Chapter-6 ,Macro Economics , Banking
Q. no. -1 What are commercial banks? Discuss the various functions performed by commercial banks in a country?
Ans.-1 The Commercial banks are those institutions, which accept deposits from the public & give loans and advance loans. These banks are commercial in nature because their main motive is to earn profit. They accept deposits from the public and hence in the process they create money and credit.
Que:-2 Define commercial bank ?
Ans:-2 According to Culbertson, “Commercial banks are the institutions that make short term loans to the business and in this process create money”.
The Indian banking companies act 1849 lay down that the commercial banking consists in “The accepting for the purpose of lending or investment, deposit of money from the public, repayment on demand or otherwise and withdrawal by cheque profit order or otherwise”.
Que:-3 State the function of the commercial bank
Functions: -
The various functions can be classified into two categories: -
1. Primary function
2. Secondary function
Que:-4 explain the primary function of commercial bank ?
Ans:-4
1. Primary Function: -
1. Accepting Deposit
2. Advancing Loan
1. Accepting deposit: - The most important function of any commercial bank is to accept the deposit from the public. The various types of bank deposits are: -
a. Current and demand deposit: These are also known as demand deposits since any sum or any number of withdrawals / claims can be presented by such an account holder. Banks do not pay any interest on these accounts. Contrary to that, banks impose service charges on their clients for running these accounts.
b. Fixed and timed deposit: These are also known as time deposits since the amount deposited with a bank cannot be withdrawn before the maturity of the period. These deposits carry interest at higher rates.
c. Saving deposit: - It is a sort of safety vault for the people with idle cash. Deposits in this account earn interest at nominal rates, as the bank can always be called upon by a depositor to release his account.
d. Recurring deposit: - It refers to the account in which amount is deposited on regular basis whether daily, weekly, monthly, quarterly or yearly.
2. Advancing Loan
Advancing of Loans:- The deposits received by banks are not allowed to remain idle. So, after keeping certain cash reserves, the balance is given to needy borrowers & interest is charged from them, which is the main source of income for these banks. Different types of loans & advances made by Commercial banks are:
(i) Cash Credit: Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is credited in his account. The borrower may withdraw any amount within his credit limit and interest is charged on the amount actually withdrawn.
(ii) Demand Loans: Demand loans refer to those loans which can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interestis payable on the entire sum
(iii) Short-term Loans: They are given as personal loans against some collateral security. The money is credited to the account of borrower and the borrower can withdraw money from his account and interest is payable on the entire sum of loan granted.
Que:-5 explain the secondary function of commercial bank ?
Secondary Functions
In addition to primary functions, commercial banks also perform the following secondary functions:
1. Overdraft Facility
It refers to a facility in which a customer is allowed to overdraw his current account upto an agreed limit. This facility is generally given to respectable and reliable customers for a short period. Customers have to pay interest to the bank on the amount overdrawn by them.
2. Discounting Bills of Exchange
It refers to a facility in which holder of a bill of exchange can get the bill discounted with bank before the maturity. After deducting the commission, bank pays the balance to the holder. On maturity, bank gets its payment from the party which had accepted the bill.
3.Agency Functions
Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients. Some of the agency functions are:
(i) Transfer of Funds: Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like demand drafts, mail transfers, etc.
(ii) Collection and Payment of Various Items: Commercial banks collect cheques, bills, interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.
(iii) Purchase and Sale of Foreign Exchange: Some commercial banks are authorised by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.
(iv) Purchase and Sale of Securities: Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.
(v) Income Tax Consultancy: They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.
(vi) Trustee and Executor: Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.
(vii) Letters of Reference: They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.
4. General Utility Functions Commercial banks render some general utility services like:
(i) Locker Facility: Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody.
(ii) Traveller's Cheques: Commercial banks issue traveller's cheques to their customers to avoid risk of taking cash during their journey.
(iii) Letter of Credit: They also issue letters of credit to their customers to certify their creditworthiness.
(iv) Underwriting Securities: Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks.
(v) Collection of Statistics: Banks collect and publish statistics relating to trade, commerce and industry. Hence, they advice customers on financial matters.
Que:-8 State the main function of a Central Bank. [CBSE, Delhi 2005]
Or
Que:-8 Explain any two functions of central bank.
Functions of Central bank: -
Que:-8 Explain Central Bank’s function as currency authority.
or
Explain ‘bank of issue’ function of central bank.
