Money and Banking - Business Studies Form 4 Notes

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  • Money is anything that is generally accepted as a medium of exchange for goods and services.
  • Banking refers to all the activities carried out by financial institutions involving money

Financial institutions includes

- Central bank
- Commercial banks
- Non-financial institutions

Barter Trade

  • Exchange of goods and services for other goods and services

Merits/Advantages /Benefits of Barter Trade.

  1. Satisfaction of wants: And individual is able to get what he or she needs.
  2. Surplus disposal: an individual or country is able to dispose off its surpluses.
  3. Social relations: it promotes social links since the communities trade together.
  4. Specialization: some communities shall specialize in a particular commodity.
  5. Improved living standards: this is enhanced by receiving what one is unable to produce.

Limitations/Draw Backs of Barter Trade

  1. Lacks standard measure of value.
    - It is very difficult to determine how much of a commodity can be exchanged for another
  2. Perishability of commodities
    - Some commodities cannot be stored for a long period to be used in future for exchange purposes
  3. Requires double coincidence of wants
    - There must be somebody who wants exactly what you have for you want he has for barter trade to take place.
  4. Indivisibility of commodities
    - Some commodities cannot be divided into smaller units without loss of value.
  5. Inconvenience in Transporting some Goods
    - Heavy and bulky goods are difficult to carry as you look for a trading partner.
  6. Lacks units of Account
    - Where barter trade is used, it is difficult to calculate and hence keep a record of the values of different commodities.

Money System

Characteristics of Money

  1. Acceptability
    - It must be accepted by everyone to be used as a medium of exchange
  2. Divisibility
    - It should be divided into smaller units without loss of value.
  3. Portability
    - Should be light and not bulky to carry around
  4. Durability
    - It should be able to last for long without getting defaced torn or losing its shape and texture
  5. Stability
    - Money should be able to last for a long time without changing in value so that it maintains credibility and acceptability.
  6. Homogeneity
    - Money of the same denomination should be uniform in quality and therefore identical.
  7. Scarcity
    - Money should be relatively scarce in supply. If it‟s abundant in supply then it would loss value

Functions of Money

  1. Medium of exchange
    - Money is generally accepted by everybody in exchange for goods and services
  2. Measure of value
    - Money provides a common denominator in which the value of various goods and services are expressed
  3. Unit of account
    - The values of different commodities are calculated and records kept in terms of money
  4. Store of value
    - Money is the most convenient means of storing wealth.This is because money is easily convertible into other forms of assets
  5. Standard Deferred payments
    - A debt incurred today can be paid later using money .This is because money is acceptable by everyone at all times.

Demand for Money/Liquidity Preference

- It refers to the tendency of an individual or general public to hold onto money instead of speeding it.

  1. The transaction motive
    - This is a situation where one holds money with a motive of meeting daily expenses such as buying food, paying for transport costs and entertainment. It is divided into two: Business motive and income motive
  2. The precautionary Motive
    - This is where people tend to hold money to meet expenses that might occur unexpectedly such as sickness accidents.
  3. The speculative Motive
    - Money can held to be used in the future especially when people anticipate that the prices of goods and services will be lower than they are presently.

Supply of Money

- Supply of money therefore refers to the stock of monetary items that are in circulation in an economy at a particular time. It includes Total currency and Total demand deposits


- The banking system of Kenya consists of four elements

  1. Central bank at the top
  2. Commercial banks follows
  3. Specialized development banks is next
  4. The fourth category are non-bank financial institutions

Commercial Banks

- Formed with the main aim of making profit through financial intermediation. There profits are usually generated through

  1. Interests earned on loans and overdrafts extended to customers
  2. Investments in medium term government securities
  3. Income from operations

Services Offered by Commercial Banks

A. Accepting deposits

- Commercial banks play an important role in the economy by mobilizing domestic savings and enabling efficiency and convenience in transactions by accepting deposits

B. Lending Money

- They may lend money to individuals, private businesses, the government and other public authorities in form of loans and overdrafts

C. Safekeeping of valuable items

- They accept valuable items such as title deeds, share certificates, jewellery and wills for safe keeping for their customers.

