CBSE SYLLABUS

• Money is what money does.

• Anything which is commonly accepted by the
people as a medium of exchange is called as
money
• Anything which is used as
• a medium of exchange
• store of value
• measure of value and
• standard of deferred payments is called money.
BARTER SYSTEM
 Meaning & Inconvenience of Barter
system
• Direct exchange of goods against goods without use of money
is called Barter system.
• Transactions are made by exchange of goods
without the medium of money
• Exchange is bilateral
• Such an economy is called as CC economy- commodity for
commodity exchange
 Major inconveniences or drawbacks
of Barter System
• LACK OF DOUBLE COINCIDENCE OF WANTS:
Simultaneous fulfillment of mutual wants of buyers &
sellers.A has to have what B wants & vice versa
Ex: producer of jute may want shoes in exchange but the
shoe-maker might or might not be willing to sell his pair of
shoes in exchange for jute
In this context we have two trading costs and they are:
(i)Search costs(searching for suitable person)
(ii) disutility of waiting (time pd).
This gave way to the evolution of money.
LACK OF COMMON MEASURE OF VALUE
• No common measure that is the unit.The question is in what
proportion the two goods are to be exchanged.
• Each article has a different value & so exchange ratio becomes
difficult. For ex how much metres of cloth is to be exchanged
for a bag of rice.
• Absence of common denominator to express exchange ratios
becomes difficult.
• Money removes these difficulties and acts as a convenient
unit of value as money quotes different prices for different
articles.
LACK OF STANDARD OF DEFERRED PAYMENT

• Problem of borrowing & lending

• Not possible to engage in contracts which involve
future payments as there is no unit of value.
• There could be disagreement about the quality of
the good,specific type of good & change in the value
of good
 LACK OF STORE OF VALUE
• It is difficult to store wealth for future use.
• Most of the goods do not possess durability like
wheat ,rice ,vegetables etc.Their quality deteriorates
with passage of time .
• Holding of stocks involves costly storage,time &
effort.
• LACK OF DIVISIBILITY
• How to exchange goods of unequal value?
• Ex : buffalo & half metre of cloth.
 MONEY- Definition & Meaning
• Money is anything which is generally accepted as a medium of
exchange,measure of value,store of value & means for
standard of deffered payment.

• Anything which is generally accepted by the people in

exchange of goods & services or in repayment of debts

• The term money is used to measure things like coins,currency

notes,cheques,e-money,cards etc which are used to conduct
business transactions & settlement of business claims
 FUNCTIONS OF MONEY
FUNCTIONS OF MONEY

PRIMARY FUNCTION SECONDARY FUNCTION

MEDIUM OF MEASURE OF STD.OF DEFERRED

STORE OF VALUE
EXCHANGE VALUE PAYMENT

“ Money is a matter of functions four

A medium,a measure,a standard,a store. “
 1.MEDIUM OF EXCHANGE
• Basic primary function of money.
• Overcomes the difficulty of double coincidence of wants
• It has separated the act of purchase & sale-can be done
independently of one another
• Money has no utility ..is used only as an intermediary
• Money has no power to satisfy human wants but
provides purchasing power
• Money is also called as bearer of options as it provides
freedom of choice to buy what he or she wants
2. MEASURE OF VALUE (UNIT OF ACCOUNT)

