CMA Foundation · Fundamentals of Business Economics and Management

Money and Banking: formula sheet

Full chapter guide

Key formulas

Primary functions: Medium of exchange + Measure of value; These two directly remove the problems of barter.
Secondary functions: Standard of deferred payment + Store of value + Transfer of value; They depend on money keeping a stable value over time.
Contingent functions: Distribution of national income + Basis of credit + Liquidity (most liquid asset) + Equalising marginal utility/productivity; Wording varies by book. Learn these as extra uses beyond the five main functions.
Types by backing: Commodity money (own value) | Fiat money (government order) | Credit money (bank liabilities); Test the value of the object itself versus the acceptance by law or trust.
Legal tender: Legal tender = cannot be refused for debt settlement; Notes and coins are legal tender. Cheques are not.
Reserve money (M0): M0 = Currency in circulation + Bankers' deposits with RBI + Other deposits with RBI; Also called high powered money or monetary base. It is the RBI's liability.
Narrow money (M1): M1 = Currency with the public + Demand deposits with banks + Other deposits with RBI; Most liquid measure. Time deposits are not included.
M2: M2 = M1 + Savings deposits with post office savings banks; Built on M1 alone. Bank time deposits are not added here. Only post office savings deposits are.
Broad money (M3): M3 = M1 + Time deposits with banks; Built on M1 alone, parallel to M2. It does not include post office savings deposits. It is the most widely used measure of money supply.
M4: M4 = M3 + All deposits with post office savings organisation (excluding NSCs); Built on M3, not on M2. Widest and least liquid of the four.
Currency with the public: Currency with public = Currency in circulation − Cash in hand with banks; Banks' own cash is not part of money held by the public.
Order of liquidity: M1 is the most liquid; M4 is the least liquid; M1 is smaller than M2, M3 and M4. M4 is larger than M3. M2 and M3 are separate additions to M1.
Fisher's equation of exchange: MV = PT; M = money supply, V = velocity of circulation, P = price level, T = volume of transactions. Extended form: MV + M'V' = PT, where M' is bank money (credit money).
Price level from Fisher's equation: P = MV ÷ T; Assumes V and T are constant in the short run. Then P changes in direct proportion to M.
Cambridge equation: M = kPY; k = proportion of income held as cash, P = price level, Y = real income (output). Often written as P = M ÷ kY.
Value of money: Value of money = 1 ÷ P; Value of money moves inversely to the price level.
Keynes's demand for money: L = L1(Y) + L2(r); L1 is transaction and precautionary demand, which depends on income Y. L2 is speculative demand, which depends on the interest rate r.
Scheduled bank: Scheduled bank = bank included in the Second Schedule of the RBI Act, 1934; Non-scheduled banks are those not included. Scheduled status gives access to RBI borrowing facilities.
Payment bank rule: Payment bank = deposits + payments + remittances, but no lending; It cannot give loans or issue credit cards. This is the most tested point.
Small finance bank rule: Small finance bank = deposits + small-scale lending to underserved sections; Focus is financial inclusion, unlike payment banks which do not lend.
Development bank rule: Development bank = long-term finance for a specific sector; NABARD for agriculture and rural areas, SIDBI for small industries, EXIM Bank for foreign trade.
Cooperative bank rule: Cooperative bank = member-owned, service motive, local focus; Contrast with commercial banks owned by the government or shareholders.
Money (credit) multiplier: Multiplier = 1 ÷ r, where r = reserve ratio (as a fraction); Simple model: no cash leakage, all loans redeposited. A 20% ratio gives 1 ÷ 0.20 = 5.
Total deposits created: Total deposits = Initial deposit × (1 ÷ r); This includes the initial deposit itself.
Credit created (new loans): Loans created = Total deposits − Initial deposit; Use when the question asks for additional credit, not total deposits.
Loanable amount in one round: Lendable = Deposit × (1 − r); Bank keeps r as reserve and lends the rest.
Currency issue: RBI issues notes of ₹2 and above; Government of India issues the ₹1 note and all coins; RBI puts them into circulation; The RBI does not issue coins. Do not say the RBI issues every coin or note.
Banker to Government: RBI = Government's banker + agent + adviser + debt manager; Includes accepting receipts, making payments, ways-and-means advances and managing public debt.
Banker's bank: RBI = custodian of bank cash reserves + lender of last resort + clearing house + supervisor; Banks keep CRR balances with the RBI.
Custodian of reserves: RBI = keeper of foreign exchange and gold reserves + administrator of forex rules (FEMA) + curbs excess forex volatility; Reserves are held for the nation, not for any single bank. The exchange rate is market-determined.
Credit control tools: Quantitative: Bank Rate, Repo, Reverse Repo, CRR, SLR, open market operations; Qualitative: margin requirements, moral suasion, selective credit control; Details belong to the monetary policy topic.
Tightening (anti-inflation) stance: ↑ CRR, ↑ SLR, ↑ Repo, ↑ Reverse repo, ↑ SDF rate, ↑ Bank rate, OMO sale of securities ⇒ credit ↓, money supply ↓; Used when inflation is high. Banks have less lendable money and loans become costlier. Reverse repo is a liquidity-absorption tool: the RBI borrows from banks to absorb surplus liquidity, and a higher reverse repo rate makes parking funds with the RBI more attractive.
Easing (growth) stance: ↓ CRR, ↓ SLR, ↓ Repo, ↓ Reverse repo, ↓ SDF rate, ↓ Bank rate, OMO purchase of securities ⇒ credit ↑, money supply ↑; Used in a slowdown. Banks have more lendable money and loans become cheaper. A lower reverse repo rate means banks earn less for parking surplus funds with the RBI, so they are nudged to lend.
CRR amount: Required cash with RBI = CRR % × NDTL; Held as cash with the RBI. No interest is earned on it.
SLR amount: Required liquid assets = SLR % × NDTL; Held by the bank itself in cash, gold or approved securities.
Lendable funds (simple): Funds available to lend = NDTL − CRR amount − SLR amount; A simplified exam view. It shows why raising CRR or SLR reduces lending capacity.
Repo vs reverse repo: Repo: RBI lends to banks. Reverse repo: RBI borrows from banks.; Remember the viewpoint is always the RBI's.
Rate order (usual): Reverse repo < Repo < MSF = Bank rate; MSF is above repo, and the bank rate is aligned with the MSF rate. Since April 2022 the SDF (Standing Deposit Facility) rate, which is the repo rate minus 0.25 percentage points, sets the floor of the rate corridor. The fixed-rate reverse repo remains a separate liquidity-absorption tool.
Money market vs capital market (maturity): Money market: up to 1 year | Capital market: more than 1 year; The most tested difference. Remember: money market = liquidity, capital market = long-term investment.
Treasury Bill yield idea: Discount = Face value − Issue price; T-bills carry no coupon. The investor's gain is the discount, received at maturity as face value.
NPA test: Overdue for more than 90 days ⇒ NPA; Applies to term loans and most advances as per RBI norms. Quote it as the general rule.
Gross NPA ratio: Gross NPA ratio = Gross NPAs ÷ Gross advances × 100; Shows the share of bad loans in total loans.
Net NPA: Net NPA = Gross NPA − Provisions; Used in simple numerical questions.
Regulators: Money market → RBI | Capital market → SEBI; Quick elimination aid for MCQs.