D. Provision of foreign Exchange

- A person with foreign currency can convert it into local currency at the prevailing exchange rates

E. Giving Advice on investments and Management of Funds

- Commercial banks can give advice to their clients on available investment opportunities and the best ways of managing their funds.

F. Acting as a Guarantor or Referee

- Commercial banks may act as guarantors to customers who would want to either get goods on credit from new supplies or secure loans from a financial institution.

G. Acting as intermediaries Between savers and borrowers

- By accepting money from people who have excess to save and give loans to investors, commercial banks act as intermediaries between the two parties.

H. Money Transfer Facilities

- Commercial banks provide convenient methods of transferring money through facilities such as;

  • Standing order
    - Instruction to the bank by the customer to be paying a certain amount of money to a named person or institution after a given interval until a specified date.
  • Credit transfers
    - A method of paying many people using one cheque. Its main advantages are saving time, stationary and bank handling costs
  • Telegraphic transfers
    - Method of remitting money offered by commercial banks to anybody who wants to send money to another,
    - It must have the following information:
    1. Name of the person
    2. Name of payee
    3. The amount of money being remitted
    4. The bank where the money would be paid
  • Cheque
    - A cheque is a written order by the drawer to a bank to pay on demand a specified amount of money to the person named as the payee or to the bearer.

Types of Accounts Offered By Commercial Banks

- It has three main accounts

1. Current Accounts

  •  Money is withdraw able on demand by means of cheque.


  • A cheque is used to withdraw money from the account
  • Money is withdrawable on demand
  • No minimum balance is required to be maintained
  • Does not earn interest but instead the bank charges ledger fees for services rendered
  • Have overdrafts that is bank allows customers to withdraw more money than they have in their current accounts.

Advantages of current account

  • No minimum balance is maintained hence the account holder can access all his/her money.
  • Withdrawals can be made at any time.
  • Transactions are made easier by use of cheques for example; one does not have to go to the bank in order to make payment.
  • Overdraft facilities are available..
  • It is possible to deposit any amount at any time during the office hours.
  • Use of cheques as means of payment serves as evidence of payments made.
  • Payments can be done even if there are insufficient funds in the account using post dated cheques.
  • The account holder can withdraw any amount at any time without notice as long as there are sufficient funds in the account.

Disadvantages of current account

  • Lengthy procedures of opening the account.
  • The account holder does not earn any income since the balances in the current account does not earn interest.
  • Initial deposit when opening the account is usually high hence discourages prospective customers.
  • Customers are not encouraged to save since they can access their money at any time.
  • Ledger fees are charged on the account making the operations of the account expensive

2. Savings Account


  • Balance on the account above a certain minimum earn interest
  • Funds are not withdrawn by use of cheques
  • Overdrafts not allowed
  • Most cases one is required to maintain a certain amount in the account
  • Withdrawable of money exceeding certain maximum amount may require a notice to be given by the customer.
  • Ordinarily withdrawals can only be made by the account holders themselves.

Advantages of Savings account

  • Customers are encouraged to save because of the restricted withdrawals.
  • There are relatively low banking charges.
  • Initial deposit is usually low as compared to other accounts.
  • The balances earn interest to account holder hence an incentive to save.
  • ATM facilities have made account operations very convenient to customers.

Disadvantages Savings account

  • A minimum balance must be maintained at all times and the customer is denied access to that money.
  • For across the counter withdrawals, it is only the account holder who can withdraw cash.
  • Withdrawals are restricted and sufficient notice is required before large amounts are withdrawn.
  • The account holders do not enjoy services such as cheque books and overdraft facilities like the current account holders.
  • Easy access to the money through ATM cards encourages overdrawals.
  • Anybody who knows the pin of the card (ATM card) can withdraw money from the account.


