Here we are providing Class 12 Economics Important Extra Questions and Answers Chapter 3 Money and Banking. Economics Class 12 Important Questions are the best resource for students which helps in class 12 board exams.
Class 12 Economics Chapter 3 Important Extra Questions Money and Banking
Money and Banking Important Extra Questions Very Short Answer Type
Question 1.
What is meant by money? (C.B.S.E2010) (CBSE Outside Delhi2011,201 f (Comp.))
Answer:
Money can be defined as a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value.
Question 2.
What is barter? (C.B.S.E 2013 (Comp))
Answer:
Barter is a system of exchange in which goods and services are directly traded for other goods and services without the mediation of money.
Question 3.
Define bank money.
Answer:
Bank money mainly means cheques and bank drafts.
Question 4.
Give two demerits of money.
Answer:
Demerits of money are:
(i) Increase in corruption
(ii) Inequality of income
Question 5.
Write secondary function of money.
Answer:
Secondary functions of money include:
(i) Store of value
(ii) Standard of deferred payments
Question 6.
What will be the effect of a rise in bank rate on money supply?
Answer:
A rise in bank rate will reduce the money supply.
Question 7.
Define money supply? (C.B.S.E 2018, C.B.S.E 2011)
Answer:
Money supply is the total stock of money of different types of money (currency in circulation and deposits) in an economy at any specific point of time.
Question 8.
What are the various money stock measures?
Answer:
M1 ,M2, M3 and M4 are the various money stock measures.
Question 9.
What are the constituents of money supply in narrow sense?
Or
State the components of money supply. (C.B.S.E 2010,2011 Comp), (C.B.S.E Outside Delhi 2013)
Answer:
The constituents of money supply in narrow sense are coins, currency notes and demand deposits.
Question 10.
What is a commercial bank?
Answer:
Commercial bank is a financial institution that accepts deposits from the public and advances loans to other people in order to earn profits.
Question 11.
What are the functions of commercial banks?
Answer:
The main functions of commercial banks are accepting deposits and advancing loans.
Question 12.
What are demand deposits? (C.B.S.E 2012,2013,2014)
Answer:
Demand deposits are those deposits in the banks, which can be withdrawn by drawing cheques on demand.
Question 13.
What are time deposits? (C.B.S.E Outside Delhi 2012,2014)
Answer:
Time deposits are those deposits of the public in banks which are deposited for a fixed period.
Question 14.
What is bank rate? (C.B.S.E 2009,2011 Comp.)
Answer:
Bank rate is that minimum rate at which the central bank discounts the first class bills and provides credit to the commercial banks.
Question 15.
Define ‘money multiplier’. (C.B.S.E Outside Delhi 2019)
Answer:
Money multiplier measures the amount of money that the banks are able to create in form of deposits with every initial deposit.
Question 16.
What is central bank?
Answer:
Central bank is the apex institution, which controls and regulates the quantity of money for the economic welfare of the public.
Question 17.
What is the main function of central bank?
Answer:
The main function of central bank is to design and control the monetary policy of its country.
Question 18.
What is meant by Statutory Liquidity Ratio? (C.B.S.E 2010,11)
Answer:
Statutory Liquidity Ratio (SLR) is the ratio of total demand and time deposits of commercial bank which it has to keep in the form of specified liquid assets.
Question 19.
What is meant by Cash Reserve Ratio? (C.B.S.E 2010, 11)
Answer:
Cash Reserve Ratio (CRR) is the ratio of bank deposits that the commercial banks must keep with the central bank as reserves.
Question 20.
What are the quantitative instruments of credit control?
Answer:
The quantitative instruments of credit control include:
(i) Bank Rate
(ii) Open Market Operations
(iii) Cash Reserve Ratio
Question 21.
What are the qualitative instruments of credit control?
Answer:
The qualitative instruments of credit control include:
(i) Marginal Requirements
(ii) Rationing of Credit
(iii) Moral Suasion
(iv) Direct Action
Money and Banking Important Extra Questions Short Answer Type
Question 1.
Briefly explain any two functions of money.
Answer:
Two functions of money are given below:
(i) Money as a Unit of value: Money acts as a convenient unit of account. The value of all goods or services can be expressed in monetary units. Money as a unit of value helps in measuring the value of exchange for various goods and services. For example, if the price of a pen is X 10 then a pen can be exchanged for ten monetary units. Therefore, money is a useful measuring rod of value provided the value of money or purchasing power remains constant.