Quick revision

Money functions: medium of exchange, unit of account, store of value, standard of deferred payment.
Money is accepted widely for payment; its value depends on what it can buy, so it falls when price levels rise.
M1 is the narrowest of the money-supply measures M1 to M4: currency with the public + demand deposits with banks + other deposits with RBI. Broader aggregates add more assets.
M2 = M1 + savings deposits with post offices; M3 = M1 + time deposits with banks; M4 = M3 + total post office deposits. M2 and M3 are each built from M1 separately, so M3 does not include M2's post office savings deposits.
Broader aggregates (M3, M4) include less liquid assets than M1.
Demand for money arises from motives such as transactions, precaution and speculation.
Credit multiplier = 1 ÷ reserve ratio; a lower reserve ratio means more credit creation. The multiplier is never less than 1 (it equals 1 only if the reserve ratio is 100%).
Commercial banks accept deposits and give loans; they create credit by lending out part of deposits.
The RBI is the central bank: it issues currency, acts as banker to the government and to banks, and regulates credit.
Quantitative tools work on the overall amount of credit; examples are the repo rate, reverse repo rate, bank rate, open market operations (OMO), CRR and SLR.
To fight inflation, the RBI tightens policy by raising rates or reserve requirements; to boost growth, it eases them.
Money markets deal in short-term funds; capital markets deal in long-term funds.
Read each MCQ for words like 'except', 'not' and 'only' before choosing.

Common mistakes

Treating store of value as a primary function. Fix: Primary functions are only two: medium of exchange and measure of value. Everything else is secondary or contingent.
Calling a loan repayment example 'medium of exchange'. Fix: If the payment is promised for a future date, the function is standard of deferred payment.
Treating M0 as the first step of the M1 to M4 series Fix: M0 is the RBI's liabilities and is the base for money creation. M1 to M4 are measures of money supply held by the public. The two overlap: the public-held part of currency and other deposits with the RBI appear in both M0 and M1.
Adding bank time deposits to get M2 Fix: M2 adds post office savings deposits to M1. Bank time deposits come in only at M3.
Saying the speculative motive depends on income. Fix: Remember that only the speculative motive depends on the interest rate. The other two depend on income.
Thinking the value of money rises when prices rise. Fix: Value of money is what a rupee buys. Higher prices mean a rupee buys less, so value falls.
Saying payment banks can give loans. Fix: Remember payment banks only take small deposits and offer payment services. They do not lend.
Treating scheduled banks as only government banks. Fix: Scheduled means included in the Second Schedule of the RBI Act, 1934. Private and other banks can also be scheduled.
Using the multiplier as r ÷ 1 or multiplying the deposit by r. Fix: Remember the multiplier is always larger than 1. It is 1 ÷ r, so a smaller reserve ratio gives a bigger multiplier.
Giving total deposits when the question asks for credit created. Fix: Underline the ask. Credit created = total deposits − initial deposit.

Exam tips

Memorise the two primary and three secondary functions as a fixed list. Many questions test only this classification.
Questions often give a short real-life situation. Convert it to a verb (buy, price, save, pay later, move) and pick the function.
For types of money, always check what gives the money its worth. This separates commodity, fiat and credit money.
Remember that cheques and drafts are not legal tender. This is a favourite statement-based MCQ.
There is no negative marking, so attempt every question. Eliminate options that name the wrong category first.
Learn the components of each aggregate word for word. Most questions test exactly one component.
Watch the odd-one-out style: 'which is not included in M1?' Usually the answer is time deposits.
For sum questions, ignore figures that do not belong in the formula. Extra data is a common trap.