Requirements for opening an account

- The following are some of the requirements for opening either a current account or a savings account:

  1. Photocopies of identification documents such as National Identity Card or Passport.
  2. Passport size photographs (number varies from bank to bank). Some banks are nowadays taking the photographs instead of the customers providing them.
  3. For current account holders, an introductory letter from an existing customer from the prospective customer’s employer.
  4. Filling in the application form provided by the bank
  5. Signing of the specimen signature cards. Usually two.

NB: Once these requirements are fulfilled, the bank allocates the customer an account number, upon payment of an initial deposit

3. Time Deposits/Fixed Deposit Account

- They are called fixed deposit account because they do not allow withdrawal or addition of money before the end of a fixed pre-determined period.


  • Earns interests at an agreed rate
  • There is minimum account that can be allowed for this type of account
  • On expiry of the deposits period the account holder can withdraw all the money together with interests.
  • If money is withdrawn before the agreed period the customer losses accrued interest, but can be charged for breach of contract

 Advantages of Fixed deposit account

  • Interest earned is relatively high as compared to savings account.
  • There are no bank charges to the account holder.
  • Money held in fixed deposit account can be used as security to acquire bank loans.
  • Restricted withdrawals encourage savings.
  • The account holder has time to plan for the deposited money.

Disadvantages of Fixed deposit account

  • Access to money is not allowed until the end of the agreed period.
  • Interest is forfeited if there is pre-mature withdrawal.
  • The minimum amount of money for this account is high.
  • The customer is not allowed to deposit more money in this account.
  • A notice is required if the customer wants to terminate the contract before expiry date.
  • The customer is denied the use of the deposited funds before the expiry of the period.

Non- Banking Financial Institutions (NBFI)

- They address themselves to the financial needs of particular sectors of the economy which commercial banks have not been able to cater for adequately.


  1. Development Finance Institutions (DFI)
    - Provide medium and long term finances especially to the manufacturing sector. They include:
    • Kenya Industrial Estate KIE
    • Development Finance Company of Kenya DFCCK\
    • Industrial Development Bank IDB
    • Small Enterprise Finance Company SEFC
  2. Housing Finance Companies
    - They are mainly involved in financing housing activities.
    • Houses Finance Company of Kenya HFCK
    • East Africa Building Society EABS
  3. Savings and credit co-operation Societies (SACCOS)
    - These are co-operative societies formed to mainly enable the members save and also obtain loans most conveniently and at a favorable conditions.
  4. Insurance companies
    - These companies provides finance to commercial organizations as well as to individuals.

Difference between Commercial Banks and Non-banking Financial Institutions.

  1. Commercial banks provides current account facilities to their customers while NBFIs do not.
  2. Commercial banks normally provide short –term and medium –term finance while NBFIs provide medium and long term finance
  3. Commercial banks provides finance that is not restricted to any particular activity while NBFIs provide finance for specified purpose.
  4. Commercial banks can provide foreign exchange transactions to their customers while NBFIs do not.
  5. Commercial banks provide finance mainly for working capital while NBFIs provides finance for capital development
  6. Commercial banks do not participate in capital market trade while NBFIs can participate
  7. Commercial banks participate in clearing houses while non-bank institutions do not.

The Central Bank

  • An institution that control and manage the supply of and demand for money in a particular country.
  • The objective of monetary control by the central bank
    1. Facilitate rapid and steady economic growth
    2. Create employment
    3. Stabilize prices of commodities
    4. Ensure balance development
    5. Enhance equilibrium in the balance of payment

