NCERT Questions for Class 12 Economics Chapter 3 – Money and Banking

Important Questions with Solutions of Class 12 Economics Chapter 3 – Money and Banking

1) Evaluate the money multiplier & the total deposits produced if the initial deposit is ₹500 crores & the legal reserve ratio is 10%.

Ans – Calculate the Value of the Money Multiplier:

The money multiplier is derived by the following formula:

Money Multiplier = 1 / LRR

Given that the legal reserve ratio is 10% or 0.10:

Money Multiplier = 1 / 0.10 = 10

Calculate the Total Deposits Created:

The total deposits that can be created can be found by multiplying the initial deposit by the money multiplier.

Total Deposits = Initial Deposit × Money Multiplier

Since the initial deposit is Rs. 500 crores:

Total Deposits = 500 crores × 10 = 5000 crores Therefore, the total deposit created by an initial deposit of Rs. 500 crores with an LRR of 10% will be Rs. 5000 crores.

2) What does “high-powered money” refer to?

Ans – High-powered money is also called the monetary base. It’s that money created by the central bank, says the RBI. Being held by the public and the banks, it comprises the following:

Currency with the Public: This comprises paper money & coins in real cash form which circulates in the hands of the people and companies.

Reserves with the Central Bank: The name suggests that these are the deposits that commercial banks and the government make in the central bank.

High-powered money can be expressed through the following formula:

H=C+R

Where:

H = High-Powered Money

C = Cash for the public (including paper money and coins)

R = Reserves held by banks and the government with the central bank High-powered money lies at the root of the money multiplication process since it is what commercial banks are supposed to leverage in their lending, thereby creating even more money. It is mostly controlled and issued by the central bank.

3) Why do banks keep a fraction of deposits as cash reserves?

Ans – Fractional reserve banking refers to a system where a fraction of the deposits are kept in banks as cash. It means that, out of money deposited in the bank, it will on-lend all except a little saved to meet the demand for withdrawal on a day-to-day basis. Here is the reason for keeping a fraction:

• Patterns of Withdrawals: Not all depositors take away their deposits simultaneously. There is a history and experience where most deposits remain in the bank, and only a small percentage of these are withdrawn at any given time.
• Continuing Deposits: Depositors make fresh deposits at all times leading to a continuous inflow of fresh liquidity available at any given time for withdrawals and the disbursement of loans.

This allows banks to earn interest on the entire sum of deposits, while only keeping a small sum of it as reserves in hands, but remaining adequately liquid to cover day-to-day transactions and withdrawals.

4) Explain the Central Bank’s role in controlling the supply of money & credit.

Answer: The central bank has been playing its part in managing the money supply and credit control through various monetary policy tools. Here’s how it influences the economy:

Bank Rate Adjustment: The central bank can always fall back upon the bank rate to control lending or expansion of credit. A rise in the bank rate raises the level of interest in the market & increases the cost of borrowing. This would deter people from borrowing, and hence the banks reduce the level of lending by reducing the rate of growth in credit expansion.

Correspondingly, any reduction in the rate leads to reduced interest rates and hence a cheapening of the cost of borrowing, encouraging borrowing & stimulation of commercial & industrial activities that result in increased bank credit.

Open Market Operations: This is an open market operation, whereby a central bank buys or sells government securities to regulate the money supply within an economy. For example, the purchase of the securities injects money into the economy, while their sale soaks up the money, hence controlling liquidity.

Reserve Requirements: Adjusting the reserve requirements that commercial banks must hold, the Central Bank is said to decrease the portion of money that a bank can lend out and increase how much a bank must hold in reserve. Reducing reserve requirements allows more money to be lent out by banks, which increases the amount of credit & increases requirements that restrict lending.

Discount Rate: Discount rate refers to the interest rate charged to commercial banks while borrowing from the Central Bank set by the Central Bank. A high discount rate discourages borrowing, thus reducing the money supply, while a low discount rate encourages borrowing increasing the money supply.

Using such instruments, the Central Bank works towards managing the aggregative money supply, controlling inflation, and supporting economic stability.

5) Write a short note on the desired operations of the Central Bank of India:

1. Bank of Issue

Ans – The “Bank of Issue” is the function of the Central Bank of India as indicated at the very outset, the Reserve Bank of India (RBI). It refers to:

Currency Issuance: RBI is the sole authority approving banknotes & coins in India. With this authority, RBI can control money in our economy. This ensures that currency is supplied to the public in desired denominations.

Implementation of Monetary Policy: The RBI can regulate interest rates and inflation with this control on the money supply, thereby having an overall oversight in the economic policy.

It designs and regulates the various banknotes. The design of banknotes is updated by the RBI to include new security features & prevent counterfeiting. The RBI has introduced the Mahatma Gandhi Series banknotes since 1996 in the denominations of Rs. 5, Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 200, and Rs. 500.