(ii) Money as a Medium of Exchange: Money acts as an intermediary in the exchange transactions of goods and services. Money solves the problem of double coincidence of wants by acting as a medium of exchange for all goods and services. For example, if a vegetable grocer wants a cart but the cart manufacturer wants clothes, and not vegetables, then the grocer can use money to buy a cart.
Similarly, the cart manufacturer can then use the money to buy clothes. Thus, everyone’s wants can be satisfied as money acts as a medium of exchange. Money is also called a bearer of options or generalised purchasing power. This indicates the freedom of choice that the use of money offers. This function can only be performed properly if the value of money remains constant.
Question 2.
Give meaning of money. Explain the ‘store of value’ function of money. (C.B.S.E 2012,14,2017)
Answer:
Money can be defined as a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value.
Money as a Store of value: Money is not a perishable item and its storage costs are also considerably low. Moreover, it is acceptable to anyone at any point of time. Thus, money acts as a store of value for individuals.
Under barter system, wealth in the form of goods like wheat, rice, cattle etc. deteriorate with the passage of time or involve heavy storage cost. However, wealth can easily be stored in the form of money for future use.
Question 3.
What is ‘Barter’? Explain ‘standard of deferred payment’ function of money. (C.B.S.E. 2012, 14)
Answer:
Barter is a system of exchange in which goods and services are directly traded for other goods and I services without the mediation of money. Money as a Standard of Deferred Payment: Deferred payments refer to those payments, which are made at some specific time in future.
Money acts as standard in terms of which future or deferred payments are stated because money maintains a constant value over a period of time. Under barter system, goods could not be used for future contracts due to the risk associated with j type, quality and value of the goods. Money exchange has no such problem.
Question 4.
Explain the evolution of money.
Answer:
Money is a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value. Money has undergone a process of historical evolution spread over a long period of time. During this process of historical evolution, a variety of things had been used as money.
Commodities such as hides and skins of animals, domestic animals such as cattle, goats and agricultural products such as rice, wheat had been used as money in different stages of economic evolution. In more recent times, metallic coins and paper notes have been used as a medium of exchange.
Question 5.
Explain the significance of the unit of account function of money. (C.B.S.E Outside Delhi 2014)
Answer:
Money is to be a unit of value or a unit of account. The monetary unit is the unit in terms of which the value of all goods and services is measured and expressed. The value of each good or service is expressed as a price, which is the number of monetary units for which the good or service can be exchanged. If the price of a pen is ^ 10 then a pen can be had in exchange for ten monetary units. Therefore, money is a useful measuring rod of value only if the value of money itself remains constant.
Question 6.
Explain the problem of double coincidence of wants faced under barter system. How has money solved it? (C.B.S.E 2013)
Answer:
Double coincidence of wants requires that a person who is willing to exchange his or her goods j should find another person who is not only willing to buy the goods offered by the first person, but should also possess what the first person wants in exchange. Double coincidence of wants is hard to find. Money solves the problem of double, coincidence of wants by acting as a medium of exchange for all goods and services.
For example, if a vegetable grocer wants a cart but the cart manufacturer wants clothes, and not vegetables, then the grocer can use money to buy a cart. The cart manufacturer can then use the money to buy clothes. Thus, everyone’s wants can be satisfied as money acts as a medium of exchange.
Question 7.
Explain “difficulty in storing wealth” problem faced in the barter system of exchange. (C.B.S.E Outside Delhi 2017)
Answer:
The value of money cannot be stored in the form of goods. This problem can be cited by an example. Suppose an American dancer comes to India to earn money by exhibiting her dance performances. Indians offer her grain, hay, horses, elephants, etc., happily. She returns to America with these items on a large ship. On the way, the cattle consumes the grain and fodder.
The sea route being long and due to the onslaughts of unfavourable climatic conditions, the cattle becomes ill and dies. She had no money when she reaches America, i.e., if money is preserved in the form of goods, which are perishable in nature, one is left with none. Therefore, perishable goods cannot be stored for long.
Question 8.
Give meaning of money supply. State its components. (C.B.S.E 2014,2017)
Or
Explain the concept of money supply. (C.B.S.E 2013 Comp.)
