refers to the central bank's persuasion and request to commercial banks to follow the country's general monetary policy. Commercial banks may be convinced to limit credit privileges for speculative and non-essential businesses during an inflationary period. During deflationary periods, banks may be asked to increase their loans and advances, even against inferior securities that they would ordinarily reject. This strategy only applies moral pressure to commercial banks, as it carries no threat or legal sanction. The RBI, on the other hand, has employed moral suasion skilfully and effectively in India. In the United Kingdom, the Bank of England has utilised this strategy with some success.

Direct Action: It refers to the penalties that a central bank may impose in one or more of the following ways:

1. For credit required by a commercial bank beyond a set limit, the central bank may charge a criminal rate of interest in addition to the bank rate.

2. Commercial banks whose credit policies do not align with the central bank's broad monetary policy may be denied rediscounting facilities.

3. The central bank may reject future credit to commercial banks whose borrowings are determined to be in excess of their capital and cash reserves.

In practise, however, it may be difficult for the central bank to take action against any commercial bank because it is not always straightforward to determine non-essential and unproductive loan uses. Furthermore, ensuring that a loan issued for productive purposes has not been diverted to any speculative or non-essential use is challenging.

Publicity: In recent years, central banks have attempted to exert psychological and moral pressure on the banking sector by publicising hazardous loan practises as well as what should be the banks' proper policy. To assist member banks in determining what they should do, the central bank provides statements of assets and liabilities of the banking system, reviews of credit and business conditions, and developments in the money market on a regular basis.

Q3) 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.

Ans) Other than commercial and cooperative banks, Non-Bank Financial Intermediaries (NBFIs) are a diverse set of financial entities. They comprise a wide range of financial entities that generate cash from the general public, either directly or indirectly, in order to lend them to final spenders.

Features

1. Financial intermediaries function as go-betweens for financial transactions involving banks or funds.

2. These intermediaries aid in the creation of efficient markets and the reduction of transaction costs.

3. Leasing and factoring services are available through intermediaries; however they do not accept deposits from the general public.

4. Financial intermediaries provide benefits such as risk sharing, cost reduction, and economies of scale, among others.

A financial intermediary, such as a commercial bank, investment bank, mutual fund, or pension fund, acts as a go-between for two parties in a financial transaction. Consumers benefit from financial intermediaries in a variety of ways, including safety, liquidity, and economies of scale in banking and asset management. Although developments in technology threaten to eliminate the financial middleman in some sectors, such as investing, disintermediation is less of a concern in other areas of finance, such as banking and insurance.

Savers can combine their assets through a financial intermediary, allowing them to make big investments that benefit the organisation in which they are investing. Financial intermediaries, on the other hand, pool risk by distributing funds across a varied variety of assets and loans. Households and governments profit from loans because they allow them to spend more money than they now have.

Financial intermediaries can also help you save money on a variety of fronts. For example, they can take use of economies of scale to expertly assess potential borrowers' credit profiles and maintain records and profiles at a low cost. Finally, they lower the expenses of the numerous financial transactions that an individual investor would normally have to perform if a financial intermediary were not available. Shareholders' capital is pooled and managed actively by mutual funds. The fund manager interacts with shareholders by investing in companies that he believes will beat the market. As a result, the manager offers assets to shareholders, capital to enterprises, and liquidity to the market.

Deposits from the general public are not accepted by a non-bank financial intermediary. Factoring, leasing, insurance policies, and other financial services may be provided through the middleman. Many intermediaries participate in securities exchanges and manage and develop their funds using long-term strategies. The actions of financial intermediaries and the growth of the financial services industry might reveal a country's overall economic stability. Financial intermediaries transfer money from those with excess capital to those who require it. The approach results in more efficient markets and cheaper corporate costs. A financial advisor, for example, connects with clients by helping them buy insurance, stocks, bonds, real estate, and other assets.

Banks provide cash from other financial institutions and the Federal Reserve to connect borrowers and lenders. Insurance businesses collect premiums and pay out benefits to policyholders. A pension fund is a trust that collects money on behalf of its members and distributes it to retirees. The Indian Central Banking Enquiry Committee recognised the usefulness of unit trusts in mobilising small savers' money as early as 1931. In 1954, the Shroff Committee emphasised the importance of establishing these trusts once more. The Unit Trust of India, however, was established in 1964 under the UTI Act of 1963. The UTI is a financial institution that provides all investors with a stake in India's industrial growth and productive investment with low risk and appropriate returns.

The Unit Trust of India (UTI) is not a development bank in the traditional sense. It's an investment trust, as the name implies. It is a type of financial institution that collects savings from other businesses and lends them to people who want to put them to good use. In the United States, unit trusts are similar to mutual funds. The major goal of UTI is to encourage and mobilise the community's savings. It directs them into inductive corporate investments in order to boost the country's economic growth and diversity.