• Money is treated as a standard unit for quoting prices,lending

or borrowing.
• Money serves as a common unit of account or a measure of
value.
• Different goods are measured differently like clothes in
metres,milk in litres,sugar in kilograms,distance as kilometres
• Thus money is used as a common measure for quoting prices
& hence removed the problem of barter system.
 SECONDARY FUNCTIONS
• 3.MONEY AS A STANDARD OF DEFERRED
PAYMENT:
• Deferred payments are payments which are contracted to be
made in future.
• Everyday millions of transactions take place in which
payments are not made immediately.
• Money as a standard of deferred payments has simplified the
borrowing & lending operations because money generally
maintains a constant value through time.
• It has led to the creation of financial institutions
• Money is the link which connects the value of today with
those of the future.
 4.MONEY AS A STORE OF VALUE
• Keynes places great emphasis on this function of
money.Money as a store of value means money can be stored
as an asset for use in future.
• People normally wish to keep a part of their wealth in the
form of money because savings in terms of goods is very
difficult. This desire is known as liquidity preference. Another
function Liquidity of money is added these days.Money is
perfectly liquid.Liquiditity means convertibility into
cash.Clearly,money is the best form of store of
value.Possession of money enables one to get hold of almost
any commodity.
 Advantages of store of value
Money as a store of value has the following advantages:
 Money is available in fractional denominations which solves
the Barter system problem of lack of divisibility.
 Money is easily portable
 It is easy & economical to store money as its storage does not
require much space.
 Money has the merit of general acceptability
 Saving in terms of money is more secured than in terms of
goods.
 ADVANTAGES OF MONEY
Money has overcome the drawbacks of Barter system:
1 i.Money as medium of exchange has overcome the problem
of double coincidence of wants & has separated the act of
purchase & sale.
ii.Money as a measure of value solves the problem of absence
of common measure.The value of each good or service is
expressed as price & money serves as a yardstick to measure
the exchange value.
iii.Money as a store of value solves the problem of storing
wealth.
iv.Money as a standard of deferred payment helps to make
contracts which help future payments.
 Continuation…..
2.It facilitates exchange of goods & services
3.Money helps to maximise consumers satisfaction& producers
profit.It helps in savings
4.Money promotes specialisation which increases productivity &
efficiency
5.Optimum distribution of National income among factors of
production
6.Money helps in reviving the economy from depression
7.Enables the govt.to realise taxes,fines,fees & other sources of
public revenue.
8. Money has proved as a valuable social instrument of promoting
economic welfare.
Thus in the words of Alfred Marshall:
“Money is the centre around which economic science clusters.”
 DEMAND FOR MONEY
(Extract from NCERT)
• Money is the most liquid of all assets in the sense that it is universally
acceptable & hence can be exchanged for other commodities very
easily.On the other hand it has an opportunity cost.If instead of holding
on to a certain cash balance,you put the money in savings account in some
bank you can earn interest on that money.

• While deciding on how much money to hold at a certain point of time one
has to consider the trade off between the advantage of liquidity and the
disadvantage of foregone interest.Demand for money balance is thus
referred to as liquidity preference.People desire to hold money balance
broadly due to two motives and they are:
(i) Transaction motive and (ii) speculative motive and you also have the
third one called the (iii) precautionary motive
 TRANSACTION MOTIVE
• It refers to the demand for money for conducting day-to day transactions.
Motive can be looked from the perspective of consumers who want
income to meet their household expenditure(income motive) & from the
businessmen point of view(business motive),he requires money to carry
on his business activities.
• The income which a person gets is not continuous whereas expenditure is
continuous.So to bridge the gap between expenditure & income we need
cash.
• According to Keynes,Transaction demand for money is positively
associated with the level of income.
• Higher the level of income larger would be the size of money holdings for
transactions.
Definition:The transaction motive relates to demand for money to meet
the current transactions of individuals & business units.
(what ,why.who)
 PRECAUTIONARY MOTIVE
• It refers to the desire of the people to hold cash balances for
unforeseen contingencies.
Unforeseen contingencies like
sickness
accidents
Higher the level of income more will be the cash balances for
contingencies
 SPECULATIVE MOTIVE
• It refers to the desire of the holder to keep cash balance as an
alternative to financial assets like bonds.

wealth
cash bonds

EXPECTATIONS
CHANGES

Rate of Interest Value of assets

The interest rate

(high) varies inversely
Market value of securities(bonds)
(demand for money becomes less)
 What Is a Liquidity Trap?
• A liquidity trap is a contradictory economic situation in which interest
rates are very low and savings rates are high, rendering monetary
policy ineffective.

• First described by economist John Maynard Keynes, during a liquidity

trap, consumers choose to avoid bonds and keep their funds in cash
savings because of the prevailing belief that interest rates could soon rise
(which would push bond prices down).