Answer:
Money supply is a stock variable. It is the total stock of different types of money (currency in circulation and deposits) available in an economy, at a specific point of time. In India, M1 ,M2, M3, M4 are the four alternative measures of money supply. They are defined as follows:
M1 = CU + DD
M2 = M1 + Savings deposits with post office saving banks
M3 = M1 + Time deposits of commercial banks
M4 = M3 +Total deposits with post office savings organisations (excluding National Savings Certificates)
where, CU = Currency (notes and coins held by public)
DD = Net demand deposits held by the commercial banks
Question 9.
What is ideal supply of money?
Answer:
The ideal supply of money is that quantity in which the production capacity of the country can be fully utilised. In other words, that quantity of money which helps in achieving the full employment level and maximum output is called ideal supply of money.
Question 10.
State any two components of Ml measure of money supply. (C.8.S.E 2019)
Answer:
The two components of Ml measure of money supply:
(i) Currency: Currency is the main component of money supply. Currency consists of coins and
(ii) Demand Deposits: Demand deposits are also an important component of money supply, These are payable by the banks on demand from the account holder. For example: Current and Savings Account Deposits.
Question 11.
Explain the effect of an increase in bank rate on credit creation by commercial banks.
Answer:
The bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to the commercial banks.
Increase in the bank rate makes the borrowings from the central bank costlier than before. This reduces the lending or credit creation capacity of the commercial banks as they get funds at a higher interest rate from the central bank. Increase in bank rate also increases the rate at which commercial banks lend to the general public. Consequently, credit contracts in the economy.
Question 12.
Describe two main functions of commercial bank.
Answer:
The following are the main or primary functions of a commercial bank:
(i) Accepting Deposits: Commercial banks accept deposits from the public and lend this money I to companies and other people for investment projects. The banks offer interests on deposits j to the deposit holders. Deposits can be broadly into:
(a) Demand Deposits: These are, payable by the banks on demand from the account holder. For example: Current and Savings Account Deposits.
(b) Time Deposits: These deposits have a fixed period to maturity. For example: Fixed Deposits.
(ii) Advancing Loans: Extending loans is another important primary function of the commercial banks. After keeping a certain portion of the deposits as reserves, the bank gives the balance to the borrowers in the form of loans and advances.
The rate at which banks lend out their reserve to investors is called the lending rate. Lending by commercial banks consists mainly of cash credit demand and short-term loans to the private investors and banks. The credit worthiness of a person is judged by his current assets or the collateral a security pledged for the repayment of a loan).
Question 13.
Give four agency functions of commercial banks.
Answer:
The agency functions of a commercial bank are as follows:
(i) To transfer funds from one place to another.
(ii) To collect funds on behalf of the customers.
(iii) To purchase and sell shares and debentures on behalf of the customers.
(iv) To provide income-tax consultancy.
(v) To pay bills and insurance premium as per customer’s direction.
(vi) To provide facility of travellers’ cheque and letter of credit.
Question 14.
Explain the lending function of commercial banks.
Answer:
Extending loans is one of the two primary function of the commercial banks. After keeping a certain portion .of the deposits as reserves, the bank gives the balance to borrowers in the form of loans and advances. The different types of loans and advances made by banks are as follows:
(i) Cash Credit: Cash credit is given to the borrowers against their current assets. The required amount of money is sanctioned on a consolidated basis to save time and effort. The amount is transferred into the borrower’s account that he can use according to his or her needs. The bank charges interest only on the amount withdrawn from the account.
(ii) Demand Loans: Demand loans are secured loans as they are made against security. The loan can be repaid in instalments.
(iii) Term Loans: Terms loans are long term loans, the maturity period for which is usually more than 3 years. The entire loan amount is credited into the account of the borrower. The bank charges interest on the entire loan amount.
(iv) Overdrafts: The banks provide overdraft facility, which allows their customers to withdraw more than the available amount in their current accounts up to an agreed limit. The banks charges interest on overdrawn amount.
(v) Discounting of Bills of Exchange: The banks provide instant loans by discounting the bills of exchange written during trade transactions. The banks deduct commission or interest and pay the value of bill to the holder.
Question 15.
Define Credit Multiplier.What role does it play in determining the credit creation power of the banking system? Use a numerical illustration to explain. (C.B.S.E 2019)
Answer:
Credit multiplier measures the amount of money that the banks are able to create in form of deposits with every initial deposit. Through the process of money creation, the commercial banks are able to create credit which is in excess of initial deposits.
