What is a Banknote?
A banknote is a negotiable promissory note which one party can use to pay another party a specific amount of money. A banknote is payable to the bearer on demand, and the amount payable is apparent on the face of the note. Banknotes are considered legal tender; along with coins, they make up the bearer forms of all modern money.
Paper currency of a country issued by its central bank. Also called currency note.
Unsecured, interest bearing, payable on demand promissory note issued by a bank in large denominations ($100,000 and above). Bank notes are similar to bonds and, like a certificate of deposit (CD), may be used as a cash equivalent. They, however, are not protected under deposit insurance.
A banknote (often known as a bill (in the US), paper money, or simply a note) is a type of negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand. Banknotes were originally issued by commercial banks, which were legally required to redeem the notes for legal tender (usually gold or silver coin) when presented to the chief cashier of the originating bank. These commercial banknotes only traded at face value in the market served by the issuing bank. Commercial banknotes have primarily been replaced by national banknotes issued by central banks or monetary authorities.
National banknotes are often — but not always — legal tender, meaning that courts of law are required to recognize them as satisfactory payment of money debts. Historically, banks sought to ensure that they could always pay customers in coins when they presented banknotes for payment. This practice of “backing” notes with something of substance is the basis for the history of central banks backing their currencies in gold or silver. Today, most national currencies have no backing in precious metals or commodities and have value only by fiat. With the exception of non-circulating high-value or precious metal issues, coins are used for lower valued monetary units, while banknotes are used for higher values.
How Banknotes Work
Before modern societies and financial systems were set up, people used valuable objects, such as gold and silver, to pay for goods and services through bartering. Eventually, paper money and coins replaced these physical assets as representative currency. When this happened, precious metals backed the new currencies to give it credibility.
At present, only the government backs banknotes. Although in earlier times commercial banks could issue banknotes, the Federal Reserve Bank is now the only bank in the United States that can create banknotes and mint money. Worldwide, billions of financial transactions use banknotes every day.
Historically, U.S. citizens could exchange U.S. government-issued paper money for gold or silver. This bimetallic standard system consisted of paper currency in a fixed ratio with gold and/or silver. However, in 1964, the U.S. government gradually began to halt the bimetallic standard; in 1971, the U.S. went off the gold standard altogether. The decision created a pure fiat currency, which the government supported only with its good faith in its ability to pay off any debts.
Fiat money derives its value from the relationship between supply and demand, not the value of the currency’s physical material. Since fiat money is not linked to physical reserves, it risks becoming worthless, due to hyperinflation. For example, if in a distant future U.S. citizens lose faith in the U.S. dollar bill, this paper currency will no longer hold value. Luckily, the likelihood of the U.S. dollar collapsing is very low.
Many use the terms banknotes, currency notes, and bills interchangeably. While both are promissory notes, many use currency notes more frequently for common dealings.
There are various types of banknotes issued for specific purposes. However, most of them are just prototypes and are not legal tenders. Some examples are plate proof banknote, test notes, educational notes, replica banknotes, and hell banknotes (which are commonly found in Asian countries. They are burnt in rituals to send money to the dead).
Specimen banknotes are printed in limited quantities and given to central banks to help them identify notes from other countries. To distinguish specimen notes from original ones, “SPECIMEN” is usually printed across its face to prevent people from using it as a legal tender.
Advantages and Disadvantages
Prior to the introduction of banknotes, precious or semiprecious metals minted into coins to certify their substance were widely used as a medium of exchange. The value that people attributed to coins was originally based upon the value of the metal unless they were token issues or had been debased. Banknotes were originally a claim for the coins held by the bank, but due to the ease with which they could be transferred and the confidence that people had in the capacity of the bank to settle the notes in coin if presented, they became a popular means of exchange in their own right. They now make up a very small proportion of the “money” that people think that they have as demand deposit bank accounts and electronic payments have negated the need to carry notes and coins.
Banknotes have a natural advantage over coins in that they are lighter to carry but are also less durable. Banknotes issued by commercial banks had counterparty risk, meaning that the bank may not be able to make payment when the note was presented. Notes issued by central banks had a theoretical risk when they were backed by gold and silver. Both banknotes and coins are subject to inflation. The durability of coins means that even if metal coins melt in a fire or are submerged under the sea for hundreds of years they still have some value when they are recovered. Gold coins salvaged from shipwrecks retain almost all of their original appearance, but silver coins slowly corrode.
Other costs of using bearer money include:
- Discounting to face value: Before national currencies and efficient clearing houses, banknotes were only redeemable at face value at the issuing bank. Even a branch bank could discount notes of other branches of the same bank. The discounts usually increased with distance from the issuing bank. The discount also depended on the perceived safety of the bank. When banks failed, the notes were usually partly redeemed out of reserves, but sometimes became worthless. The problem of discounting within a country does not exist with national currencies; however, under floating exchange rates currencies are valued relative to one another in the foreign exchange market.
- Counterfeiting paper notes has always been a problem, especially since the introduction of color photocopiers and computer image scanners. Numerous banks and nations have incorporated many types of countermeasures in order to keep the money secure. However, extremely sophisticated counterfeit notes known as superdollars have been detected in recent years.
- Manufacturing or issue costs. Coins are produced by industrial manufacturing methods that process the precious or semi-precious metals, and require additions of alloy for hardness and wear resistance. By contrast, bank notes are printed paper (or polymer), and typically have a higher cost of issue, especially in larger denominations, compared with coins of the same value.
- Wear costs. Banknotes don’t lose economic value by wear, since, even if they are in poor condition, they are still a legally valid claim on the issuing bank. However, banks of issue do have to pay the cost of replacing banknotes in poor condition and paper notes wear out much faster than coins.
- Cost of transport. Coins can be expensive to transport for high value transactions, but banknotes can be issued in large denominations that are lighter than the equivalent value in coins.
- Cost of acceptance. Coins can be checked for authenticity by weighing and other forms of examination and testing. These costs can be significant, but good quality coin design and manufacturing can help reduce these costs. Banknotes also have an acceptance cost, the costs of checking the banknote’s security features and confirming acceptability of the issuing bank.
The different disadvantages between coins and banknotes imply that there may be an ongoing role for both forms of bearer money, each being used where its advantages outweigh its disadvantages.
Important Points of Banknote
Some of the important point with respect to the banknotes is as follow:
- Bank Note is issued by the bank and is payable on demand to the bearer
- The banknotes do not carry any interest in it i.e. if there is any transfer of the banknotes or it is deposited in the bank than no interest will be paid or received on it.
- Initially, the objects like gold or silver were used by the persons for paying the goods or services received by them from the other party but eventually, these physical assets were replaced with the paper money and the coins as over the period of time governments started issuing the banknotes which could allow the exchange for the objects of value.
- The value of the banknote is apparent on the face of the note itself and for the payment against any good or service or for any other purpose that value will only be considered.
- All the banknotes which are issued in the country United States have the emblems which indicate that they are being issued by the country’s Federal Reserve and they also include the security features in them which reduce the risk of forging. Along with United States banknotes are used in different other nations as well and their banknotes are issued by the respective central bank of that country.