MONEY (MAZIKU TINA)

1. Money refers to anything which is widely acceptable in payment for commodities and in settling debts not for itself but because it can be simply passed on.(Mudida,2002)

There are different ways of defining money in economy based on functions of money as defined below;

Money is anything that is commonly used and generally accepted as a medium of exchange, or as a standard of value. (Kent, 1956)

Money can be defined as anything that is generally accepted as a means of exchange and at the same time acts as a measure and as a store of value.

Money refers to those things which are (at any time and place) generally accepted without doubt or special enquiry as a means of purchasing commodities and services and defraying expenses are included in the definition of money. ( Marshall, 1924)

2. (a) Credit creation refers to the ability of the bank to expand deposits as a multiple of its reserve. It is the unique power of the banks to multiply loans and advances and hence deposits. It is because of the multiple credits creating power that the commercial banks have been called the factories of credit or manufactures of money.

Is the power of commercial banks to expand secondary deposits either through the process of making loans or through investment in securities. Creation of credit is one of the most important functions of commercial banks. Banks take deposits from the customers and provide loans from their deposits after keeping necessary reserves like cash reserves etc.  Actually the banking system creates credit rather than a bank individually.

(b).Yes, Banks create money by the following ways;

Purchasing securities; this way of creating money is very simple the bank can purchase securities without paying any cash. It issues its own cheque pay the purchase price, the cheque deposited in the bank or some other bank and the small cash reserve which the bank keeps is sufficient to meet an obligation arising from this transaction.

Advancing loans and overdraft; by advancing loans on cash credit basis or by an over drafting credit is also money created. In this way money lent out by commercial banks using the cheque facilities expands to result into grater volume of credit over and above the amount originally amount, also a bank may receive interest simply by permitting customers to overdraw their occounts.

Example: Mr. A puts deposit worth Tsh. 1000 in X bank. For simplicity we assume that there is a reserve requirement of 20%. X bank can lend Tsh 800. Mr. B gets this loan and deposits in his bank account with Bank Y. Now if forms part of deposits of Y who can lend Tsh 640 from the deposit. This chain continues till the time money remains in banking system. This process is called credit creation where deposit of Tsh 1000 has created credit more than that. The process stops at the point where money is moved out of banking system.

(b) By the following conditions banks create money;

Saving and investment habit; the power to create credit by the commercial banks is very much influenced by the habits of the people to save means if the people habitual is using the cheques then the volume of credit will expand and on the other hand it will be contracted if they do not have such habit of saving.

Policy of the central bank; if the banks have large deposits they can create more credit and if they have the small deposit then their power of credit creation will be limited, since the central bank has the monopoly power of note issue if it increases the quantity of money the deposits of commercial banks will increase and they will expand the volume of credit in the inquiry and on the other hand if the supply of money decreases the volume of credit also decreases

The cash ratio; every bank keeps adequate cash reserves for meeting the cash requirements of its customers, the bank will not allow its cash ratio to fall below a certain minimum level and when the minimum level is reached then the bank will not advance any more money and if the liquidity ratio is high the creation of credits will be lower.

The collateral security available; the bank advances loans to the borrowers against some kind of collateral securities. If these are available then, the power of credit creation will be high.

Conclusion: While banks would prefer an unlimited capacity for creating credit to increase profits, there are many limitations. These limitations make the process of creating credit non-profitable. Therefore, a bank continues to create additional credit as long as there is a negligible chance of the loans turning into bad debts as well as the interest rate that banks charge on loans and advances is greater than the interest that the bank gives to depositors for the money deposited in the bank.

REFERENCES

Kent,R.P ,(1956),Money and Banking, New York.

Lipsey R, G, (1983), Positive economics 8^th Edition. Oxford University press, New York.

Marshall A,(1924),Principles of Economics, London :Macmillan.

Mudida R, (2002), Modern economics, Nairobi.