• Because bonds have an inverse relationship to interest rates, many

consumers do not want to hold an asset with a price that is expected to
decline. At the same time, central bank efforts to spur economic activity
are hampered as they are unable to lower interest rates further to
incentivize investors and consumers.
 LIQUIDITY TRAP
A situation of
very low rate
of interest
where people
expect the
interest rate to
rise in future &
consequently
bond prices to
fall

People withhold as inactive balance of any amount of money they have & nothing is
invested.When rate of interest declines to 3%,speculative demand for money becomes
infinite.(perfectly elastic)making the demand curve a horizontal straight line parallel to
X axis beyond a point .Economist call it a situation of Liquidity trap because expansion in
money supply gets trapped in the sphere .
 Add on…
• A liquidity trap is a situation, described in Keynesian
economics, in which, "after the rate of interest has fallen to a
certain level, liquidity preference may become virtually
absolute in the sense that almost everyone prefers holding
cash rather than holding a debt which yields so low a rate of
interest." Wikipedia
 MONEY SUPPLY
• Money supply refers to the total amount of money which is in
circulation in an economy at a given point of time.

• The supply of money in simple terms refers to total stock of money

held by the public.
• Supply in ‘Money supply’ denotes stock.so it is a stock variable &
not a flow variable.
• Money supply of a country is the stock of money on a specific day.

• There are four measures called as M1,M2,M3,M4.

• M1 & M2 are called as the narrow definition of money supply
• M3 & M4 are called as the broad definition of money supply
• M1,M2,M3,M4 are in descending order of liquidity.M1 has the
highest liquidity & M4 has the least.
 COMPONENTS OF MONEY SUPPLY
• M1 = Currency + Net Demand Deposits with
banks + Other Deposits with RBI.

• M2 = M1 + Post Office Savings Deposits

• M3 = M1 + Net Time Deposits with Commercial

banks

• M4 = M3 + Post Office Savings Deposits

 MEASURES OF MONEY SUPPLY
• The basic measure of money supply includes those assets
which can be directly used for transactions.It is also called as
transaction money.
• It consists of (i) currency and (ii) demand deposits
• Money supply consists of currency notes & coins held by
public outside the banks.The RBI is the only institution which
can issue currency in India.However coins are issued by the
Government of India.
CURRENCY

COMMERCIAL
PUBLIC BANKS
 CURRENCY
• CURRENCY –Issued by RBI
• Is also called as
i. High powered money
ii. Reserve money
iii. Monetary base which helps in credit creation
iv. Currency notes & coins are also called as Legal tender money as
they cannot be refused by any citizen for the settlement of any
transaction.
v.They are also called as Fiat money because every currency note bears
on its face a promise from the Governor of RBI that it is is
responsible for giving the person the purchasing power equal to
the value printed on the note. Fiat money is not backed by any
gold/silver ,it is just paper money & coins.Transaction money &
paper money are other names.
 CURRENCY WITH PUBLIC
• Currency includes coins & currency notes and is called as high
powered money.
• In India we have coins ranging from one paise to ten
rupees.We have currency ranging from one rupee to two
thousand rupees.These notes are also called as paper money.
• Currency is also called as Fiat money which under law must
be accepted for all debts.
• Money supply includes only currency held with public i.e
currency held by the banks is not included. This is one of the
component
 NET DEMAND DEPOSITS
• It refers to demand deposits of the people with commercial banks.These
are chequable deposits which can be withdrawn or transferred on
demand.They can be withdrawn on demand,anytime by the account
holder …that is why it is called as demand deposits.
• Writing a cheque enables the depositor to make payt or get cash.In
technical lang.of banking,it is called dd deposits because such deposits are
payable on dd.your dd deposit acc balance is virtually hard cash in your
pocket.so,it is treated as equal to currency held.
• So money supply is the total amount of coins and currency held by the
public & total amount of dd deposits at a particular point of time.
• NOTE: Distinction may be drawn between gross dd deposits & Net dd
deposits with the commercial banks.Net demand deposits do not include
Inter-banking claims of one bank against the other.
• Only Net dd deposits are taken as a part of money supply.
 OTHER DEPOSITS
These are other deposits which include:
(i) dd deposits with RBI of public financial institutions like
NABARD(National bank for agri.& rural devt)
(ii)dd deposits with RBI of foreign central banks & of the foreign
govts.
(iii) dd deposits of International financial institutions like IMF &
World bank.
OD does not include:
Deposits of the Govt.of the country with RBI
Deposits of the country’s banking system with RBI
 BANKING
• Bank is a financial institution whose demand deposits are widely
accepted as money for making payments,& which has power to create
money.
• Banking system is a two-tier system :a central bank and many commercial
banks.
• There are many organizations which are engaged in borrowing & lending
like insurance companies,mutual funds like UTI,ICICI Prudential,Tata
mutual fund etc…so what then is the difference?
• (i) Bank deposits are chequable:
• Bank deposits are chequable which means you can draw by just writing a
cheque without giving any prior notice to the bank.Other financial
institutions do not allow this.This makes deposits in banks as good as cash
in the pocket of depositors.
• BANKS CREATE MONEY:
• Secondly banks create money while other financial institutions do not.
Banks dd deposits are a part of money ss & they are called as bank money.
 COMMERCIAL BANK
• A Commercial bank is a financial institution which performs
the functions of accepting deposits from the public and
advancing loans. The bank acts as an intermediary between
those who have surplus money and those who are in need of
money.
 Types of deposits held by the
Commercial Banks
(a)Current account deposits: Such accounts are generally maintained by a business
man.The depositor can withdraw his money at any timewithot any restriction.
Cheque facility is provided to the depositor. The Bank does not pay any
interest,instead imposes service charges.

