Money and banking

Before money, societies relied on barter, which is the direct swapping of goods and services. This system is highly inefficient because it requires a 'double coincidence of wants'. This means for a trade to occur, not only must you find someone who has the good you want, but that person must also want the good you have. For example, a baker who wants shoes must find a shoemaker who wants bread. If the shoemaker wants cheese, the baker cannot trade. This makes exchange difficult, limits specialisation, and slows down economic activity. Money solves this by acting as a universally accepted medium of exchange, breaking the trade into two separate transactions.

For something to be officially considered 'money', it must successfully perform four key economic functions. If it fails at any one of these, it is not functioning properly as money. The four functions are: 1. A Medium of Exchange: It is generally accepted by everyone as payment for goods and services. 2. A Unit of Account (or Measure of Value): It provides a common yardstick to measure and compare the value of different goods and services (e.g., a car is worth $20,000, a coffee is worth $4). 3. A Store of Value: It must be possible to save money and have it hold its purchasing power over time. 4. A Standard for Deferred Payment: It must be acceptable to make payments and settle debts in the future (e.g., paying back a loan).

To perform its functions well, whatever is used as money needs to possess certain characteristics. The key characteristics of 'good' money are: 1. Acceptability: People must be confident that it will be accepted by others in exchange for goods and services. 2. Durability: It must be able to withstand being used repeatedly without easily wearing out. 3. Portability: It should be easy to carry around. 4. Divisibility: It must be easily divided into smaller units to pay for items of different value. 5. Scarcity: Its supply must be limited, otherwise it will lose its value. 6. Uniformity (or Homogeneity): All units of the same denomination must be identical.

Commercial banks are profit-making financial institutions that provide essential services to the general public and firms. Their primary role is to act as an intermediary between those who have surplus money (savers) and those who need to borrow money. Their main activities include: 1. Accepting Deposits: Providing current accounts for daily transactions, savings accounts for accumulating funds, and fixed deposit accounts for longer-term saving. 2. Making Loans: Offering funds to individuals and businesses in the form of overdrafts, personal loans, mortgages for property, and business loans for investment. 3. Facilitating Payments: Enabling customers to make and receive payments using services like debit cards, credit cards, cheques, and electronic bank transfers. Commercial banks make most of their profit from the 'interest rate spread' – the difference between the interest rate they charge borrowers and the interest rate they pay to savers.

The central bank is the apex financial institution in a country. It is a non-commercial, state-owned body that acts as the banker to both the government and the commercial banks. It does not provide services to the general public. Its functions are critical for maintaining the stability and efficiency of the entire economic system. Key functions include: 1. Issuing Currency: It has the sole legal right to print and issue the nation's notes and coins. 2. Banker to the Government: It manages the government's bank accounts, processes its payments, and manages the national debt by issuing bonds. 3. Banker to Commercial Banks: It holds deposits for commercial banks and provides a system for them to settle debts with each other. 4. Lender of Last Resort: If a commercial bank faces a liquidity crisis and cannot borrow from elsewhere, the central bank may provide an emergency loan to prevent its collapse and protect the financial system. 5. Implementing Monetary Policy: It manages the country's money supply and sets the main interest rate to control inflation and manage economic growth.

A stock exchange is a highly organised market where shares of public limited companies (PLCs) are bought and sold. Its primary economic function is to enable companies to raise long-term finance. When a company wants to raise funds for major investment, like building a new factory, it can issue new shares. This process is called a 'flotation' or 'Initial Public Offering' (IPO) if it is the first time the company is selling shares to the public. Investors who buy these shares become shareholders, meaning they own a small part of the company. In return for their investment, they may receive dividend payments (a share of the company's profits) and can sell their shares later on the stock exchange, hopefully for a higher price. This 'share capital' is a vital source of finance because, unlike a bank loan, it does not have to be repaid.