Function of Central Bank

  1. Issue of currency
    - The responsibility of issuing new currency that is notes and coins is solely in the hands of the central bank
  2. Acts as a bank banker
    - The central bank acts as a banker to commercial banks and other financial institutions in that it accepts deposits from these organizations. It also acts as a lender of last resort
  3. Acts as the government bank
    - The government operates its account with the central bank. The central bank is also the government financial adviser
  4. Controlling commercial Banks
    - The central bank controls commercial banks and other financial institutions by giving instructions to them on lending procedures and proper banking practices.
  5. Acts as a link bank to external financial institutions
    - The central bank acts as a link to central bank and monetary authorities of the other countries thereby facilitating international financial relationships.
  6. Maintaining stability in Exchange Rates
    - The central bank is responsible for maintaining a suitable exchange rate between the local currency and foreign does this through setting off specific foreign exchange rates or intervening in the foreign exchange market through revaluation or devaluation of domestic currency.
  7. Administering Public Debt
    - Public debt is the amount money the government has borrowed both internally and externally that is outstanding. The central bank is responsible for management and repayment of the debt when it matures
  8. Lender of last resort
    - The central bank plays the role of lender of last resort to the commercial bank. This means that commercial banks can obtain loans to meet their day to day financial obligations.
  9. Control of Monetary system
    - The central bank is responsible for controlling the monetary system in order to regulate the economy.

Ways In Which The Central Bank Regulate Money In The Economy

  1. Bank rates.
    - This is the rate at which the central bank lends to commercial banks. It can be varied to encourage or discourage credit/ raising/ lowering bank rate
  2. Open market operation
    - The central bank may sell or buy securities in the market. Selling securities reduces the money supply (For lending)
  3. Special deposits/ compulsory deposits/ minimum reserve requirements
    - The central bank require other financial institutions to have a certain percentage of deposits deposited in the central bank which can be varied to encourage / discourage credits
  4. Cash ratio/ liquidity ratio
    - The ration of cash/ deposits may be carried to control money supply credit which can be increased to reduce money supply/ can be decreased to increase money supply.
  5. Moral persuasion/ Liquid assets persuasion
    - The central bank may appeal/ request/ persuade/ restrain leading/ credit rationing. The commercial banks may be required by the central bank to approve loans only for special types of projects e.g. agriculture, manufacturing etc.
  6. Direct action/ directive/ instructions
    - Central banks can use its authority to direct/instruct the financial Institutions to lend more/ less/ apply credits squeeze/ credit expansions margins requirements.

Trends in Banking

- These are the positive changes that have taken place in the banking sector to improve their service deliveries to their customers. They include;

  1. The use of Automatic Teller Machines (ATMs), which has made it possible for the customers to access their money any time of the day. The ATM cards that are used for withdrawals from the ATM machines can also be used as a debit card to make purchases.
  2. Networking all their branches, which has enable the customers to carry out their transactions in any of the branch.
  3. E-Banking, which is the banking through the internet. This has made it possible for the customers to transact their financial businesses on-line.
  4. Relaxation of some of the conditions on opening and operating some of the accounts to make them be more attractive to their customers.
  5. Offering varieties of products which includes easier credit facilities to their customers to attract more customers.
  6. Liberalization of foreign exchange dealings by licensing forex bureaus to offer services to the customers, improving the accessibility to the service.
  7. Improving the customers care services, with some bank setting up a departments known as the customer care department to offer detailed assistance to their customers.
  8. Allowing non bank financial institutions to offer banking services to the members of the public, for example; KWFT, SACCOs, FOSA, Faulu Kenya, etc
  9. Mobile Banking services (M-Banking), which allows the customers to carry out their financial transactions over their mobile phones. It has brought about several benefits/ advantages to their customers which includes;

    Advantages of m-banking
    - Easy transfer of funds from one account to the other in the same bank (inter account transfer)
    - Easy transfer of money from ones account to his mobile phone for other transactions
    - Ability to check ones account balance in the bank with ease
    - Easy to monitor your financial transactions by checking your transaction details over the phone
    - Easy payment of the bills such as electricity bill, Dstv bills, etc and other wages
    - Ability to transfer money from one mobile number to other in collaboration with the service providers
    - Easy request for new cheque books and bank statements from the banks
    - Able to top up air time to your mobile phones in collaboration with the service providers
    - Reduced risk of carrying large sums of money in cash or cheques that may be stolen