Que:-8 Explain the ‘currency authority’ function of central bank.
1. Issue of Currency: -
The most important function of any Central bank in the country is to issue the currency. There is an issue department, which performs the task of issuing currency. The Central bank issues the currency on the basis of different systems like gold standard system & the minimum reserve system. Just as in India R.B.I. can issue any amount of currency by keeping minimum gold reserve worth Rs. 200 crores. In India all currency notes of Rs. 2 & higher denomination are issued by R.B.I., which carry a promise. This currency is unlimited legal tender money because unlimited payment can be made in the form of this currency.
Que:-9 Explain the function of a Central Bank as banker to the government.
Or
Que:-9 Explain ‘banker to the government’ function of Central Bank.
2. Banker of the govt.: -
The Central bank acts as a banker, agent & financial advisor to the govt. As a banker it maintains all govt. accounts. As an agent it performs all banking functions on behalf of the govt. and as a financial advisor it advises the govt. on various economic, financial and money matter.
3. Bankers bank: -
Que:-10 Explain the ‘banker’s banks and ‘supervisor’ function of the central bank.
or
Que:-10 Explain ‘banker’s bank’ function of Central Bank.
It performs the function of banker to all the commercial banks in the country. The Central bank keeps a part of cash balance of all commercial banks as security & therefore it helps the commercial banks by providing loans and credit so that the commercial banks are able to meet their liabilities.
Que:-11 Explain the ‘lender of last resort’ function of the Central Bank.
4. Lender of last resort: -
The Central bank acts as a lender of last resort to all commercial banks in the country. Whenever the commercial banks face financial crisis or they fail to meet their liabilities, the Central bank grant loan by rediscounting the securities and therefore help the commercial banks during emergency or financial crisis. Therefore the Central bank saves them from becoming bankrupt & insolvent.
Que:-12 Explain the ‘Custodian of foreign exchange’ function of the Central Bank.
5. Custodian of foreign exchange: -
The Central bank acts as the custodian of foreign exchange reserve of any country. It buys and sells foreign exchange. It maintains the external value of our currency in terms of currency of other countries. It maintains stability in the foreign exchange rate and therefore all foreign exchange operation are carried on by the Central bank.
Que:-13 Explain the ‘Clearing house’ function of the Central Bank.
6. Clearing house: -
The Central bank acts as a clearing house for all the commercial banks in the country. There is a clearing house or clearing department in the central bank, which performs the clearing function by entries of debit and credit. The various commercial banks make payment on each other’s behalf. But hey do no make cash transactions. They maintain their ledger by showing debit and credit and prepare final balance sheet. It is cleared by central bank and hence the central bank acts as a clearing house.
7. Control of Credit: -
The most important function of Central bank is to control the credit i.e. it expands the credit during depression & contracts the credit during inflation. The central bank uses two types of functions such as quantitative and qualitative methods. To control the credit it adopts cheap credit policy for expansion of credit and clear credit policy for contraction of credit.
8. Collection and publication of statistics: -
The Central bank collects statistical information about credit money supply, expansion of banking facility, foreign exchange position etc. This information is published through various general newspapers and magazines, which helps in preparation of planning & decision making. It also helps in preparing the economic conditions of different countries.
9. Miscellaneous or other functions: -
Beside above mentioned functions the Central bank also perform several other functions such as: -
a. Agriculture credit: - It provides credit to the agriculture sector like in India R.B.I. has set up co-operative banks, divisional rural banks and national agriculture bank for rural development. To perform the function of rural credit, these banks give subsidies, loans at low rate of interest to the agriculture sector, which helps in the development of agriculture sector.
b. International monetary conference: - In order to discuss the financial and money matters a Central bank conducts monetary conference. It invites foreign delegates, representation of world banks etc. to take part in the monetary conference in the country and also send its delegates or representatives to participate in such conference in other countries.
c. Export import finance: The Central bank also provide finance to increase the foreign trade by increasing export and import such as in India R.B.I. has set up export import Bank. This bank provides import subsidies & loan to the exporter and importer. Therefore the central bank helps in the development of foreign trade.
d. Return of torn currency: - The Central bank in every country take back the torn currency notes and issue new currency in its place. In short the Central bank occupies the Central position in the monetary and banking system of the country because it performs various important functions like issue of currency, credit control, banker of the govt., lender of last resort etc. and therefore by performing these functions it plays a significant role in the economic development of any country.