b) Saving Account deposits: This combines features of both current account & fixed
account.The depositor can withdraw his money at any time. However, the bank
may impose some restrictions on withdrawal. Interest rate is low when compared
to time deposits. The purpose of this deposit is to encourage small savings.

c) Fixed or Time Deposits: Money is deposited for a fixed period of time. The depositor
can withdraw money only after completing that term. Interest rate is high.

d) Recurring Deposit: It aims at encouraging regular savings by the people. The

depositor can deposit money in installments for a given period of time.Withdrawal
can be done only after completing the term.
 How do commercial banks create
money?
CREDIT CREATION/MONEY CREATION/DEPOSIT MULTIPLIER/MONEY MULTIPLIER.
It is one of the most important activities of commercial banks.Through the
process of money creation ,commercial banks are able to create credit,which is in
far excess of the initial deposits.
Assumptions:
(i) The entire commercial banking system is one unit & is termed as BANKS.
(ii) All receipts & payments in the economy are routed through banks…payt
through cheques & all receipts are deposited in the banks.
It is legally compulsory for the banks to keep a certain minimum fraction of their
deposits as reserves & the fraction is called as the Legal Reserve
ratio(LRR)….reserve as indicated by the Central bank.
Only a fraction is kept as cash reserves as all the depositors are not going to
withdraw the entire amount & there is always a constant flow of new deposits
 Refer Sandeep pg no 6.5
DEPOSITS LOANS CASH RESERVES
(LRR=20%)
INITIAL DEPOSIT 1000(A) 800 (B) 200
ROUND 1 800 (B) 640 (c) 160
ROUND II 640 512 128
------ ----- ---- ------
------ ------ ----- -------
TOTAL 5000 4000 1000

As seen in the table banks are able to create total deposits of Rs 5000 with the initial
deposit of 1000.It means total deposit becomes five times of the initial deposit.Five
times is the value of money multiplier.
 Continuation…
MONEY MULTIPLIER:
Money multipler refers to the process of creation of credit by the
commercial banks,with the help of the initial deposits made by the public
& legal reserve ratio.It is calculated as
Money Multiplier= 1/LRR
In the given example, LRR is 20% or 0.2
Money Multiplier = 1/0.2= 5
So value of money multiplier is determined by LRR.Higher the value of
LRR,lower is the value of money multiplier & less money is created by
commercial banks.