    However this development has also come with its challenges, which includes:

    Disadvantages of m-banking
    - Registration to enjoy all these services must physically be done in the banking hall, which subject the customers to stress queues of the bank
    - Only the registered mobile number can carry out these transactions which limits the customer to only using one number
    - Users requires a mobile phone with a screen that can display the transaction which a times some may not a ford
    - Mobile phones can easily be lost or stolen from the owner, inconveniencing him from carrying out the transactions
    - Bank transaction information may load slowly, which may makes it expensive for the user
    - Possibility of transferring the funds to a wrong account, due to error in typing of the account number
  10. Introduction of agency banking, which has made them to make their services to be more accessible to even areas where they may have not put up a banking hall.
    - Agency banking is whereby a retail stores, supermarket, or any other commercial businesses are authorized by the financial institutions to carry out financial transactions on their behalf.
    - They may offer the following services
    • Receiving customer deposits
    • Offering withdrawal services
    • Transfer of funds for customers
    • Pay bills for the customers
    • Balance inquiry services
    • Opening new accounts for the customers
    • Fill loan application forms for them

    Advantages of agency banking
    - Reduction of set up and delivery cost to the banks, which in turn passes to the customers in form of reduced cost of accessing services
    - Time saving as the agents are located close to the customer and the customer may carry out other transactions as he withdraw the money
    - More convenient for the customer to bank with their local retailers other than the traditional banking halls
    - Enable the bank to reach far places within the country

Past KCSE Questions on the Topic

Paper 1

  1. State how a credit transfer is used as a means of transferring money through the commercial banks (3 mks)
  2. Highlight four advantages of using a telegraphic money order as a means of remitting money though the post office.  (4 mks)
  3. state four limitations of barter trade (4 mks)
  4. In the spaces provide below indicate with a tick whether each of the following statements is true or false about commercial banks (5 marks)
      True  False
    - Accept deposits from the members of the public
    - Provides safe custody for the valuables
    - Issues currency for the use in the country
    - Controls money supply in the country
    - Lends more to the public
  5. List four characteristics of money (4 mks)
  6. State four methods that central bank may use to control credit (4 mks)
  7. List four functions of development (4 mks)
  8. highlight four reasons why loans advanced by commercial bank in Kenya may not appeal to many people (4 mks)
  9. Give four disadvantages of barter trade (4 mks)
  10. State four banking services that the central bank of Kenya provides to the government (4 mks)
  11. Wambua intends to import a car from Dubai which costs Kshs. 20, 0000 Dirams. If 4 Dirams = 1 Us Dollar and Kshs 70 = 1 Dollar, calculate the amount in Kenya shillings that Wambua will pay for the car.
  12. Highlight 4 functions of the Central Bank of Kenya
  13. Given below is the first stage in the historical development of money list the next four stages in their order of occurrence (4 mks)

Paper 2

  1. Explain five in which banks contribute to the development of Kenya (10 mks)
  2. Outline five reasons why banks currently account is popular with traders(10 mks)
  3. Explain service offered to commercial banks by the central bank of Kenya(10 mks)
  4. In what ways of the functions of commercial bank differ with those of non- bank financial institutions (10 mks)
  5. Explain five ways in which central bank of Kenya may control the supply of money in the country (10 mks)
  6.  Describe methods which may be used by commercial banks to advance money to customers.
  7. A businessman wishes to obtain a loan from a commercial bank. Highlight the conditions that he should satisfy before the bank can grant him the loan (10 mks)
  8. Explain five services that the central bank of Kenya offers to commercial banks (10 mks)
  9. Explain four disadvantages of using a bank overdraft as a source of finances (8 mks)
  10. Describe four ways in which a non- bank financial institutions differ from the commercial banks (8 mks)
  11. Discuss five reasons why business people prefer to operate bank current accounts
  12. Outline the benefits that bank customer gets from operating a current account (10 mks)
  13. Explain the 5 services offered by a commercial banks to their customers(10 mks)
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