Q.no.-7 What is a Central Bank? Make a comparison between Central and commercial bank. Discuss the various functions performed by a Central bank in a country?
Ans-7 The Central bank occupies a very important place in the monetary and banking system of every country. It is the controlling body, which controls the entire banking system. It is responsible for issue of currency and the control of credit. In every country there is a central bank such as Bank of England. This bank is the central bank of U.K. as R.B.I. is the central bank of India.
According to Prof. Samuelson, ”Every central bank has one function. It operates to control the economic supply of money and credit.
Comparison between Central and Commercial Bank is as follows : -
Basis | Central bank | Commercial bank |
Meaning | Central bank is an apex Body that control ,operate ,regulate and direct the entire banking and monetary structure of the country | Commercial is an institute which performs the function of accepting deposits, granting loans and making investment with the objective of earning profits |
Status | It is the apex institute in the money market | It is merely a unit in the banking structure of the country and operates under the control of central bank. |
Ownership | It is generally owned and governed by the government . | It can be owned and governed by the government or the private sector . |
Objective | It operate in public interest without profit motive | It aim to maximize the profit |
Issue of currency | It has sole monopoly in issue of currency | It has no power to issue currency |
Public dealing | It does not directly deals with the public | It deals directly with the public |
No. of banks | There is only one central bank in a country due to peculiar nature of its activities .for example RBI in India | There are no. of commercial banks in the country .for example state bank of India , Punjab national bank etc in India . |
Q.no-14 Why is the central bank regarded as an apex of economies Banking system?
Or
Que:-14 What is meant by central bank? Why is it known as the apex body?
Ans-14 Central bank is regarded as an apex of economies banking system because of its following functions:
1. The regulation of currency in accordance with the requirements of business and the general public, for which purpose it is granted either the sole right of note issue or at least a partial monopoly thereof.
2. The performance of general banking and agency services for the state.
3. The custody of cash reserve of the commercial banks.
4. The custody and management of the nation’s reserves of international currency.
5. The granting of accommodation, in the form of rediscounts, or collateral advances, commercial banks, bill brokers and dealers, or other financial institutions, and general acceptance of responsibility of tender of last resort.
6. The settlement of clearances between the banks.
7. The control of credit in accordance with needs of business and with a view to carrying out the brand monetary policy adopted y the state.
Que:-15 Explain the process of money creation by the commercial banks with the help of a numerical example.
Ans:-15 The process of creating secondary or derivative deposits on the basis of primary deposits is called Credit Creation. Thus deposits, which are received by commercial banks in cash from the public, are called primary deposits. The deposits created with the banks by granting loan and credit are called secondary or derivative deposits. Therefore the process of creating secondary deposits with the help of primary deposits is called credit creation.
Assumption of the process of Credit Creation :-
(i) The entire commercial banking system is one unit and is termed as ‘bank’
(ii) All receipt and payments in the economy are routed through the bank i.e. all payment are made through cheques and all receipts are deposit in the bank .
The deposit held by the banks are used for giving loan .However bank can not use the whole of deposit for lending .it is Legally compulsory for the bank to keep a certain minimum fraction of their deposit as reserve .The fraction is called the legal reserve ratio LRR and is fixed by the central bank
The money created by the commercial bank is determined by the amount of initial deposit and the legal reserve ratio (LRR) .suppose the amount of initial deposit is Rs 10,000 and LRR is 0.20 . the bank will keep 20% i.e. Rs 2,000 as reserve and lending the remaining Rs 8,000 .Those who borrow will spend the money it is assumed that 8,000 will come back to the banks. This raise total deposits to Rs 18,000 .Banks again keep 20% of Rs 8,000 i.e. Rs 1,600 as reserve and lend 6,400 this further rise the amount with the bank .In this way, deposits go on increasing @80% of the last deposit .The number of times , the total deposits will become , is determined by the initial deposit or money multiplier
Money multiplier = 1 = 1 = 5
LRR .2
The total deposit will be = Initial deposit X Money multiplier = 10,000 X 5
Particular | Deposit | Loans | Cash reserve (LRR=20%) |
Initial deposit | 10,000 | 8,000 | 2,000 |
Round I | 8,000 | 6,400 | 1,600 |
Round II | 6,400 | 5,120 | 1280 |
_ | _ | _ | _ |
_ | _ | _ | _ |
_ | _ | _ | _ |
Total | 50,000 | 40,000 | 10,000 |
Que:- 16 Calculate the total deposit created by commercial banks if reserve ratio is 10% and primary deposit is Rs. 1,250 crores.
