Principles Of Money And Banking

 

1.0. INTRODUCTION

Understanding these principles of money and banking does not only helps you understand

how the financial system works today in Nigeria, but also gives you an insight into why

things go wrong, and what the consequences might be for future events in the economy.

The simple Principles of money and banking you shall learn in this note include the

principle of time (time has value), the principle of risk compensation, the principle of

decision making on the basis of adequate information, the principle of efficient resource

allocation by markets, and the principle of stability.

2.0. OBJECTIVES

At the end of this note, you should be able to;

· Describe the importance of timing of payments in banking transactions

· Explain why risks in banking transaction needs compensation

· Describe the implication of a decision taken on the basis of an adequate

information

· Describe how markets are an efficient way of resources allocation

· Explain the Principle of Stability in banking transaction.

3.0. PRINCIPLES OF MONEY AND BANKING

3.1. The principle of Time; (time has value)

The timing of payments is an important part of any transaction. Lenders will demand

compensation for parting with their money and getting it back slowly overtime. Borrowers are

willing to give this compensation in return for getting the funds today. This is the basis for an

interest rate. Furthermore, how long payments are stretched out, and how frequently they occur

will be important in determining the value of any financial investment. Value is based on both

the SIZE and the TIMING of promised payments.

3.2. The principle of Risk compensation

Risk is pretty much unavoidable, and no one like it. Putting these two realities together means

that people are willing to pay to avoid risk and those who assume certain risks will demand

compensation. This is the whole basis of the insurance industry. Therefore, the value of a

financial instrument is based on the SIZE, TIMING, and CERTAINTY of payments associated

with instruments.

3.3. The principle of Decision-making on the basis of Adequate Information

At the core of microeconomics is the assumption of rational decision - making. Rational

decisions are partly based on using all available information to make a decision. Some decisions

are more important than others, e.g. buying a car vs buying your lunch. Some information are

harder to gather than other types.

Problems can arise especially when one party to a transaction has more / better information than

the other party. This asymmetric information problem is a big motivation for financial

intermediation by banks, insurance companies and other institutions. One role of financial

institutions is to gather and disseminate information so that financial markets run smoothly.

3.4. The principle of efficient resources allocation by markets.

In economics, we learn about the fundamental problem of scarcity and that most of the

time markets are an efficient way to allocate scarce resources. A market sets a price that rations

scare resources to those willing and able to pay. In the financial sector markets will determine

what investment projects get funded and what capital stock is built.

3.5. The principle of Stability

This principle is closely related to the core principle of risks compensation. People

prefer the known to the unknown, all things being equal. Therefore when financial institutions

offer instruments with stable payments or insurance against variability, and central banks work to

create a stable financial system, individuals tend to be better off. That is, stability improves

welfare.

4.0. CONCLUSION

This note throws light on the time value of money, principles of risk compensation and

the principle of decision making. It also sheds light on the principles of efficient resources

allocation and stability.

5.0. SUMMARY

In this note, we have learned about;

i. The principle of time in banking business,

ii. The principle of risk management,

iii. The principle of decision-taking on the basis of adequate information,

iv. The principle of efficient resources allocation by markets, and

v. The principle of stability banking business.

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