“Banks are efficient medium of exchange.” Explain

By opening a bank account, people deposit their money in banks. Banks provide fixed interest (usually around 5%) on the deposited amount and help people to keep their money safe. People can withdraw their money whenever they want. They can transfer money from one bank account to another with the help of cheques, demand drafts and Internet banking. Nowadays, UPI apps are widely used methods of online payment services.

Banks are an important part of our daily lives. Banks are financial institutions that provide services like accepting deposits, withdrawing money and providing loans. One of the main functions of banks is to act as a medium of exchange. Only 15% of their total cash deposits are kept by a bank to meet their daily withdrawal requests.  They use their remaining money to provide loans to the people at a predetermined rate of interest.

Barter System  

In the barter system, people used to exchange goods and services in return for goods and services without exchanging money. 

 In the old days, when money was not introduced in society, people used to trade with the help of goods and services. In simple words, it is a system in which similar value goods and services are exchanged between two individuals.

For example, A person needs wheat and another person needs wood. They exchanged their goods with each other.

Money 

In modern times, money is used as a universal acceptor for exchanging goods and services. Money gives the opportunity to reduce the cost of transactions.

 Money is usually described in terms of the three roles:

•  Money helps in exchange.
•  Money is a storage of merit.
• Money is an accounting unit.    

To overcome the limitations of the barter system people choose money as a medium of exchange. Money is an item that is globally accepted as a method of payment for goods and services. Using money as a medium of exchange, transactions became easier because money has a standard unit of value which can be used to measure the worth of goods and services. The most important thing about Money as a medium of exchange is that it is easy to store and can be used to build wealth.

What Is a Medium of Exchange?

A medium of exchange is defined as a mechanism that plays the role of a middleman between different parties – either people or organizations. It helps to facilitate the exchange, purchase, or transfer of goods and providing services. A system need to be a true reflection of a unit of merit, for the pupose  to serve as a medium of exchange. Additionally, all parties that are involved have to follow the norms. It should be recognised as a unit of payment for the exchange of goods and services. There are so many goods and commodities which can be used as mediums of exchange, including money, silver and gold, but money  is being the most common medium of exchange in lives of people.

Money as a Medium of Exchange 

Money is the most common form of exchange in the modern world. When money is used as a medium of exchange, it acts as a link between buyers and sellers. They don’t have any doubts in their mind about its value because its value is determined by the government and is same for all. Traditionally, there was no way to compare the value of two different commodities like we can’t determine the value of a cow in return of hens.  But after the arrival of money, trading different commodities became comparatively easier. 

Banks 

Banks are an important part of every financial system. They help a nation’s economy by providing financial help to businesses and individuals providing services.

A bank is a financial institution which provides the facilities for deposits and other money-related services. It accepts money from those who have an excess of it and gives it to those who need it. A bank is a financial intermediary that accepts deposits and provides lending services either directly by giving loans or indirectly through capital markets. A bank is a link between customers who have extra money and customers with a shortage of money. 

Characteristics of the Bank

1. Dealing in Money Bank is a financial institution which deals with money, given by depositors.

2. Individual / Firm / Company A bank could be a person, firm or company. A banking company is usually a company which is in the business of banking.

3. Acceptance of Deposit A bank accepts money from people in the form of deposits which is easily withdrawable on demand or after the expiry of a fixed period. It gives safety to the deposits.

4. Giving Advances A bank lends money to people in the form of loans to fulfil their requirements. 

5. Payment and Withdrawal A bank facilitates easy payment and withdrawal activities to its customers in the form of cheques and drafts. 

6. Profit  Earning The main purpose of a bank is to earn profit by giving service to the people.

7. Connecting Link A bank acts as a connecting link between those who have surplus money and give the same to those who are in need of money.

Functions of Bank

1. Accepting Deposits:  The primary function of a bank is to accept deposits from customers. These deposits have three types: current, savings and fixed deposits. 

2. Lending Money:   The primary source of a bank’s income is lending money to its customers in the form of loans. These loans can be in the form of personal loans, home loans, car loans, and business loans. Banks charge interest on these loans.

3. Issuing Credit Cards:    With the help of credit cards customers can buy things on credit without the need for cash. The bank then charges interest on the credit card balances and customers are required to pay the balance in full or in installments on time.

4. Facilitating International Trade: Banks help organisations to trade outside the country by providing features like foreign currency exchange and issuing letters of credit.

5. Safekeeping of Valuables: Banks provide locker facilities to their customers to secure personal items like jewellery, securities and important documents. The bank charges its customers for these services. 

6. Investment Banking: Banks provide their customers with the facility of investing in publicly traded companies.

7. Payment Services: Banks provide payment services to their clints  which include issuing checks, electronic fund transfers, and other online banking services like UPI (the most common these days).

8. Money Transfer: Banks act as a mediator between individuals and businesses for money-transferring activities.

9. Foreign Exchange Services: Foreign currencies can be bought or sold through banks because banks provide foreign exchange services to the people.

10. Service of Financial Advice: Banks provide financial advice to their customers which includes how to make investments, how to plan retirement and how to save tax on their savings. 

Indian Banking System: 

Reserve Bank of India: It controls the functioning of all the commercial  banks in India. It is also called a banker’s bank in India or the Main bank.

Commercial Banks: Commercial banks are the banks for the people of a country. The commercial bank facilitates  money making. They provide all other banking facilities to the people of the country.