The Trust's specific objectives are as follows:

It mobilises the community's savings and directs them into productive investment. The trust encourages people to save by offering them the triple benefits of safety, liquidity, and profitability from their assets. It allows everyone to indirectly hold shares and securities in a large number of choice companies, allowing investors to benefit from the expanding affluence brought on by industrial expansion. The UTI's starting capital was set at Ks. 5 crore by statute.

The Reserve Bank of India (Rs. 2.5 crore), the Life Insurance Corporation of India (Rs. 0.75 crore), State Rank of India and its subsidiaries (Rs. 0.75 crore), and other financial institutions including banks (Rs. 1.0 crore) were also expected to contribute. The Reserve Bank of India's initial capital was transferred to the lDBl in 1976, and the UTI became an associate institution of the latter.

The UTI's major source of funds is unit capital, which is raised through the sale of units to the general public under various programmes. The Unit Scheme of 1964 and the Capital Gains Units Scheme of 1983 account for the majority of the funds gained in this manner. These two schemes currently account for more than two-thirds of all proceeds from unit sales. The UTI's initial programme, the Unit Scheme, was created in 1964 and has always been popular with investors. The face value of the units sold under this plan is Rs. 10. Their market price, on the other hand, is decided on a regular basis and is higher than the face value. The market valuation of the UTI's aggregate investments throughout the previous period is used to determine the market price of units under this scheme. The buying price is kept lower than the sale price, and there has always been a MARGIN of 30 paise or more between the two.

The UTI's investment approach is to find a balance between principal security and capital return. The securities in which investments are made must be of proven soundness and easily marketable from the standpoint of capital security. This suggests that safe and liquid securities should be selected while investing. These securities frequently provide a good return on investment as well as reasonable capital appreciation potential.

Q4) Describe the working of the IMF. How does it help member countries in dealing with their temporary balance of payments problems?

Ans) Working of IMF

Determination of Quotas

In 1989, the total quotas of all members totalled SDR 90 billion. After analysing the situation in September 1989, the Interim Committee of the IMF proposed that members' quotas be increased on a priority basis, taking into account changes in the world economy and the members' relative position in the world economy. It is vital to maintain a balance between different groups of countries when updating quotas of individual member countries.

Member country quotas represent their contribution to the IMF's resources and serve as a basis for determining members' access to those resources as well as their voting power. Members' shares of Special Drawing Rights (SDRs) allocation are also determined by their quotas. The member countries' quotas have been calculated based on their national revenues, gold and foreign exchange reserves, and international trade volume.

As a result, there are significant disparities in the quotas of different countries. The United States has the greatest quota, accounting for 20% of the IMF's total quota. The IW's other key members are the United Kingdom, France, West Germany, and Japan. They account for a little more than the US quota combined. Other countries' quotas are small; thus they don't mean much in terms of decision-making. Indeed, the US quota's vast size has given it unrivalled leverage to influence the IMF's policies and practises.

It is important to recognise that a country's quota has three dimensions:

1. It states the amount of the member country's contribution to the IMF. 25% of this donation will be paid in gold, with the remaining 75% in national currency.

2. The drawing right of a country, i.e. the amount it can borrow from the IMF, is determined by its quota.

3. The voting rights of member countries are likewise determined by the quota.

Determination of Par Values or Exchange Rates

Members of the IMF were required by law to declare par values of their currencies in terms of gold control of the US dollar (later in terms of SDR) until the system established at Bretton Woods in 1944 did not collapse in the early 1970s. Because this was a legally obligatory responsibility, most countries followed through and declared their currencies' par values. There were several defaulters, but even those countries strove to maintain de facto parities by adhering to the 1MF's stable exchange rate system, sometimes known as the pegged r exchange rate system.

The IMF conducted transactions with member countries at official per-value rates. Even for private transactions, only these exchange rates were to be used. In the case of spot trades, a 1% departure from the par value was permitted. The Smithsonian Agreement, signed in December 1971, increased the range to 2.25 percent above or below par value. This clearly indicates that the IMF's founders, in their wisdom, believed that a stable exchange rate system was beneficial to both international trade and capital flows.

Member nations had the right to adjust the par values of their currencies in the range of 10% by merely informing the IMF during the previous phase, which lasted more than two and a half decades. Changes in exchange rates of more than ten percent, on the other hand, required IMF permission. These adjustments were permitted where they were necessary to correct fundamental imbalances in the 'balance of payments.' As a result, the IMF never emphasised exchange rate rigidity while always attempting to support exchange rate stability. Despite the fact that the dollar was losing its lustre by the end of the 1960s due to recurrent balance-of-payments deficits in the United States, there was no crisis of trust in it.