The credit creation by banks depends on credit multiplier as it is inversely related to legal resenve ratio. It is legally compulsory for the banks to keep a certain minimum fraction of their deposits as reserve. The fraction is called legal reserve ratio and it is fixed by the central bank. Higher the credit multiplier, higher will be the total credit created and vice-versa.
Example: Suppose the legal reserve is 0.1 and initial deposit is ₹ 1,000.
Credit Multiplier \(=\frac{1}{0.1}=10\)
Thus,
Total credit created = 10 x 1,000 = ₹ 10,000
Now suppose legal reserve is 0.5 and the initial deposit is ₹ 1,000.
Credit Multiplier \(=\frac{1}{0.5}=2\)
Thus,
Total credit created = 2 x 1,000 = ₹ 2,000
It can be seen that with the same initial deposit, total credit creation decreases with a fall in the value of credit multiplier.
Question 16.
Explain the credit creation role of commercial banks with the help of a numerical example. (C.B.S.E Outside Delhi 2013)
Answer:
Money creation (credit creation) by the commercial banks is determined by:
(i) the amount of the primary deposits; and
(ii) the Legal or Cash Reserve Ratio (CRR), which is the minimum fraction of the total deposits with the commercial banks, which they are required to keep with the central bank.
It is assumed that all the money that goes out of banks is re-deposited into the banks. Suppose the cash reserve ratio (CRR) is 20 percent. Further assume that Bank A receives a primary deposit of ₹ 10,000. Bank A will keep 20 percent of ₹ 10,000 ( ₹ 2,000) as reserve and will lend out the balance ₹ 8,000, to the borrowers. People who receive ₹ 8,000 from Bank A will either spend the amount on goods or pay to the creditors.
The money will eventually come back to the banking system, say in Bank B. After keeping a reserve of ₹ 1 1,600 (20 percent of? 8,000), Bank B will lend out the balance ₹ 6,400, to the borrowers. Those who receive ₹ 6,400 from Bank B will spend the amount. Thus again, the money will come back to the banking system, say in Bank C.
After keeping a reserve of ₹ 1,280 (20 percent of ₹ 6,400), Bank C will lend out the balance ₹ 5,120, to the borrowers. This process of deposit turning into loan or investment, which again becomes a new deposit, goes on until the primary deposit of? 10,000 is completely exhausted. The total of all the deposits resulting from primary deposit will be 5 times of ₹ 10,000.
Given the primary deposit and the CRR, the total money creation can be estimated as:
Total Money Creation = Primary Deposit x\(\frac{1}{C R R}\)
= ₹ 10,000 x \(\frac{1}{0.2}\)
= ₹ 50,000
Question 17.
How does a central bank control the availability of credit by open market operation?
Answer:
Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. RBI purchases government securities from commercial banks and general public in a bid to increase the stock of high powered money in the economy. Similarly, RBI sells government securities to commercial banks and general public in a bid to decrease the stock of high powered money in the economy.
Question 18.
Describe any one method of quantitative credit control.
Answer:
Bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to the commercial banks. Higher bank rate reduces the lending capacity of the commercial banks as they get funds at a higher interest rate from RBI.
Consequently, credit contracts in the economy as public borrows less at high rate of interest. Similarly, lower bank rate increases the lending capacity of the commercial banks as they get funds at a lower interest rate from RBI. Consequently, credit expands in the economy as public borrows more at low rate of interest.
Question 19.
Explain the role of the Reserve Bank of India as the “lender of last resort”. (C.B.S.E 2018, C.B.S.E Outside Delhi 2019)
Answer:
During crisis, if commercial banks fail to meet the obligations of their depositors, the central bank plays a crucial role. The central bank stands by the commercial banks as a guarantor and advances necessary credit to the commercial banks against securities to ensure the solvency of the latter. This saves the commercial banks from possible breakdown.
Question 20.
Explain ‘Banker’s Bank’ function of central bank. (C.B.S.E 2012,2017, C.B.S.E Outside Delhi 2014, C.B.S.E Outside Delhi 2015.2019)
Answer:
Central bank act as banker to all other banks in the country just as commerical banks act as banker to general bank public. It performs following function:
- Making polices and regulation for commercial banks
- Maintaining cash reserve as deposit by the commercial banks
- Providing financial assistance to commercial banks during crisis
Question 21.
