Chapter – 4 Money Supply


What is money?

Money is something that passes freely from one person to another and could be used to settle debt.

In the old age banking, many types of metals were used as money to settle debts. Such metals were like gold, silver, cowrie shells, etc.

Development of modern money though in stages started because barter system of settlement of debt made fixing of pricing of a product difficult.

The problem of fixing prices of products led to the development of modern money that enables a man to receive payment for the goods or services provided, and to purchase, at a time he chooses, the goods and services he requires.

Quality of Money

First important aspect of money is to know its quality aspects.

Money must possess certain qualities to qualify to be used as acceptable (acceptability factor) mode of debt settlement. Acceptability thus becomes prime factor. To be acceptable, experts have suggested several qualities of money, of which important are:

(a) Portability: Commodity used as money should be easy to carry, since transactions taking place at different places could be settled there and then.

(b) Durability: Money used should be durable in use. The commodity used as money should withstand frequent handlings. It should also not wear out quickly or deteriorate in quality with passage of time.

(c) Divisibility: Money used must be capable of being divided into convenient number of smaller units. This will help in carrying out business transactions of smaller values.

(d) Homogeneity: Each unit should be exactly the same as every other unit.


Second part of knowledge of money is to know what are its functions. These functions are as follows:

1. It contains a value

2. It is a unit of account.

3.It is used as a medium of exchange.

4. It functions as a standard of deferred payment.

Present day money we use consists of coins, banknotes, etc

Quasi Money: There is another form of money defined in developed economies called as “quasi money” or “near money”. Bank deposits, transferable by cheque or other instruments of transfer are generally acceptable as a means of payment.


The RBI controls the money supply in the economy by various means.

Various measures of money supply are:

M1 = It purely reflects the non-interest bearing monetary liabilities of the banking sector. It contains money with public + demand deposits with banking system + ‘other’ deposits with RBI.

M 2 = It includes, besides currency and current deposits, savings and short term deposits reflecting the transactions balances of entities. In other words it is measured as M 1 + Time liabilities portion of savings deposits with the banking system + certificate of deposits issued by banks + term deposit of residents with a contractual maturity of up to 1 year with banking system.

M 3 = It includes M 2 + term deposits of residents with a contractual maturity of over 1 year with banking system + call borrowings from non-depository financial corporations by the banking system. In other words it is measured as M 2 + net time deposits of banks.

M 4 = M 4 money supply is measured as M 3 + total deposits with Post Office savings bank (excluding NSC) but including various other deposits with PO like time deposits, recurring deposits and CTD of PO.


• ‘High powered money’ as used by RBI means money produced by RBI and Government of India and held by public and banks.

• Ingredients of high powered money include post office deposits + public sector bank deposits + deposit held by RBI including cash reserves of banks partly held in the form of currency as ‘cash in hand’ and partly as deposit with RBI and other deposits of RBI.

• Difference between high-powered money and ordinary money supply is that ordinary money supply includes demand deposits with banks plus currency with public plus other deposits with RBI whereas high powered money includes currency with public besides cash reserves of banks and other deposits of RBI.

• Reserve Bank of India takes certain extreme steps of termination of license of existing or new banks or recommends moratorium on bank or file winding up petition in Court when it considers bank is doing business not in the interest of its clients or considers that bank functioning and affairs are beyond redemption.

• Narrow Money concept used by RBI means those assets which represent immediate purchasing power and act as a ‘medium of exchange’ function of money.

• Blocked Currency means when one money currency of a country is not permitted to be exchanged with another country’s money currency, then it is called blocked currency.

• Rationale behind defining money as ‘money held by the public’ is to separate the producers of money from those who demand it.

• RBI measures money supply in order of descending order of liquidity.


• Reserve Bank of India has the sole responsibility to manage the currency in India with power it derives from the RBI Act, 1934.

• Currency Chest is the storehouse for storing money (notes and coins) not in use or surplus with commercial banks.

• Currency Chest along with the money held therein remains the property of RBI. At present there are nearly 18 centers identified by RBI to run currency operations. Such operations are done through dedicated / designated branches of the commercial banks.

• The money stored in the currency chest is the property of the Reserve Bank of India and is held by the bank on its behalf.

• When a commercial bank deposits the money in the currency chest, such money becomes the credit in the bank’s account with RBI and vice versa.

• The currency chest facilities maintained by commercial banks are made available to all banks, government and general public.

• When the money is moved from one currency chest to another, the cost of transportation is normally borne by the RBI along with the charges of police escort.

• Issuable notes, soiled notes, new notes, mutilated notes or other damaged notes (torn notes) are all called notes.


• Owner of the Small coins is the Government of India and has the sole right under the Coinage Act of 1906 as amended from time to time.

• Government of India also exercises right to design coins of various denominations. The denominations that are designed and minted by Government are Rupee five, two, one, paisa 50, paisa 25 and paisa 10 coins.