2. Banker’s Bank

Ans – Being called the “Banker’s Bank,” the Reserve Bank of India assumes several important functions, which include:

Bank-to-Bank Services: RBI disburses necessary services to commercial banks, interbank transactions, and short-term loans. Commercial banks maintain current accounts with the RBI from which they can draw funds whenever required.

Currency Distribution: The RBI distributes banknotes and coins to commercial banks, which provide them to the public through several channels, such as over-the-counter transactions or automated teller machines (ATMs).

Commercial Banks Regulations: The regulations of commercial banks are in the control of RBI through various provisions like the Cash Reserve Ratio, bank rates, open market operations, etc. which maintain stability in the financial system and control the creation of credit by commercial banks. In sum, the role of the RBI the Banker’s Bank implies supervision and facilitation of the activities of commercial banks, meanwhile under its control over national money supply and credit conditions.

6) Mention the end-to-end functions of money.

Ans – Money has many vital economic functions & facilitates its role in economic activity. The most important among these functions of money are:

Medium of Exchange:

Money allows the purchasing of goods and services without the need for a barter system. It is used as a universally acceptable medium through which payments are made. Using money facilitates the transference of goods and services with minimal direct exchange of commodities.

Example: You go to buy groceries. However, in return, you do not barter with other products using money.

Unit of Account:

Money provides a common metric for measuring and estimating value. It provides a general unit in which prices can be measured and through which financial accounts can be kept. By measuring value in money terms, record-keeping of finances becomes less effective.

Example: When products are sold in a shop, they bear a tag of some currency as the price. That gives a ground upon which the cost of other commodities can be measured and evaluated easily.

Standard of Deferred Payments:

Money is used to set the terms for future payments, making it possible to conduct transactions that are settled later on. This function is crucial during loan and credit transactions payment occurs over time.

Example: Suppose you borrow money; what you have to pay back is expressed in money, at a later time.

Store of Value:

Money can be saved for the future and used afterward without losing its value. It possesses the advantage of hoarding wealth and planning the expenditure of plans. Since money retains its value, it provides an efficient medium for saving and making investments.

Example: Money can be saved in a bank account or under the mattress, where it can be used afterward for any future needs or making purchases.

Liquidity of Money:

Money exhibits high liquidity, given that it can effortlessly and quickly be used while exchanging other forms of value or losing its value. One of the most fundamental characteristics of this specific function of money is its liquidity. The liquidity of money is a prime characteristic of its function is crucial to make sure that money can be readily used in transactions & financial planning. Example: Cash is highly liquid because it can be used immediately for purchases or placed in bank accounts for future use.

7) Mention the main functions of commercial banks.

Ans – The functions of the banks in the financial system are quite vital as they provide many services to individuals & companies. Commercial banks are for-profit banks that play a crucial role in economic activity through several functions. The functions of commercial banks can be divided into two sections: Primary & secondary bank functions.

a. Primary Bank Functions

1. Accepting Deposits: Commercial banks undoubtedly have the core function of accepting deposits from the public. There are majorly two types of deposits they offer for their customers:

Demand Deposits: These funds one can withdraw at any time without giving advance notice; for example, checking accounts.

Time Deposits: Such deposits are held for a specific period and normally attract higher interest rates; for example, fixed deposits.

Purpose: Deposits contribute money to the bank to carry out its major operations and act as a lender.

2. Advancing Loans: Commercial banks use the deposited money to advance loans to various individuals and businesses. Examples of advancing loans are:

Overdrafts: The bank allows customers to withdraw over the balance lying in their account.

Cash Credit: The banks advance short-term loans to the business people for carrying on business operations.

Discounting Bills of Exchange: A bill of exchange is purchased at an amount less than face value so that the party immediately gets the cash required by selling the bill of exchange to the bank.

Objective: Loans boost economic activity since they can finance personal requirements and the working of businesses.

b. Secondary Functions:

1. Agency Functions: Commercial banks carry out several agency services considering customers, which include the following:

Collection of Checks: Collect cheques and bills.

Income Collection: Receiving and collecting the income employees on the account of its customers

Expense Payments: Banks make payments of different bills and other expenses either as per standing instructions or specific orders or requests of the customer.

2. General Utility Functions: In addition to these, banks provide some more services of ancillary to give more comfort and management of finance:

Provisions of Locker Facilities: Safe deposit vaults to keep valuable items.

Trader of Traveller’s Checks: It issues prepaid checks for traveling to any part of the world.

Foreign Exchange Dealer: It provides services to exchange currency for traveling to foreign countries.

Money Transfer: The bank provides the facility of money transfer through drafts or other means from one place to another within and outside the country.

3. Other Facilities: Commercial banks provide new services that can be included in the category of modern banking concerning the changing needs of the customers:

Electronic Banking: It includes ATMs, credit cards, internet banking, and mobile banking.Lending and Deposits Management: The provision of different kinds of loans and the management of demand deposits.