Explain ‘Government’s bank’ function of central bank. (C.B.S.E Outside Delhi 2015, C.B.S.E 2015,2017)
Answer:
Generally, central bank provides those services to the government which a commercial bank provides to his customers.
(i) As a banker to the government it makes transaction on the behalf of the government and government keeps its cash balance on current account with the central bank It accepts receipts and makes payments forthe government and carries out exchange, remittance and other banking operations.
(ii) As an agent, the central bank undertakes buying and selling of securities on behalf of the government.
(iii) As a financial advisor to the government, the central bank advises the government on important issues of economic policy such as deficit financing, devaluation of currency, trade policy and foreign exchange policy etc. and also guides the government from time to time.
Question 22.
Distinguish between a commercial bank and a central bank.
Answer:
Following are the points of distinction between the commercial banks and the central bank
| S.No. | Commercial Bank | Central Bank |
| 1. | The commercial bank is a constituent unit of the banking system. | The central bank is the apex monetary institution. |
| 2. | The primary objective of the commercial bank is to make profit. |
The central bank’s primary objective is to maintain economic stability through monetary measures. |
| 3. | The commercial bank deals directly with the public. | The central bank does not deal directly with the general public. |
| 4. | The commercial bank does not have any note-issue authority. |
The central bank has the monopoly right of note-issue. |
| 5. | The commercial bank deals in foreign ex-change. |
The central bank is the custodian of foreign exchange reserves of the country. |
| 6. | The commercial bank act as a banker to the general public. | The central bank acts as a banker to the government. |
Question 23.
Explain central bank’s function as currency authority. (C.B.S.E 2010)
Answer:
The central bank is the sole authority for the issue of currency in the country. All the currency issued by the central bank is its monetary liability. This means that the central bank is obliged to back the currency with assets of equal value. These assets usually consist of gold coin, gold bullion, foreign securities and the domestic government local currency securities. The country’s central government is authorized to borrow money from the central bank.
Question 24.
Explain how do ‘open market operations’ money creation by commercial banks. (C.B.S.E 2010,2011 Comp.)
Answer:
Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. RBI purchases government securities from commercial banks and general public in a bid to increase the stock of high powered money in the economy. Similarly, RBI sells government securities to commercial banks and general public in a bid to decrease the stock of high powered money in the economy.
Question 25.
Explain the components of Legal Reserve Ratio. (C.B.S.E 2012)
Answer:
Following are the components of Legal Reserve Ratio:
(i) Cash Reserve Ratio: Cash reserve ratio (CRR) is the minimum fraction of the total deposits with the commercial banks, which they are required to keep with the central bank.
(ii) Statutory Liquidity Ratio: Statutory Liquidity Ratio (SLR) is the minimum fraction of the total deposits with the commercial bank, which they are required to maintain in the form of specified liquid assets.
If CRR or SLR is high, banks are required to keep more part of their deposits in the form of reserves or securities and will have fewer funds to lend. This will contract credit. Similarly, if CRR or SLR is low, banks are required to keep less part of their deposits in the form of reserves or securities and will have more funds to lend. This will expand credit.
Question 26.
Explain the‘bank of issue’function of the central bank. (C.B.S.E 2015, Outside Delhi 2015)
Answer:
The central bank of a country is the sole note issue authority. In India, RBI as the central bank issues the notes of all denominations of the country except One Rupee note which is issued by the Ministry of Finance, Government of India. According to De Kock, the main reasons for granting power of issuing notes to central bank are:
- To maintain similarity in notes circulation and better regulation of currency
- To grant distinctive prestige to currency notes
- To avoid unnecessary credit creation by the commercial banks
- To make government inspection on issuing notes effective
Question 27.
Explain the role of reverse repo rate in controlling money supply. (C.B.S.E 2017)
Answer:
Reverse repo rate is the rate at which the RBI or Central Bank borrows from other commercial banks. It plays an effective role in controlling the money supply. For example, an increase in the reverse repo rate implies that the bank will get a higher rate of interest from the RBI on their lendings.
As a result, the banks will lend more to the RBI and less to the public thus, resulting in a decrease in the money supply. Similarly, in case the RBI decreases the reverse repo rate, the banks will get a lower rate of interest on their borrowings. As a result, they will lend more to public, which will in turn increase the money supply.
Question 28.
Distinguish between ‘Qualitative and Quantitative tools’ of credit control as may be used by a Central Bank. (C.B.S.E Outside Delhi 2019)
Answer:
Two types of methods are adopted by the central bank to control credit. These are quantitative methods and qualitative methods.
