Money & the Banking System

Updated 1 July 20263 min read

The functions of money, the measures of money supply (M0–M4), the role of the RBI, and the types of banks that make up India's banking system.

Key Takeaways

The RBI (established 1935, nationalised 1949) is India's central bank and monetary authority.
Money supply is measured in graded aggregates — M0 (reserve money) to M3 (broad money) and M4.
Banks were nationalised in two waves — 14 banks in 1969 and 6 more in 1980.

1935

RBI established

1969

First bank nationalisation (14)

M0–M4

Money supply measures

2nd Schedule

Defines 'scheduled' banks

Core concept

Money is anything generally accepted as a medium of exchange. Its functions are: a medium of exchange, a measure of value (unit of account), a store of value, and a standard of deferred payment. The banking system creates and channels money, and the Reserve Bank of India (RBI) sits at its apex.

Static foundation — money supply (M0 to M4)

Measure	Composition	Name
M0	Currency in circulation + bankers' deposits with RBI + other deposits	Reserve / high-powered money
M1	Currency with public + demand deposits + other deposits with RBI	Narrow money
M3	M1 + time deposits with banks	Broad money (most used)

The RBI and Types of Banks

The RBI is the monetary authority (sets policy), issuer of currency (except one-rupee notes/coins, issued by the government), banker to the government, banker's bank and lender of last resort, regulator of the banking & payment system, and manager of foreign exchange (under FEMA).

Financial inclusion

Landmarks: bank nationalisation (1969), RRBs (1975), the Jan Dhan Yojana (2014) for universal accounts, and the JAM trinity (Jan Dhan–Aadhaar–Mobile) enabling Direct Benefit Transfer (DBT). India's UPI has made it a global leader in digital payments.

Current affairs linkage

Live themes: bank consolidation (mergers of public-sector banks), the NPA / bad-loan cycle and the IBC, and the rollout of the Central Bank Digital Currency (e-Rupee). (Add the latest data on NPAs, credit growth, or CBDC pilots.)

Prelims trap zones

Payment banks CANNOT lend and cannot issue credit cards — they only take (limited) deposits and enable payments.
M3 = broad money = M1 + time deposits — the most-cited aggregate.
One-rupee notes and all coins are issued by the Government of India, not the RBI (the RBI only distributes them).

Knowledge Check

2 questions · check your understanding

1. Broad money (M3) is defined as:

2. Which of the following can a Payment Bank NOT do?

Prelims Pointers

M3 (broad money) = M1 + time deposits with banks; M1 is 'narrow money'.
M0 is 'reserve money' or 'high-powered money'.
Scheduled banks are those listed in the Second Schedule of the RBI Act, 1934.
Priority Sector Lending mandates credit to agriculture, MSMEs, and weaker sections.

Mains Angle

'Financial inclusion is the foundation of inclusive growth.' Discuss the steps taken in India.
Examine the rationale and consequences of bank nationalisation in India.

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