Que:-17 If total deposit created by commercial banks is Rs. 20,000 crores and the primary deposit is Rs.2, 500 crores, what is the value of money multiplier and reserve ratio?
Que:-18 Define money multiplier
Ans:-18 Money multiplier or deposit multiplier measures the amount of money that a bank is able to create in the form of deposit with a every unit of money it kept as reserve it is calculated as
Money multiplier = 1
LRR
Que:- Hots Commercial banks create credit only on the advice of the government. It is true?
Ans:- Hots No, this is false, Commercial banks do not create credit only on the advice of government. However, their capacity to create credit depends on credit policy of the central bank of country.
Que:- Hots How can Jan-Dhan Yojana’ be used as an instrument to increase supply of money by the commercial banks?
Ans:- Hots A large section of the population in India do not have their bank accounts. ‘Jan-Dhan Yojana’ promots people to open their bank accounts. When more and more accounts are opened then some of the cash balances with the people (or idle cash lying with the people) is bound to reach the banking system as cash deposits or primary deposits. This increase enables commercial banks to increase their cash reserves with the commercial banks. If CR (additional cash reserves with the RBI) = Rs.10,000 and if CRR=4%, then the additional demand deposits the banks can create =
. This is how Jan-Dhan Yojana may be used as an instrument to increase supply of money by the commercial banks.
Que:- Hots How does currency deposit ration impact the supply of money in the economy?
Ans:- Hots Currency deposit ratio refers to the ration between (i) money held by the people in terms of cash, and (ii) money held by the people in terms of demand deposit in the banks. It is expressed as:
CU / CD = CDR
Cash in Hand Demand deposits Currency
with the people of the people deposit ratio
In reflects liquidity preference of the people. Higher this ratio, greater the preference for liquidity (cash in hand). This reduces flow of cash in the banking system and lower cash reserves of the commercial banks. Lower cash reserves imply lower credit creation capacity of the banks. Consequently, supply of money tends to reduce. Conversely, if banking habits of the people are well-grown (as in advanced countries), cash in hand is less in relation to deposits with the banks. This increases cash reserves of the commercial banks, and raises their capacity to create credit. Accordingly, supply of money tends to rise.
Q.no-19 What is meant by credit control? What are the different methods adopted by the central bank to control the credit.
Ans-19 The regulation of credit by the Central bank in any country to control inflation and deflation is called credit control. The Central bank expands the volume of money supply and credit during deflation and contracts the supply of money and credit during inflation. Therefore the credit control refers to the expansion and contraction of credit by Central bank. In order to achieve the objectives of price stability and high growth rate. There are two type of credit control measure
1. Quantitative measure
2. Qualitative measure
Quantitative Credit Control refers to overall credit control in the economy, affecting all sectors of the economy equally and without discrimination. but Qualitative Credit Control refers to selective credit control that focuses on allocation of credit to different sectors of the economy. Flow of credit is encouraged to the priority sectors, while it is discouraged to the non-priority sectors.
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Que:-20 What is Repo Policy/ How does it work as a method of credit control?
1. Repo (Repurchase) Rate: Repo rate is the rate at which the central bank of a country (RBI in case of India) lends money to commercial banks to meet their short-term needs. The central bank advance loans against approved securities or eligible bills of exchange.
An increase in repo rate increase the cost of borrowings from the central bank. It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans. It reduces the ability of commercial banks to create credit. A decrease in the repo rate will have the opposite effect.
Que:- Hots Is repo rate an instrument of selective credit control?
Ans:- Hots No, repo is an instrument of quantitative credit control. It impacts the availability of credit across all sectors of the economy.
Que :-21 The reserve bank of India aims to make credit costly for the general public in order to reduce the availability of credit . what should be done ?
Ans:-21 The reserve bank of India should increase the repo rate . An increase rate in repo rate increase the cost of borrowing from the central bank .it force the commercial bank to increase their lending rate which discourage the borrower from taking the loans . it make the credit costly for the general public and reduce the availability of credit
Que:-8 “Rate cuts might not be imminent”-Reserve Bank India.
Why RBI is not ready to cut the rates? Write your opinion.
Ans:-8 Here, rate cut refers to repo rate. The RBI believes that a cut in repo rate going to fuel retail inflation which is already high. Hence, a cut in repo rate (which will increase money supply in the economy) is not recommended.