• At present coins are minted at four major centers of the country, viz. Mumbai, Alipore (Kolkata), Saifabad and Cherlapally (Hyderabad) and NOIDA (UP),

• Coins are distributed by RBI through its issue offices. These issue offices are at Chandigarh,Chennai, Guwahati, Hyderabad, Jammu, Jaipur, Kolkata, Lucknow, Mumbai, Nagpur, New Delhi, Patna and Thiruvanantheapuram.

Decimals coinare system

Decimalisation is the process of converting a currency from its previous non-decimal denominations to a decimal system, i.e. a system based on one basic unit of currency and one or more sub-units, such that the number of sub-units in one basic unit is a power of 10, most commonly 100.

In India, Pakistan, and other places where a system of 1 rupee = 16 annas = 64 paise = 192 pies was used, the decimalisation process defines 1 new paisa = 1⁄100 rupee. The following table shows the conversion of common denominations of coins issued in modern India and Pakistan. Bold denotes the actual denomination written on the coins.


• Beneficiaries of the currency chest are banks, government and public

• Currency chest helps to withdraw surplus cash from the banks’ branches that pass on the credit to the depositing bank.

• Un-issuable notes can be removed from the market.

• Mutilated notes can be exchanged with fresh notes.

• Shortfall in cash receipts and payments on any day can be quickly withdrawn from the currency chest.


• Notes are printed by Reserve bank of India whereas coins are minted by Government of India.

• The basis of printing notes by RBI is/are:

Additional need of money
Need for reserves required under law.
Need for replacing the old, mutilated, torn etc.notes in the market.
Based on the futuristic needs (forecasting needs)
• Coins and Rupee one note is signed by the Secretary (Finance), Government of India whereas all other denominations of notes like rupee 5,10,20,50,100,500 and 1000 are signed by the Governor of Reserve Bank of India.

• RBI has directed Banks not to staple any currency notes instead the bundle (s) should be tied or secured by paper band or rubber band.

• While maintaining cash, branches use “clip system”. Clip system is the mode of verification of cash.

• For printing of the Indian currency specially produced paper from 100 per cent cotton. Cotton is used because it gives natural whiteness, provides lengthy fibers that provide strength, currency notes are crisp and cotton can withstand many folding.

• Normal strength of cotton used in paper currency is around 6000 to 7000 folds whereas international standard / parameter is around 6000 folds.

• Security thread in paper currency is:

Metallic or plastic thread that can’t be photocopied,
Thread is woven inside the note, and
Thirdly thread gives a blue look under the ultra violet lamp (UV lamp)
• All currency distributed in the economy is a liability.

• Normally mutilated note means the one which has a missing piece and /or note composed of pieces.

• Notes issued by the Controller of currency before 1935 (before the establishment of RBI) are called currency notes.

• Bank Note is a promissory note payable to the bearer and issued by RBI on demand

• The form of approved assets that RBI ensures before currency notes are issued include Government Rupee and foreign security of any maturity, bullion and gold coins and rupee coin and eligible promissory notes and bills of exchange that are payable in India and purchasable by RBI.

Cash factory in Lucknow

India’s largest lender State Bank of India (SBI) launched its first Currency Administration Branch (CAB), an exclusive branch to handle currency notes in Lucknow. Also known as cash factory, CAB is part of the bank’s plan to open one currency chest in every city that will distribute notes and rupee coins to the local banks and ATMs, apart from identifying counterfeit currencies.

The cash factory will be the nodal point for issuing currency notes to all local SBI branches as well as ATMs. About half a dozen sophisticated note sorting machines will sort out currency notes in four varieties in the branch office.


• Reserve Bank of India issues notes based on certain methods. In first method called Deposit System, RBI issues paper money which is backed fully by gold or silver reserves.

• Sometimes fixed amount of money is permitted to be issued against securities, without necessary gold or silver reserves. This method is called Fixed Fiduciary method.

• In another method called Maximum Limit System or Maximum Fiduciary System, limit of issue of paper notes is fixed.

• In yet another method called Minimum Reserve System, minimum reserve in the form of gold and silver is fixed. This is the method which is big presently used in India to issue note.

• The currency coins of Rupee 1 that is issued by the Central Government through the Public Debt Office of RBI, is made of metal like bronze whereas paisa 25 and 50 are normally manufactured with nickel. However the new coins of 2, 5 and 10 new paisa are made of an alloy made of copper and nickel.

• Rupees 500 note was reintroduced in Indian economy in 1987 after withdrawing it for some period whereas Rupees 1000 note was reintroduced in the year 2000.

• India has declared its par value of rupee in terms of ‘gold’ under Bretton Woods System and as a member of IMF.

• India delinked its rupee from pound sterling and linked it with ‘basket of currencies’. With the advent of reforms, RBI in 1992 announced a system of partial convertibility and liberalized exchange rate system.

• For holding reserves for issuing of notes, RBI is required to hold minimum Rupees 200 crore of which not less than rupees 115 crore shall be gold.

• RBI as on date issues note in the denominations of rupees 2,5, 10, 20, 50, 100, 500 and 1000