TOTAL DEPOSIT = INITIAL DEPOSIT X MONEY MULTIPLIER

MONEY MULTIPLIER = 1/LRR
 CENTRAL BANK
Central Bank is the apex institution of a country’s monetary system.An
“Apex” body means Supreme body which
• Controls
• Operates/organises
• Regulates
• Directs &
• Supervises (CORDS)
the entire banking and monetary structure of the country.
• Central Bank occupies the top position in the monetary and banking
system of the country.
• All financially developed countries have their own central bank.
 INDIA – It is the Reserve Bank of India -RBI(established in April 1935,
under RBI Act of 1934)
 UK – Bank of England
 USA – Federal Reserve System
 Functions of the Central Bank (RBI)
1.Authority of currency issue/Bank of Issue
The Central Bank is the sole authority or given the monopoly of issuing
currency notes in India.This improves efficiency in the financial system.
Firstly ,it leads to uniformity in the issue of currency.
Secondly, it gives central bank direct control over money supply.
The Central bank issues currency on the basis of Minimum Reserve
System.It maintains a minimum reserve of 200crores of which 115 crores
should be in the form of gold & the remaining 85 crores in the form of
foreign securities. RBI issues all currency except one rupee notes & coins
which are issued by the central govt(by the ministry of finance),but put
into circulation only by the central bank
 One rupee notes signed by the finance secretary
 Other Notes – you will find the Signature of Governor of
RBI
Mr.Ajay Bhushan Pandey is the present finance secretary.
Mr.Shaktikanta Das is the present Governor of RBI
 Advantages of Sole Authority of Note
issue
• Leads to uniformity in note circulation
• Gives the central bank power to influence money supply because
currency with public is a part of money supply.
• Enables the government to have supervision and control over the central
bank with respect to issue of notes
• Ensures public faith in the currency system
• Helps in stabilization of internal and external value of currency.
 (ii) Banker to the government
Commercial
banks RBI

The RBI acts as a

PUBLIC GOVT
• Banker
• Agent
• Financial advisor to the Central and all State Governments
As a banker, it carries out all banking business of the government.
• It maintains a current account for keeping their cash balances.
• It accepts receipts and makes payments for the government and carries out
exchange, remittance and other banking operations.
• It also gives loans and advances to the government for temporary periods.

Central Government is also authorized to borrow money from Central Bank when it
faces deficit in the budget.
It borrows from Central Bank by selling its treasury bills.
When CB acquires these securities ,it issues new currency.
This is known as ‘Monetizing the Government’s Debt’ or ‘Deficit Financing’
 CONTINUATION…
As an Agent
The Central Bank also has the responsibility of managing the
public debt.
As a Financial Advisor
The CB advises the government from time to time on
economic financial and monetary matters like deficit
financing,price stability,management of public debt,foreign
currency management etc.
The public debt is how much a country owes to lenders outside of itself. These can
include individuals, businesses, and even other governments. The term "public
debt" is often used interchangeably with the term sovereign debt. Public
debt usually only refers to national debt. Public debt –is a financial obligation
assumed by the government where it agrees to make interest and principal
payments on certain dates .
 iii.BANKER’S BANK AND SUPERVISOR
There are number of commercial banks in a country.There should be some agency
to regulate and supervise their proper functioning.Being the apex bank it acts as
the banker to other banks and Central bank functions in three capacities.

1. Custodian of cash reserves

2. lender of the last resort
3. Clearing house
 i. Custodian of cash reserves

Commercial banks keep a certain

proportion of deposits with
central bank
Cash Reserve Ratio (CRR)

All the commercial banks have to keep some percentage of their deposits with the
RBI. This is called Cash Reserve Ratio (CRR) As on date CRR is 3%
ii. Lender of the last resort
Commercial banks
approach the central
bank For loans and
advances
Approved securities and bills of
exchange

When commercial banks fail to meet their financial

requirements from other sources, they approach
the CB who help through discounting of approved
securities & bills of exchange.
 iii. Clearing house The central bank easily
settles claims of the
!Cash other banks by entering
reserves!
debit and credit in their
books as it holds cash
reserves of every
commercial bank .

As Central bank holds the cash reserves of all the

commercial banks,it becomes easier & more convenient
to act as their clearing house.All commercial banks have
account with central banks & hence…..
Wherever RBI is not there SBI helps in clearance of the
cheques
 RBI

INDIAN PUNJAB LAKSHMI

IOB NATIONAL VILAS ICICI BANK
BANK
BANK BANK

Susheela
Balambaal
(borrower)
(lender)

ICICI CHEQUE
ICICI CHEQUE
FOR RS 1 LK
FOR RS 1 LK
1. Licensing
2. Branch expansion
3. Liquidity of assets
4. Management
5. Merging
6. Winding up ...... Etc......Through
periodic inspection

The central Bank gives licenses to start commercial banks, inspects

the work of commercial banks periodically and sometimes asks the
banks to wind up.
4.Custodian of Foreign exchange
Reserves
Helps the bank in stabilising
the external value of currency

Helps in pursuing a
coordinated policy towards
the balance of payments
situation of the country

