University of Hargeisa
Faculty of Business and Public
Administration
Course Title; Banking principle and
practice
Introduction; Nature ,Functions and Definitions of Money
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Nature and Functions of Money
• Definition of money: generally acceptable
as payment for goods or services and
discharge of debt.
• To day most common definition: Currency
and coins held by the public + checkable
(transaction) accounts of the public .
Introduction slide 2
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Functions of Money
Monetary economy Vs. a barter economy
1. Standard of value or unit of account –one of the
functions performed by money is to serve as a
“numeraire” (common denominator) in
measuring value in exchange.
– in a barter economy each goods and service
will have an exchange rate (price) in terms of
each of the other goods .
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Cont……..
– Money as common denominator greatly
simplifies exchange, reduces information and
transaction costs
• 2. Medium of exchange- money serve as physical
means for conducting transactions. Allows for the
separation of transactions: purchases from sales.
– In a barter economy requirement of “double
coincidence of wants “ high cost of search
– Money increases efficiency in the economy:
reduces cost of exchange (time and resources).
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Conti……………..
• 3. Store of value- related to medium of exchange
function. Allows for separation over time between flow
of income and flow of consumption.
– Money is not unique; other financial assets can
serve as store of value. Money however is the most
liquid:
– Liquid means ease (cost) with which an asset can be
converted into a medium of exchange.
– What happens in periods of substantial inflation to
the value of money and its functions?
• Value of money inverse of price level
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2. Types of Money
Evolution of money (payment system):
– commodity money,
– credit-fiat money and
– electronic money.
1) Commodity Money
• earliest form of money
•Definition: Commodity monies are things with
intrinsic value or value in nonmonetary uses was
roughly equal to the value in exchange.
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Cont……
•Required properties of commodity money:
scarcity and stability of supply
durability
divisibility
•Metallic money fulfilled these requirements: iron and
copper; silver; gold.
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Conti………
Special case of commodity money :
•The Gold Standard- full bodied money:
– to maintain the system the government must:
(1)fix the value of gold in terms of the monetary
unit ($).
(2) be willing to buy all gold at that price.
(3) legalize melting down of gold coins.
12/23/24 Money and Banking slide 8
2)Credit, Fiat Money
•Not convertible into comparable value as commodity.
Decreed as money by government
– Little value as commodity
– Maintains value - medium of exchange because
people have faith that the issuer will stand behind
it.
– purchasing power stability.
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– Two types:
• paper currency and coins issued by the
government and decreed as legal tender
• banking money, IOU payable on demand in the
form of checks.
Reduces cost of transactions (transportation)
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(3) Electronic Money (Paperless)
•Paper money (checks) shuffling is costly and takes time
to clear.
•Development of computer and information technology
enabled new stage in money:
• e- money- money stored electronically,
Several forms:
– debit cards- electronic transfer of funds from
bank account to merchant’s account
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– Stored-value cards- (electronic wallet), contain
fixed amount of funds, the smart card can be
reloaded. Modex smart card transfer of funds with
wireless device also between individuals.
Electronic cash- funds used on the Internet to
purchase goods and services.
– Electronic Checks used to pay bills on the internet,
equivalent of check is sent .
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•Advantages of e-money: cost saving, more efficient
•Disadvantages:
– Large initial investment in system
– paper checks provide receipts
– paper checks give the benefit of the “float”
– security and privacy concerns of e-money
•Slow rate of adoption
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STUDY QUESTION
• By Focusing on the standard of value and
medium of exchange functions of money,
analyze the benefits which accrue to society
when money is introduced into a barter
economy?
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What Are The Three Types Of Motives For Holding
Money
1. Transaction Motive
Peoples keep cash for the transaction motive.
Everybody maintains cash balance to meet the
daily transaction to pay to the creditor, to buy
goods and services, pay rent and to invest on
business etc. It is somehow one kind of
biological motives.
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2. Speculative Motive
Some people hold money for the speculation
purpose. Speculator always searches the project
to invest money temporarily so that makes the
huge profit immediately. A speculator always
maintains a cash balance to get the speculation
benefits and outcomes.
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3.Precautionary Motive
We all know that the future is always uncertain.
So everybody holds money and maintain a cash
balance for the future uncertainty. The increase
of business or individuals, all’s future is really
uncertain, so they keep cash to meet the future
uncertainty risks to overcome. A little bit related
to physiological motives.
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Banking
Keep your money safe!
Banking
• You started your business, now what do you
do with your money? Where do you get that
loan to expand your business?
• Banks of Course!
History of bank
• The term bank is either derived from old
Italian word banca or from a French word
banque both mean a Bench or money
exchange table. In olden days, European
money lenders or money changers used to
display (show) coins of different countries in
big heaps (quantity) on benches or tables for
the purpose of lending or exchanging.
Definition of bank
• bank is a financial institution which deals with
deposits, lending and other related services. It
receives money from those who want to save
in the form of deposits and it lends money to
those who need it.
Services offered by Banks
1. Direct Deposit: money from paycheck or
government. check is put directly into your
account.
2. ATM Cards: allow you to access accounts at
bank machines
3. Debit Cards: bank card used like a credit
card; money is debited from your account to
pay for a sale.
Bank Services cont.
4. Overdraft Privileges: bank pays amount of a
check even if there is not enough money in
the account
5. Online Banking: ability to check accounts,
transfer money and pay bills over internet
6. Safe Deposit Box: in bank vault to for
important papers and valuable items
Five Core Principles of
Money and Banking
1. Time has value.
2. Risk requires compensation.
3. Information is the basis for decisions.
4. Markets determine prices and allocation
resources.
5. Stability improves welfare.
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Study Questions
– What do banks do for their customers?
– Why do banks perform those services?
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