Money and Banking

This section explores the various forms of financial assets held by individuals, businesses, and the financial system. It examines the role of cash, securities, loans, deposits, and equity in economic activity and the functions of banks in facilitating these transactions.

Holding or Providing Cash

Cash, typically in the form of banknotes and coins, represents the most liquid form of money. Individuals and businesses hold cash for transactions, precautionary motives, and speculative motives.

• Transactions Motive: Holding cash for immediate purchases.
• Precautionary Motive: Holding cash for unexpected expenses.
• Speculative Motive: Holding cash to take advantage of perceived future investment opportunities.

Securities

Securities are financial instruments that represent ownership in a company (shares) or a debt owed by a company or government (bonds). They offer a higher potential return than cash but also carry more risk.

Security Type	Risk Level	Potential Return
Government Bonds	Low	Low to Moderate
Corporate Bonds	Moderate	Moderate to High
Stocks (Equities)	High	High

Loans

Loans are agreements where one party (the lender) provides funds to another party (the borrower), with the expectation of repayment with interest. Loans are crucial for investment and consumption.

Different types of loans include:

• Consumer Loans: Mortgages, car loans, personal loans.
• Business Loans: Working capital loans, investment loans.

Deposits

Deposits are funds held in accounts at banks. They are a key component of the money supply and provide a safe place for individuals and businesses to store money.

Types of deposits include:

• Demand Deposits: Checking accounts (can be withdrawn on demand).
• Savings Deposits: Accounts that earn interest.
• Fixed Deposits: Deposits held for a fixed period with a fixed interest rate.

Equity

Equity represents ownership in an asset, typically a company. It is the value of the asset minus any outstanding liabilities.

Individuals invest in equity with the expectation of capital gains and dividends.

The Role of Banks

Banks play a vital role in the financial system by facilitating transactions and channeling funds from savers to borrowers. They do this through various mechanisms:

• Accepting Deposits: Banks accept deposits from individuals and businesses.
• Making Loans: Banks lend out a portion of these deposits to borrowers.
• Creating Money: Through the process of lending, banks create new money in the economy. This is known as the money multiplier effect.

The money multiplier is calculated as: $$ \text{Money Multiplier} = \frac{1}{\text{Reserve Ratio}} $$

Where the Reserve Ratio is the proportion of deposits banks are required to hold in reserve.