The Central Bank buys and sells foreign currencies

in the market. So, we say central bank is the
custodian of foreign exchange reserves
RBI Monetary policy indicators as on
7TH June 2020

Indicator Current Rate

CRR 3%
SLR 18.50%
Repo Rate 4.00%
Reverse Repo Rate 3.35%
Marginal Standing 4.65%
Facility Rate
Bank Rate 4.65%
 5.CONTROLLER OF MONEY SUPPLY
AND CREDIT
Commercial banks create credit where as central bank controls credit. The credit
control by the Central bank is one of the most crucial functions in modern
times.The primary objective is to remove instability in price fluctuations.This policy
adopted is known as Monetary policy of the Central bank.It has two weapons to
control credit in the country. They are:

(A) Quantitative credit control measures.(B) Qualitative credit control measures .

QUANTITATIVE MEASURES QUALITATIVE
(TRADITIONAL METHOD) MEASURES(SELECTIVE CREDIT
CONTROL)
REPO RATE MARGIN REQUIREMENTS
BANK RATE MORAL SUASION

REVERSE REPO RATE RATIONING OF CREDIT

OPEN MARKET OPERATIONS
LEGAL RESERVE REQUIREMENTS
 QUANTITATIVE MEASURES
• 1. REPO RATE:Repo rate is the rate at which the central bank of a country
(RBI) lends money to commercial banks to meet their short term needs.
• The central bank advances loans against approved securities or eligible
bills of exchange.The Central bank has the legal power in fixing & changing
this rate.
• Raising Repo rate makes borrowing by the commercial banks costly.This
forces these banks to raise the interest rates on lendings to the general
public.
• Borrowings from banks become costly leading in decline in demand for
borrowings- leading to decline in spending capacity- leading to fall in
demand for goods & services.This helps in checking inflation.
• Lowering the Repo rate makes borrowings from the commercial banks
cheaper and so also for the public.Demand for borrowing rises & spending
capacity increases leading to rise in demand for goods & services.This
helps in checking deflationary tendencies in the economy.
REPO RATE
REPO RATE RISES (by RBI)
CO.BK int also rises
Less demand for borrowings
decline in spending capacity
Fall in dd for G/S
Checks inflation

Lowering of REPO RATE

CO.BK int also lowers
More dd for borrowings
spending capacity increases
Rise in dd for G/S
Checks Deflation
 BANK RATE
• Bank rate is the interest rate at which the commercial banks can
borrow from the central bank to meet their long term needs.
• Bank rate is also known as the discount rate.
• The difference between repo rate & bank rate is that the RBI lends
to commercial banks without collateral or approved securities but
lends at a higher rate of interest.
• This is also fixed by the RBI & it has the power to change it,It has
the same effect as that of Repo Rate.
• During inflation, Bank rate is increased to curb the borrowing
capacity & spending
• During Deflation, Bank rate is reduced to increase the borrowing
capacity
 REVERSE REPO RATE
• Reverse Repo Rate refers to the rate of interest at which the commercial
banks can park their surplus funds with the RBI.This allows the commercial
banks to generate income.
• Raising RRR gives incentives to commercial banks to deposit more funds
with RBI thus reducing the liquidity of the banks & it has adverse effect on
credit creation.
• Lowering RRR discourages commercial banks from parking their surplus
funds & so there is more credit creation .This helps in fighting deflationary
situation in the economy.

During Inflation, the Reverse Repo rate will be increased. The Commercial Banks will
lend more money to Central bank. They will lend less to public.Money supply and
Aggregate Demand will fall.
During deflation reverse repo rate will be reduced.Banks will lend less to RBI and more
to public. Money supply will increase. Deflation will be controlled
 OPEN MARKET OPERATIONS
Open market operations refers to the buying & selling of securities,mainly
Government securities by the central bank in the open market.By selling
the securities like National saving certificates,the RBI soaks liquidity from
the economy & by buying the securities the RBI releases liquidity.

During Inflation, the Central Bank will sell securities to the public and get
money. Money supply will decrease and inflation will be controlled.