Que:-9 RBI lowers repo rate from 8% to 7.75%.
Analyse the economic value of this statement from the viewpoint of (i) the households, (ii) investors, and (iii) the economy.
Ans:-9 A cut in repo rate (the rate at which commercial banks can raise loans from RBI) is expected to be followed by a cut in market rate of interest (the rate at which the commercial banks offer loans to the people). It is expected to impact the households and investors, and the economy as under:
Impact on Households: A cut in market rate of interest (followed by a cut in repo rate) is expected to induce borrowings for the purchase of consumer durables, as well as houses and flats. Also, the existing loans (raised against floating interest rate) will now attract lower EMI. Implying a direct monetary benefit to the households.
Impact on the Investors: As a result of a cut in the market rate of interest, the cost of borrowings (implying the cost of capital) will reduce. Accordingly, investment is expected to increase across all areas of production activity.
Impact on the Economy: When demand for consumer durables rises, aggregate demand is expected to rise. Aggregate demand also tends to rise when investment expenditure rises. Because both consumption expenditure and investment expenditure are significant components of aggregate demand. Thus, the level of planned output is expected to rise along with the level of planned purchase in the economy. Accordingly, the equilibrium GDP level is expected to rise. Implying a rise in the growth rate of GDP.
Que:-22 Explain the effect of an increase in bank rate on credit creation by commercial banks.
or
Que:-22 What is bank rate policy? How does it work as a method of credit control? or
Que:-22 How do changes in bank rate affect money creation by Commercial Banks? Explain. [CBSE, Delhi 2010]
Or
Que:-22 How is ‘bank rate’ used by central bank in influencing credit creation by commercial banks? Explain. [CBSE, All India Comptt.
2. Bank Rate (or Discount Rate): Bank rate is the rate at which the central banks of a country (RBI in case of India) lends money to commercial banks to meet their long-term needs. RBI has been activity using bank rate to control credit. Bank rate has the same effect as that of Repo rate, i.e. an increase in Bank rate increases the cost of borrowings from the central bank, which leads to increase in lending rates by commercial banks. It discourages borrowers from taking loans, which reduces the ability of commercial banks to create credit.
Que:- Hots State the Difference between Bank Rate and Repo Rate?
Ans:- Hots The Difference between Bank Rate and Repo Rate are as follows
Both bank rate and repo rate refer to the rate of interest at which commercial banks can raised loans from the RBI. However, there are some differences, as under:-
Bank Rate | Repo Rate |
Bank rate relates to the loans offered by the RBI to the commercial banks without any collateral (security for purpose of loans.) | Repo rate relates to the loans offered by the RBI to the commercial banks NOT without collateral. The securities are pledged as a security for the loans. |
Bank rate does not allow any facility of repurchases of securities. The banks rate is simply the Rate of Discount. | Repo rate allows repurchase of securities. The holder of securities can repurchase them at a later date. Therefore, repo rate is also called Repurchase Rate. |
Bank rate relates to borrowings by the commercial banks to cope with their immediate cash-crunch. | Repo rate relates to short-term borrowings by the commercial banks. |
Que:-23 What are open market operations? What is their effect on availability of credit?
or
Que:- 23 Explain the open market operations method of credit control used by Central Bank. Or
Que:- 23 How does central bank control credit creation by commercial banks through open market operations? Explain. [CBSE, All India 2013 (ii)]
Or
3. Open Market Operations: Open market operation (OMO) refers to buying and selling of government securities by the Central Bank from/ to the public and commercial banks. RBI is authorized to sell or purchase treasury bills and government securities. It does not matter whether the securities are bought or sold to the public or banks because ultimately the amounts will be deposited n or transferred from some bank.
· Sale of securities by central bank reduces the reserves of commercial banks. It adversely affects the bank’s ability to create credit and therefore decrease the money supply in the economy.
· Purchase of securities by central bank increases the reserves and raises the bank’s ability to give credit.
Que:- Hots If the commercial banks buy government securities, their capacity to create credit is reduced. Do you agree?
Ans:- Hots Yes, the given statement is correct. By allowing or inducing the commercial banks to buy government securities. The central bank soaks cash balances of the commercial banks which they could use to create credit. Accordingly, the credit creation capacity of the commercial banks is reduced.
Que:-24 What is legal Reserve Ratio? Explain its components.
