Money and Banking: Functions, Types, and Nepal’s System

TAKEAWAYS:

• Money simplifies trade by acting as a medium of exchange, store of value, and measure of worth—without it, barter would be inefficient.
• Banks create money through loans, but this process depends on reserve requirements set by the central bank (Nepal Rastra Bank).
• The central bank controls inflation, interest rates, and currency supply to stabilize the economy.
• Commercial banks earn profits by lending deposits, but they must follow rules like liquidity ratios to avoid crises.
• Nepal’s banking system includes Rastra Bank, commercial banks, and financial institutions like cooperatives and microfinance.
• Monetary policy tools (like repo rate, CRR, SLR) help Nepal Rastra Bank manage economic growth and inflation.

What is Money?

Money is anything that people accept as payment for goods and services. It makes trade easier than barter (exchanging goods directly, like cows for rice).

Functions of Money

mindmap
  root((Money))
    Functions
      Medium of Exchange
      Store of Value
      Unit of Account
      Standard of Deferred Payment

• Medium of Exchange: People accept money instead of goods (e.g., paying ₹100 for a book).
• Store of Value: Money keeps its worth over time (e.g., saving for future needs).
• Unit of Account: Prices are quoted in money (e.g., a pen costs ₹50).
• Standard of Deferred Payment: Used for loans and future payments (e.g., EMI for a phone).

Why barter fails?

• Double Coincidence of Wants: You need someone who wants what you have and has what you want.
• Lack of Divisibility: Splitting a cow into parts is hard!
• Storage Problems: Perishable goods (like milk) can’t be stored easily.

Types of Money

Money evolves over time. Here’s how:

Fun Fact: Nepal’s currency is fiat money—it has value because the government says it does!

Banking System in Nepal

Nepal’s banking system has three main parts:

1. Central Bank (Nepal Rastra Bank - NRB)

• Role: Controls money supply, sets interest rates, and regulates other banks.
• Key Functions:
  • Issues currency (₹ notes and coins).
  • Acts as a banker to the government.
  • Controls inflation via monetary policy.
  • Supervises commercial banks.

2. Commercial Banks

• Examples: NMB Bank, Global IME Bank, Standard Chartered Nepal.
• Functions:
  • Accept deposits (savings, current accounts).
  • Give loans to businesses and individuals.
  • Provide services like remittance, insurance, and forex.

How Banks Create Money (Credit Creation) Banks don’t just hold deposits—they lend out most of it to create new money!

Example:

• You deposit ₹1,000 in a bank.
• Bank keeps ₹100 as reserve (as per NRB rules).
• It lends ₹900 to a farmer.
• Farmer deposits ₹900 in another bank → that bank keeps ₹90 and lends ₹810.
• This repeats, creating more money in the economy!

Mermaid Diagram: Money Creation Process

flowchart TD
    A["You deposit ₹1000"] --> B["Bank keeps ₹100 reserve"]
    B --> C["Lends ₹900 to farmer"]
    C --> D["Farmer deposits ₹900"]
    D --> E["New bank keeps ₹90 reserve"]
    E --> F["Lends ₹810"]
    F --> G["Total money created: ₹1000 + ₹900 + ₹810 + ... = ₹10,000!"]

Key Terms:

• Reserve Ratio (RR): % of deposits banks must keep (e.g., 10%).
• Money Multiplier: How much money banks can create = 1 / Reserve Ratio.
  • If RR = 10%, multiplier = 10 → ₹1,000 deposit → ₹10,000 in total money!

3. Other Financial Institutions

Monetary Policy Tools (How NRB Controls Money)

NRB uses these tools to control inflation, employment, and growth:

Example:

• 2023 Nepal: NRB increased repo rate to 8% to fight inflation.
• Result: Banks charged higher interest → fewer loans → slower spending → inflation slowed.

Problems in Nepal’s Banking System

1. High NPA (Non-Performing Assets)

   • Many loans are not repaid (e.g., loans to failed businesses).
   • Impact: Banks lose money, charge higher interest.

2. Lack of Digital Banking

   • Many Nepalis still use cash (only ~30% use digital payments).
   • Solution: NRB pushes eSewa, Khalti, IME Pay.

3. Inflation & Currency Depreciation

   • Nepal’s ₹ loses value over time (e.g., ₹100 in 2010 = ₹150 today).
   • Cause: Too much money printing, imports > exports.

4. Banking Scams & Frauds

   • Some banks give loans to fake businesses or politicians’ friends.
   • Solution: NRB monitors banks closely.

Solved Examples (NEB-Style)

Example 1: Money Multiplier

If a bank has a reserve ratio of 20%, how much money can be created from a ₹5,000 deposit?

Solution:

1. Reserve Ratio (RR) = 20% = 0.2
2. Money Multiplier = 1 / RR = 1 / 0.2 = 5
3. Total Money Created = Initial Deposit × Multiplier = ₹5,000 × 5 = ₹25,000

Answer: ₹25,000

Example 2: Effect of CRR Increase

If NRB increases CRR from 5% to 10%, what happens to: a) Bank lending? b) Money supply?

Solution: a) Bank lending decreases because banks must keep more reserves. b) Money supply decreases because less money is available for loans.

Answer: a) Lending ↓ b) Money supply ↓

Example 3: Functions of Money

Match the following:

1. Keeping money under the mattress
2. Paying ₹200 for a shirt
3. Quoting a car’s price as ₹3,00,000
4. Paying loan installments over 5 years

Answers:

1. Store of Value
2. Medium of Exchange
3. Unit of Account
4. Standard of Deferred Payment

NEB Board-Style Questions (Practice)

Short Answer (5 marks each)

1. Explain the three functions of money with examples from Nepal.
2. What is credit creation? How do banks create money? Use a numerical example.
3. Differentiate between commercial banks and central banks with reference to Nepal.
4. What are Non-Performing Assets (NPA)? Why are they a problem in Nepal’s banking system?
5. How does an increase in repo rate affect the economy? Give one real-world example from Nepal.

Long Answer (10 marks each)

6. Describe the role of Nepal Rastra Bank (NRB) in controlling inflation. Explain any two monetary policy tools with examples.
7. "Money simplifies economic transactions." Explain this statement with the help of barter system vs. money system comparison.
8. What are the advantages and disadvantages of digital money in Nepal? How can NRB promote digital payments?
9. Explain the process of money creation by commercial banks. Why must banks keep reserves?
10. Critically analyze the challenges faced by Nepal’s banking sector and suggest possible solutions.

Exam Tip: How to Score Full Marks

✅ Define key terms clearly (e.g., "Money is a medium of exchange..."). ✅ Use diagrams (money creation, NRB tools) to explain complex ideas. ✅ Relate to Nepal (e.g., "NRB increased repo rate in 2023 to..."). ✅ Compare and contrast (e.g., commodity money vs. fiat money). ✅ Solve numericals step-by-step (show calculations for money multiplier). ✅ Discuss real-world problems (e.g., NPAs, inflation, digital banking).

Avoid: ❌ Vague answers ("Money is important"). ❌ Forgetting units in calculations (always write ₹). ❌ Ignoring Nepal-specific examples.

Good luck! Money and banking is a high-scoring unit—practice diagrams and numericals to ace your NEB exam. 🚀