When the US government announced on August 15, 1971, that it would no longer redeem dollars from other central banks for gold or other reserve assets, demand for European currencies soared, and many eager to get rid of their dollar holdings. The IMF's previous steady exchange rate regime became impractical in this situation. Several governments declined to support their currencies, enabling them to rise in value.

Attempts were made for almost four years to resurrect the previous system, but they were unsuccessful. The issue was finally resolved in January 1976 when the managed float was legalised. As a result of the IMF's failure to create explicit standards for managed floating, currency rates continue to fluctuate in reaction to movements in foreign exchange markets. This means that if a country's balance of payments continues to be in deficit, its currency will eventually decline. As a result, the country's balance of payments must be maintained in good order.

Borrowings from the IMF

The IMF's goal is to assist its members in resolving transitory balance of payments issues. In this regard, it sells the currencies that the member countries require to pay their short-term debt obligations. These currency exchange operations between the IMF and its members are not typical currency purchases and sales. In essence, they are borrowings of other nations' currencies from the IMF by member countries, with the borrowers compelled to exchange their own currencies for the IMF's foreign currencies. Borrowers must pay interest, which rises in tandem with the amount borrowed and the length of the loan. Repaying a loan entails repurchasing one's own currency, either in gold or in the currency in which the loan was initially taken out. However, a member country cannot obtain an infinite number of Ioans from the IMF.

There are two limitations in this regard:

1. For starters, the IMF will rarely keep a country's currency in excess of 200 percent of its quota. This means that in most cases, a country's overall IMF borrowings will not exceed 125 percent of its quota. In exceptional circumstances, the IMF may waive this provision.

2. Second, a worthy's borrowings from the IMF should not increase the Fund's holdings of the latter's currency by more than 25% of its quota in the year following the borrowing date.

The ability to borrow or draw foreign currencies from the IMF allows member nations to address their short-term balance of payments issues without resorting to bilateral transaction balancing. Member nations would not seek loans in the currencies of only those countries with which they have bilateral deficits in a multilateral payments system that the IMF is working to strengthen. In fact, loans in any foreign currency will be sufficient to pay debt commitments in such a system. The IMP has yet to develop a multilateral payment system in practise.

As a result, the IMF is frequently approached by member nations seeking loans in specific currencies due to their wider acceptance. Through its primary duties of monitoring, capacity development, and lending, the IMF assists nations in implementing sound and suitable policies.

Surveillance: Surveillance is one of the IMF's main responsibilities, which includes overseeing the international monetary and financial system and monitoring the economic and financial policies of its 190 member countries. The IMF analyses potential stability risks and proposes necessary policy adjustments to sustain economic development and promote financial and economic stability as part of this process, which takes place at the global, regional, and country levels.

Data: The IMF is collaborating with its members, the Financial Stability Board, and other organisations to close data gaps that are critical to global stability.

Capacity Development: The International Monetary Fund (IMF) assists countries in improving their ability to create and implement sound economic policies. It offers technical advice and training in areas where it specialises, such as fiscal, monetary, and exchange rate policies; financial system regulation and supervision; statistics; and legal frameworks.

Lending: Even the most effective economic measures will not be able to totally eliminate instability or prevent catastrophes. If a member nation has a balance of payment crisis, the IMF can give financial assistance to support policy programmes that address underlying macroeconomic issues, limit disruption to both the domestic and global economies, and help restore confidence, stability, and prosperity. In some situations, the IMF can give emergency assistance without requiring the implementation of a full-fledged programme. The IMF also provides crisis-prevention credit lines to nations with strong economic fundamentals.

Q5) Write short notes on the following:

(a) Inflationary gap

Ans) The inflationary gap was a new idea developed by Keynes. At base pricing or pre-inflation prices, the inflationary gap depicts a situation in which predicted expenditures (demand) exceed available output (supply).

As a result, the inflationary gap is defined as the difference between disposable income and production accessible for consumption on the one hand. In other words, when money income rises as a result of greater investment or government spending, or both, but the supply of products and services does not expand in the same proportion due to capacity constraints, an inflationary gap occurs, allowing prices to rise. It only occurs when the total amount of money available for consumption surpasses the whole amount of output available at pre-inflation pricing. As long as there remains an inflationary gap, prices will continue to grow.

(b) Branch Banking

Ans) Branch banking is a banking system in which two or more banking offices are operated as a single institution under a single ownership and management. As a result, the firm is run by the head office through a network of branches located all over the world. Every bank in this system is a separate legal company with its own set of shareholders and Board of Directors. India's and England's banking systems are examples of this.