(a) Quantitative methods aim at controlling the cost and volume of credit created by commercial banks by using instruments like bank rate, open market operation and legal reserve ratios.
(b) Qualitative methods regulate the direction of flow of credit among various users rather than influencing just the availability of credit. Example: margin requirement, credit rationing, direct action and moral suasion.
Money and Banking Important Extra Questions Long Answer Type
Question 1.
Define money. Explain its main functions.
Answer:
Money can be defined as a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value.
The following are the important functions of money:
(i) Medium of Exchange: Money acts as an intermediary in the exchange transactions of goods and services. Money solves the problem of double coincidence of wants by acting as a medium of exchange for all goods and services.
(ii) Unit of Value: Money acts as a convenient unit of account. The value of all the goods and services can be expressed in monetary units. Money as a unit of value helps in measuring the value of exchange for various goods and services.
(iii) Store of value: Money is not a perishable item and its storage costs are also considerably low. Moreover, it is acceptable to anyone at any point of time, Thus, money acts as a store of value for individuals.
(iv) Standard of Deferred Payments: Money acts as standard in terms of which future or deferred payments are stated because money maintains a constant value over a period of time.
Question 2.
What is meant by the supply of money? Discuss the factors which determine the supply of money.
Answer:
Money supply refers to the amount of money, which is in circulation in an economy at any given point of time.
Following factors determine the money supply:
- Monetary Standard: Money supply is affected by the monetary standard. If gold standard is adopted, there will be less supply of money. On the other hand, if paper currency system is adopted, money supply can be increased on the basis of demand.
- Production Volume: Volume of production also determines the money supply. If the level of production is high, the money supply will be more.
- Monetary Policy: Monetary policy of the government also affects the money supply. If the Central Bank increases the Cash Reserve Ratio there will be contraction in money supply.
- Fiscal Policy: Fiscal policy of the government determines the money supply. If government prepares deficit budget, money supply will increase.
- Other Factors: Banking habits, velocity of money, liquidity preference and the volume of money multiplier also determine the supply of money.
Question 3.
What are the various money stock measures?
Answer:
The various money stock measures are M1, M2, M3, and M4.
These are defined as follows:
M1= C + DD + OD
C is currency held by the public. It consists of paper currency as well as coins. DD is the demand deposits in banks. Only the net demand deposits of banks are included in money supply because the part of demand deposits that represents inter-bank deposits held by one bank with another does not constitute demand deposits held by the public.OD is other deposits with the RBI.
OD includes demand deposits of Public Financial Institutions (like IDBI etc.), Foreign Central Banks and Government, the IMF, the World Bank, etc.
M2 = M1 + savings deposits with post office savings bank M3 = M1+ net time deposits of banks.
M4 = M3 + total deposits with post office savings organisation (excluding National Savings certificates)
Question 4.
Explain the main functions of central bank.
Answer:
The main functions of Central bank are as follows:
(i) Bank of Note Issue: In the modem time, issuing of notes is the main function of the central bank of every country in the world. Central bank has the monopoly in this regard. In India, RBI issues notes as a central bank of the country except one rupee note, which his issued by the ministry of finance, government of India.
(ii) Banker, Agent and Advisor to the Government: The central bank acts as a banker, agent and advisor to the government
(iii) Banker’s Bank: Central bank acts as a banker to all other banks in the country just as commercial banks act as a banker to general public.
(iv) Lender of the Last Resort: During crisis, central bank acts as a lender of the last resort. The central bank stands by the commercial banks as a guarantor and extends loans to ensure the solvency of the latter. This saves the commercial banks from possible breakdown.
(v) Custodian of the Foreign Exchange Reserve: The central bank acts as a custodian of the foreign exchange reserves of the country.
(vi) Custodian of Cash Reserve of the Commercial Banks: The central bank also keeps the cash reserves of the commercial banks.
(vii) Bank of Central Clearance, Settlement and Transfer: Central bank is an institution where all the transactions of commercial banks are cleared, settled, and transferred very easily.
(viii) Control of Credit: The central bank has got so many instruments to control credit like bank rate, open market operation, cash reserve ratio, credit rationing, moral suasion and direct actions.
Question 5.
