Class 12 Economics Money And Banking Notes | Economics Chapter 2 Important Notes
This article will help you with Class 12 Economics Money and Banking Notes. Economics Chapter 2 Notes are very helpful if you want to score good marks, as I got 98 in CBSE 2025 Boards using these notes. study properly, and you will do good in economics. You can also check our YouTube channel for an explanation and quick concepts revision.
Money and Banking – Complete Study Notes for CBSE Class 12 Economics
These notes cover all key concepts from the Money and Banking chapter.
What is Money?
Money is anything that is generally accepted as a medium of exchange and can be used to settle payments for goods and services.
Functions of Money
| Function | Meaning | Example |
|---|---|---|
| Medium of Exchange | Used to buy/sell goods and services | Buying groceries with cash |
| Measure of Value | Standard unit for quoting prices | Price tag on a product |
| Store of Value | Means to save purchasing power | Saving money in a bank |
| Standard of Deferred Payment | Used for payments in future | Paying loan instalments monthly |
Barter System: Earlier trade involved exchanging goods directly (barter), which was difficult due to “double coincidence of wants” (both parties wanting what the other had).
Types of Money
| Type | Description | Example |
|---|---|---|
| Commodity Money | Has value in itself (used historically) | Gold, silver coins |
| Fiat Money | Value by government order (legal tender) | Currency notes |
| Fiduciary Money | Accepted on trust, more than its face value | Cheques, drafts |
| Credit Money | Created by commercial banks by lending | Loan balances |
Measures of Money Supply in India
| Measure | Components | Liquidity |
|---|---|---|
| M1 | Currency with public + Demand deposits + Other deposits with RBI | Highest/Narrow |
| M2 | M1 + Savings deposits with Post Office Savings Banks | High |
| M3 | M1 + Net time deposits with banks | Broad |
| M4 | M3 + All deposits with Post Office Saving Banks | Broadest |
- Narrow Money (M1): Most liquid, easy to use for transactions
- Broad Money (M3, M4): Less liquid, includes term deposits
Banking System in India
Types of Banks
| Type | Functions | Examples |
|---|---|---|
| Commercial Banks | Accept deposits, give loans, credit creation | SBI, ICICI, HDFC |
| Central Bank | Controls money supply, regulator of all banks | Reserve Bank of India (RBI) |
| Cooperative Banks | Provide credit, mostly for agriculture and rural areas | District Co-op Bank |
Commercial Banks: Functions
1. Primary Functions
- Accepting Deposits (Savings, Current, Fixed)
- Advancing Loans (Term loans, Cash credit, Overdraft)
- Credit Creation: Banks can lend more than they have as primary deposits, increasing money supply.
2. Secondary Functions
- Agency Services (Collecting cheques, bills, providing locker)
- General Utility Services (Debit cards, ATM, currency exchange)
Credit Creation Example
If a bank receives ₹1000 in deposits and maintains a Legal Reserve Ratio (LRR) of 20%, it can create total deposits of ₹5000 (using multiplier formula = 1/LRR).
Central Bank (RBI): Functions
| Function | Description |
|---|---|
| Issuer of Currency | Responsible for printing of notes, except 1 Rupee coins |
| Banker to Government | Manages government’s accounts and transactions |
| Bankers’ Bank | Supervises and lends to commercial banks |
| Lender of Last Resort | Provides emergency funds to banks |
| Controller of Credit | Uses policy tools to regulate money supply |
| Custodian of Foreign Exchange | Manages India’s forex reserves |
Credit Control Methods (by RBI)
Quantitative Tools
| Tool | What it Does |
|---|---|
| Bank Rate | Rate at which RBI lends to commercial banks |
| Repo Rate | Rate for short-term borrowing by banks |
| Reverse Repo Rate | Rate at which RBI borrows from banks |
| CRR (Cash Reserve Ratio) | % of deposits banks must keep with RBI |
| SLR (Statutory Liquidity Ratio) | % to be kept in safe assets (like govt securities) |
Qualitative Tools
| Tool | What it Does |
|---|---|
| Moral Suasion | RBI persuades banks to follow its policies |
| Margin Requirements | Regulates security loan amounts |
| Direct Action | Restrictions on lending practices |
Money Multiplier and Credit Creation
- Money Multiplier: Shows how much total money the banking system can create with an initial deposit.
- Formula: Money Multiplier = 1 / LRR
- Credit Created: Initial Deposit × Money Multiplier
- Example: ₹1000 initial deposit, LRR = 20% ⇒ Credit Created = ₹5000 (Total) – ₹1000 (Primary) = ₹4000 (Secondary)
Sample Table: Comparison of Measures of Money Supply
| Measure | Components | Liquidity |
|---|---|---|
| M1 | Currency, Demand Deposits | Most liquid |
| M2 | M1 + Savings in Post Office | Less liquid |
| M3 | M1 + Time Deposits with Banks | Broad money |
| M4 | M3 + All Post Office Deposits | Broadest |
Common Terms and Definitions
| Term | Definition |
|---|---|
| Legal Tender Money | Must be accepted for payment by law |
| Fiat Money | Declared by government as money, no intrinsic value |
| Demand Deposits | Withdrawable any time |
| Time Deposits | Withdrawable after fixed time |
| Credit Creation | Banks lend multiple times their actual cash base |
Sample Numerical Problem
Question:
If RBI raises CRR from 5% to 10%, how will this affect money supply?
Answer:
- Higher CRR means banks have to keep more money with RBI.
- Less money left for lending.
- Thus, money supply decreases in the economy.
Important Points for Exams
- Money removes barter difficulty (“double coincidence of wants”)
- Money supply: M1 is most liquid, M3 is broadest
- RBI is the central bank, single currency issuer
- Credit creation increases total money supply in the economy
- Repo/Reverse Repo rates – Used by RBI to manage liquidity and control inflation.
Quick Revision Table
| Concept | Key Point |
|---|---|
| Money | Anything accepted for exchange |
| Commercial Bank | Deposit-acceptor, loan-provider, credit creator |
| Central Bank (RBI) | Regulator, supervisor, lender of last resort |
| CRR/SLR | Reserve requirements to control lending |
| Money Multiplier | 1/LRR, shows money creation ability |
Summary:
Money and Banking are crucial for functioning of any economy. Money makes buying and selling easy, and banks help manage and create money. RBI (Central Bank) controls the entire system to keep the economy stable. Knowing the measures of money supply, how banks create money, and the RBI’s role will help you ace your exams!
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