Types of Commercial Banks

1. Public sector banks: In these  banks,  the government holds more than 50% share. Currently, there are 12 public banks working in India. For example Canara Bank, State Bank of India, Union Bank of India etc.

2. Private sector banks: In  these  banks in which private entities hold more than 50% share. Currently, there are 21 private banks working in India. For example HDFC Bank, Axis Bank etc.

Regional Rural banks: These banks came into existence in India in the 1970s. The main purpose of these banks was to provide credit facilities to small and marginal farmers and small enterprises. They are also commercial banks however their area of operation is restricted to a district.

Co-operative Banks: These banks came into existence in India in 1904 with the Co-operative Society Act of 1904. A co-operative bank is a bank in which its members, themselves are the owners and customers of the Bank. 

How bank act as a Medium of Exchange?

Banks act as a medium of exchange by taking cash from the person who has a surplus of it and giving loans to those who are in need of it. Only 15% of the bank’s total cash deposits are kept by a bank to meet their daily withdrawal requests. Banks use their remaining money to give loans to people who are in need of it at a specific interest rate.

 Example:

X wants to buy a car for ₹ 25,00,000. But he doesn’t have enough money right now. So he went to a bank for a loan and the bank provided the loan at a specific interest rate of 7%. He buys the car with the help of a bank loan.

Why Banks are an Effective Medium of Exchange?

Banks  are an effective medium of exchange for various reasons. These are discussed as follows:

1. Safety: Banks are considered the safest place to keep the valuables. The money will be protected from theives or fire etc.  Banks have many  security features like CCTV camera, private safe facilities, safety alarms etc.

2. Confidentiality : Most banks have a policy to not share thir customer’s details or data to anybody . 

3. Convenience: Banks are the most convenient way to access money. Customers can deposit and withdraw money from anywhere with the help of ATMs, cheques or debit cards. Banks also offer mobile and internet Banking which  allows customers to check their balances from their home and they make transactions from anywhere with the help of  internet banking services.

4. Speedy transections : In modern days, online transfer of money is the fastest way to send money from one bank account to another. The bank provides facilities like UPI  and Internet Banking which makes buying goods faster. 

5. Flexibility: Banks provide various flexible  offers to people who are in need of money. One can easily borrow or deposit  money at any time.

6. Convenience: Banks are the most convenient way to access money. Customers can deposit and withdraw money from anywhere with the help of ATMs, cheques or debit cards. Banks also offer mobile and internet Banking which allows customers to check their balances from their home and they make transactions from anywhere with the help of internet banking services.

7. Credit facility: Banks provide the facility of credit  to various individuals which allows them to purchase goods and services without cash. 

8. Encourage savings: Banks encourage customers to save their extra money at a fixed rate of interest and this helps them to use the money in times of need. 

9. Interest on deposits : Banks pay interest on deposits of their customers. This encourages people to save more and more money . This also provides  a source of funding for loans and investments to the banks.

10. Digital transactions facility: Banks provide the facility of digital  transactions over the phones  and the facility of checking their bank statements over the phone. 

11. Less formalities/ Paperwork: Banks provide the facility of borrowing without the use of too much  paperwork, which ultimately results in lesser formalities and ensuring a simple  process of borrowing money.

Conclusion

Banks are considered as an integral part of each and very  economy. They act as a medium of exchange and facilitate the transfer of money from one person to another. Banks are an effective medium of exchange because they provide safety, convenience, speed, confidentiality, digital transactions, flexibility, credit, interest etc.

Frequently Asked Questions

How do banks make money?

By opening a bank account, people deposit their money in banks. Banks provide fixed interest (usually around 5%) on the deposited amount and help people to keep their money safe. People can withdraw their money whenever they want. They can transfer money from one bank account to another with the help of cheques, demand drafts and Internet banking.

Nowadays, UPI apps are widely used methods of online payment services. Banks are an important part of our daily lives. Banks are financial institutions that provide services like accepting deposits, withdrawing money and providing loans. One of the main functions of banks is to act as a medium of exchange. Only 15% of their total cash deposits are kept by a bank to meet their daily withdrawal requests.  They use their remaining money to provide loans to the people at a predetermined rate of interest and thus helps in money making process.

What Is a Medium of Exchange?

A medium of exchange is defined as a mechanism that plays the role of a middleman between different parties – either people or organizations. It helps to facilitate the exchange, purchase, or transfer of goods and providing services. A system need to be a true reflection of a unit of merit, for the pupose  to serve as a medium of exchange. Additionally, all parties that are involved have to follow the norms. It should be recognised as a unit of payment for the exchange of goods and services. There are so many goods and commodities which can be used as mediums of exchange, including money, silver and gold, but money  is being the most common medium of exchange in lives of people.

Define “Mortgage”.

A mortgage is an agreement between two people that gives the lender the right to take the property of another person if they fail to repay the money borrowed by them.

Why are banks important for the economy?

Banks are an important part of our daily lives. Banks are financial institutions that provide services like accepting deposits, withdrawing the money and providing loans as well. One of the main functions of banks is to act as a medium of exchange. Only 15% of their total cash deposits are kept by a bank to meet their daily withdrawal requests.  They use their remaining money to provide loans to the people at a predetermined rate of interest and thus helps in economic growth of the country.