Explain any two methods of credit control used by Central Bank. (C.B.S.E Outside Delhi 2013,2019)
Answer:
Methods of credit control used by central bank are as follows:
(i) Bank Rate: Bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to’the commercial banks. The central bank increases the bank rate to correct the situation of inflationary gap or excess demand in the economy, Higher bank rate reduces the lending capacity of the commercial banks as they get funds at a higher interest rate from the central bank.
Consequently, money supply contracts in the economy as the public borrows less at high rate of interest. Similarly, the central bank decreases the bank rate to correct the situation of deflationary gap or deficient demand in the economy, Lower bank rate increases the lending capacity of the commercial banks as they get funds at a lower interest rate from the central bank Consequently, money supply expands in the economy as public borrows more at low rate of interest.
(ii) Open Market Operations: Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. The central bank sells government securities to commercial -banks and general public in a bid to correct the situation of inflationary gap or excess demand.
This decreases the stock of high powered money in the economy. Similarly, the central bank- purchases government securities from commercial banks and general public in a bid to correct the situation of deflationary gap or deficient demand. This increased the stock of high powered money in the ecbnoitiy.
Question 4.
Explain the main functions of central bank.
Answer:
The main functions of Central bank are as follows:
(i) Bank of Note Issue: In the modem time, issuing of notes is the main function of the central bank of every country in the world. Central bank has the monopoly in this regard. In India, RBI issues notes as a central bank of the country except one rupee note, which his issued by the ministry of finance, government of India.
(ii) Banker, Agent and Advisor to the Government: The central bank acts as a banker, agent and advisor to the government
(iii) Banker’s Bank: Central bank acts as a banker to all other banks in the country just as commercial banks act as a banker to general public.
(iv) Lender of the Last Resort: During crisis, central bank acts as a lender of the last resort. The central bank stands by the commercial banks as a guarantor and extends loans to ensure the solvency of the latter. This saves the commercial banks from possible breakdown.
(v) Custodian of the Foreign Exchange Reserve: The central bank acts as a custodian of the foreign exchange reserves of the country.
(vi) Custodian of Cash Reserve of the Commercial Banks: The central bank also keeps the cash reserves of the commercial banks.
(vii) Bank of Central Clearance, Settlement and Transfer: Central bank is an institution where all the transactions of commercial banks are cleared, settled, and transferred very easily.
(viii) Control of Credit: The central bank has got so many instruments to control credit like bank rate, open market operation, cash reserve ratio, credit rationing, moral suasion and direct actions.
Question 5.
Explain any two methods of credit control used by Central Bank. (C.B.S.E Outside Delhi 2013,2019)
Answer:
Methods of credit control used by central bank are as follows:
(i) Bank Rate: Bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to the commercial banks.
The central bank increases the bank rate to correct the situation of inflationary gap or excess demand in the economy, Higher bank rate reduces the lending capacity of the commercial banks as they get funds at a higher interest rate from the central bank.
Consequently, money supply contracts in the economy as the public borrows less at high rate of interest. Similarly, the central bank decreases the bank rate to correct the situation of deflationary gap or deficient demand in the economy, Lower bank rate increases the lending capacity of the commercial banks as they get funds at a lower interest rate from the central bank Consequently, money supply expands in the economy as public borrows more at low rate of interest.
(ii) Open Market Operations: Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. The central bank sells government securities to commercial -banks and general public in a bid to correct the situation of inflationary gap or excess demand.
This decreases the stock of high powered money in the economy. Similarly, the central bank- purchases government securities from commercial banks and general public in a bid to correct the situation of deflationary gap or deficient demand. This increased the stock of high powered money in the economy.
Money and Banking Important Extra Questions HOTS
Question 1.
How does money solve the problem of double coincidence of wants? Explain with an example.
Answer:
Money acts as an intermediary in the exchange transactions of goods and services. Money solves services. For example, if a vegetable grocer wants a cart but the cart manufacturer wants clothes, and not vegetables, then the grocer can use money to buy a cart. Similarly, the cart manufacturer can then use the money to buy clothes. Thus, everyone’s wants can be satisfied as money acts as a medium of exchange.
Money is also called a bearer of options or generalised purchasing power. This indicates the freedom of choice that the use of money offers. This function can only be performed properly if the value of money remains constant.
Question 2.
What is the significance of centralised cash reserves with central bank?
Answer:
The significance of centralised cash reserves with central bank are:
(i) Banks get financial accommodation when required.
(ii) Central bank gets an opportunity to exercise control over the entire banking system of the country.