All commercial banks in India (such as the State Bank of India, Bank of India, and others) have branch banking operations. The "Big Five" banks in England, including the Midland, Westminster, Barclays, Lloyds, and National Provincial, handle the majority of banking business. These five banks dominate about 75% of the banking business in the country, with over 12,000 branches.

Advantages

1. Mobilisation of Savings: Funds can be quickly transferred from branches that have excess funds to branches that are short on funds.

2. Efficiency in Management: Branch banking gives you more options for effective management. Because of its immensity. It is possible to hire professionals and qualified employees.

3. Large Scale Economies: In terms of operations such as division of labour, branch banking benefits from internal and external economies of scale. Expert services, technological advancements, computerization, and so on.

4. Diversification of Deposits and Advances: Branch banking allows for a greater variety of deposits and advances.

5. Economy in Reserves: Because monies can be shifted from one branch to another, each bank can keep its cash reserves low.

Disadvantages

1. Difficulty in Management: Branch banking is challenging to manage due to the extent of its operations and the dispersal of branches across different geographic areas. Excessive growth leads to mismanagement, incompetence, and other issues.

2. Red Tapes: Red tape and unusual delays in the resolution of critical situations are blamed on branch banking.

3. Weaker Branches: In the branch banking system, weak and sick branches can also survive. They serve as a counterbalance to the income made by other branches.

4. Cut-Throat Competition: Various banks open a number of branches in the same area under branch banking. The evils of cutthroat competition result as a result of this.

5. Less Personal Contacts and Familiarity with Local Conditions: Branch managers do not have the opportunity to create personal contacts with clients or become completely versed with local conditions due to their frequent 'transfers.

   
   

(c) State Finance Corporations

Ans) The State Financial Corporations Act of 1951, which allows all state governments (excluding Jammu and Kashmir) to establish State Financial Corporations as regional development banks, went into effect. They are designed to satisfy the financial needs of small and medium-sized manufacturing businesses in their respective states. Punjab established the first State Financial Corporation in 1953. In 1960, the state governments of Andhra Pradesh and Bihar took the lead in establishing SFCs, followed by Uttar Pradesh, Karnataka, Gujarat, Maharashtra, and Orissa. There are currently 18 SFCs operating around the country in various states and union territories.

Financial Resources

An SFC's capital structure is set by the state government, with a minimum of Rs. 50 lakh and a maximum of Rs. 5 crore. They're also allowed to raise money through the sale of stock and the issuance of bonds and debentures backed by state governments. They can also accept public medium and long-term deposits. They can also borrow money from other financial institutions.

Management

A 12-member Board of Directors oversees each SFC. The concerned State Government picks the Chairman and Managing Director, as well as three directors. Each of lFCl and lDBl nominates one director. Financial institutions choose three directors. The rest will be picked from schedule banks, cooperative banks, and other financial institutions, one from each. Non-institutional shareholders elect one director.

(d) Foreign Exchange Market

Ans) Most countries in the modern world have open economies, which means that some of their citizens participate in international transactions. These transactions can include commodity exports and imports, service exports and imports, inter-country unilateral transfers, capital flows, and gold exports and imports. The majority of these foreign transactions have one distinguishing feature that sets them apart from solely domestic transactions. They necessitate the usage of foreign currency by the transaction's participants.

For example, an Indian company purchasing goods from the United States will need to obtain dollars in order to meet payment obligations.

Similarly, a Canadian visiting India will need to exchange any dollars he may be carrying for rupees. As a result, foreign transactions necessitate the conversion of one currency into another. The foreign exchange market is where you may purchase and sell currencies. Foreign exchange refers to foreign currencies in a narrow sense. Foreign exchange, in its broadest definition, encompasses not only foreign currencies, but also bank deposits denominated in foreign currencies and short-term claims on foreigners denominated in foreign currencies. The majority of foreign exchange transactions now involve the buying and sale of foreign currencies, as well as the holding of foreign currency-denominated bank deposits.

The foreign exchange market is one of the world's most important markets. The fact that its daily trading volume has surpassed $100 billion in recent years gives you an idea of the market's scale. Spot markets and forward markets are two types of foreign exchange markets. This distinction mostly pertains to the timing of foreign exchange delivery and payment.

Transactions involving the purchase and selling of foreign currency in spot markets are made for immediate delivery. In practise, this usually takes one or two days, but seldom more than that. These transactions were conducted at prevailing exchange rates, which are referred to as spot exchange rates. Individuals buy foreign exchange in the spot market when they desire to travel abroad or remit their savings to their home countries. However, buying and selling foreign currencies on the spot markets for trading purposes may not be completely safe.