During deflation, the Central Bank will buy back securities and give money
to public. Money supply will increase. Deflation will be controlled.
 LEGAL RESERVE RATIO
• All commercial banks must comply with the instructions of the central
bank regarding maintaining minimum reserves with the CB or with
themselves.The CB uses two different instruments.
It is also known as variable reserve ratio,required reserve ratio,legal
reserve requirements or the LRR

Legal Reserve Ratio

(CRR)Cash Reserve Ratio statutory liquidity ratio (SLR)

Add on….
 There are two components of Legal Reserve Ratio-Cash Reserve Ratio &
Statutory Liquidity Ratio
CRR is the fraction of Net Total Demand deposits & Time deposits that
commercial banks must keep as cash reserves with the Central bank .
SLR is the fraction of Net Total Demand deposits & Time deposits that
commercial banks must keep with themselves in the form of liquid assets.

• When Central bank raises CRR or SLR or both,less money is left with
commercial bank for lending.As lending decreases,& money supply on the
economy decreases .
• When Central bank reduces CRR or SLR or both,more money is left with
commercial bank for lending.As lending increases,& money supply on the
economy increases .
 QUALITATIVE INSTRUMENTS
• They are designed to curb excess flow of credit in select areas without affecting
other types of credit.
• MARGIN REQUIREMENTS: Margin is the difference between the amount of loan
and market value of the security offered by the borrower against the loan.

Margin Requirement: This can be explained with a simple example. A person gives a
collateral security worth Rs 100 to a commercial bank and the bank may give him loan
of Rs 80. This means the margin is 20%. During Inflation bank will increase margin
requirement. During deflation margin requirement will be reduced.

If the Margin requirement is 40%,then the bank is allowed to give loan only upto 60% of
the value of security.By altering the margin requirements,the Central bank can alter
the amount of loans made against the securities.

Raising the MR …will decrease the money supply & will control inflation.Lowering the
margin requirements,increases the money supply in the economy and helps in times
of deflation
 MORAL SUASION
• This is a combination of persuasion & pressure that central
bank applies on other banks in order to get them act.in a
manner,in line with its policy.
• The RBI tries to persuade the commercial banks to follow its
directives,but if persuasion does not work,it uses the required
pressure as an apex bank of the country.If pressure also does
not work ,the RBI can use direct action which includes
derecognition of the concerned bank.
 SELECTIVE CREDIT CONTROLS
• Under selective credit controls, the RBI gives directions to
other banks to give or not to give credits for certain purposes
to particular sectors.
• This method can be applied in both positive and negative
manner. In positive manner, it means using measures to
channelise credit to priority sectors. This priority sector
includes small scale industry, agriculture,exports etc.
• In negative manner it means using measures to restrict flow
of credit to particular sectors.
 Difference between Central and Commercial Bank
S.N Basis Central Bank Commercial Bank
1 Meaning Central bank is an apex body that Commercial bank is an institution
Controls, Operates, Regulates,Directs which performs the functions of
and Supervises(CORDS) the entire Accepting Deposits, Granting Loans
banking and monetary structure of and making investments with the
the country objective of earning profits
2 Status It is the apex institution in the money It is merely a unit in the banking
market structure of the country and operates
under the control of central bank
3 Ownership It is generally owned and governed by It can be owned and governed by the
the government government or the private sector
4 Objective It operates in public interest without It aims to maximise profits
profit motive
5 Issue of It has sole monopoly/absolute right It has no power to issue currency
Currency in issue of currency
 Continuation
S.N Basis Central Bank Commercial Bank

6 Public It does not deal directly with the It deals directly with public and
Dealing public business firms

7 Number of There is only one central bank in a There are a number of commercial
banks country due to peculiar nature of its banks in a country. For Example, SBI,
activities. For example, RBI in India PNB etc., in India
8 Relationship It acts as a banker to the government. It has no such responsibility towards
the state

9 Decision It has a primary role & decides its It plays a supplementary role and is
Making monetary policy to realise economic quite often regulated by the Central
stability and full employment in the Bank
country
10 Custodian It is custodian of the Nation’s gold and It does not perform such function.
Foreign Exchange Reserves.
 ALSO REFER……
• 1. Difference between Fixed deposits & Demand
deposits……Sandeep pg no 6.2
• High powered money… Sandeep pg no 5.4 ..
…Sachdeva pg no 95
• Legal definition of money…Sandeep 5.13…
…Sachdeva pg 92..
• Face value & Intrinsic value Sachdeva pg 92..
• Fiat money & Fiduciary money Sachdeva pg 93..