[CBSE, All India Comptt. 2013 (i, iii)]
4. Legal Reserve Requirements (Variable Reserve Ratio Method): According to Legal reserve requirements, commercial banks are obliged to maintain reserves. It is a very quick and direct method for controlling the credit creating power of commercial banks. Commercial Banks and required to maintain reserves on two accounts:
(i) Cash Reserve Ratio (CRR): It refers to the minimum percentage of net demand and time liabilities, to be kept by commercial banks with the central bank. A change an CRR affects the ability of commercial banks to create the credit. For instance, an increase in CRR reduces the excess reserved of commercial banks and limits their credit creating power.
Que:- Hots If CRR is lowered, investment demand must rise. Defend or refute.
Ans:- Hots Yes, the above statement is correct. If CRR is lowered, credit creation capacity of the commercial banks enhanced. Higher availability of credit and at lower interest rate must lead to a rise in investment demand.
(ii) Statutory Liquidity Ratio (SLR): It refers to minimum percentage of net demand and time liabilities which commercial banks are required to maintain with themselves. SLR is maintained in the form of designated liquid assets such as excess reserves, unencumbered*, government and other approved** securities or current account balances with other banks. Change in SLR affects the freedom of banks to sell government securities or borrow against them from the Central Bank. An increase in SLR reduces the ability of banks to give credit and vice-versa. The Reserve Bank can influence the credit creation power of the banks by making changes in CRR or / and SLR.
Que:-25 What is meant by margin requirement? How can it e used to control the money supply? Explain it with the help of an example.
5. Marginal Requirements: Margin is the difference between the amount of loan and market value of the security offered by the borrower against the loan. If the margin fixed by the Central Bank security. By changing the margin requirements, the Reserve Bank can alter the amount of loans made against securities by the banks.
· An increase in margin reduces the borrowing capacity and money supply.
· A fall in margin encourages the people to borrow more.
· RBI may prescribe different margins for different type of borrowers against the security of the same commodity.
· Margin is necessary because if a bank gives a loan equal to full value of security, then bank will suffer a loss in case of fall in price of security.
Que:- Hots Is it correct when margins are raised, demand for loans is negatively impacted.
Ans:- Hots When margin are raised, the difference between the market value of the security offered for loans and value of loans granted becomes high. It is now expensive for the people to take loans from the banks. Therefore, demand for loans reduces in the economy. Thus, the given information is correct.
6. Rationing of Credit: Rationing of credit refers to fixation of credit quotas for different business activities. Rationing of credit is introduced when the flow of credit is to be checked particularly for speculative activities in the economy. The central bank fixes credit quota for different business activities. The commercial banks cannot exceed the quota limits while granting loans.
7. Moral Suasion: Sometimes, the central bank makes the member banks agree through persuasion (or pressure) to follow its directive. The member banks generally do not ignore the advice of the central bank. The banks are advised to restrict the flow of credit during inflation, and be liberal; in lending during deflation.
Que:- Hots Why has the Government in India failed to combat inflation even when a series of monetary measures are available in the textbook of macroeconomics?
Ans:- Hots Monetary measures of combating/controlling inflation focus largely on moderating/lowering the demand for goods and services by making the availability of credit and difficult. It does not address supply side of the problem.
While the fact of the matter is that in India inflation has often been triggered by the low market supplies. Unless supplies are boosted (particularly the supply of farm output) we shall continue to wrestle with inflation without taming it.
Que:-Hots Commercial banks do not have the note issuing authority, but they do contribute to money supply in the economy. Comment.
Ans:- Hots Yes, the given statement is true. The central bank is the sole authority of issuing notes in the country. However, by advancing loans through credit creation, commercial contribute to money supply in the economy.
Que:- Hots How improvement in banking habits of the people leads to improvement in the availability of credit from the commercial banks to the borrowers?
Ans:- Hots When banking habits of the people improve, they start holding less money as cash-in-hand. Instead, more and more money is deposited with the banks. Accordingly, cash reserves of the commercial banks start rising. Higher cash reserves of the banks enhance their credit creation capacity. They are able to create credit many times moiré than their additional cash reserves. We know credit is created by the commercial banks through demand deposits arising out of loans. Implying that, by way of demand deposits, the banks are able to offer more and more credit to the borrowers. Thus, we conclude that improvement in banking habits of the people lead to a higher availability of credit (from the commercial banks to the borrowers) by increasing cash reserves of the commercial banks which enhance their capacity to create credit.
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