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| Money and Banking | Unit-II | Unit-III | Unit-IV | Unit-V | Unit-VI | Unit-VII | Unit-VIII |
Ans: The various quantitative and qualitative instruments of monetary policy of central bank to control inflationary and deflationary situations are –
Quantitative Instruments –
a. Increase or decrease in bank rate
b. Open market operations- Selling and purchasing of securities in the open market
c. Cash Reserve Ratio- Every bank has to maintain some minimum amount of deposits with the central bank.
d. Statutory Liquidity Ratio- Every bank is required to maintain some fixed percentage of their assets in the form of cash or other liquid assets.
Qualitative Instruments -
a. Margin Requirement- Refers to the difference between the current value of the security offered for loans and the value of loans granted.
b. Rationing of Credit- Fixing credit quotas for different business activities
c. Direct Action - Central bank can take direct action against commercial banks in case of non-compliance of rules.
d. Moral suasion- Central bank can persuade member banks to follow instructions.
Ans: Narrow definition of money identifies money as medium of payment; however, the other functions of money are overlooked. Thus, anything which is used as medium of exchange is included in the narrow definition of money, for example; currency and demand deposits.
Broad definition of money includes, store of value function along with the function of medium of exchange. In addition to currency and demand deposits, items like time and savings deposits in banks and post offices are also included in the broad definition of money.
Ans: Money is anything, which is used as a medium of exchange, and has a legal sanction of the government. It possesses 100% liquidity. Everybody is legally bound to except it. For instance, money in India consists of coins and paper notes.
Near money is close substitute of money rather than cash and currency. It is as good as money, but it is not real money because it is not legally sanctioned. Assets, which are close substitute of money, are considered near money. Examples of near money are bonds, equity, shares, NSC, commercial bills etc. Near money cannot buy goods and services like money, but it can be converted into ready money easily within a short period of time.
Credit card is another example of near money. In case of purchases made through credit cards, the payments are not made immediately; rather they are deducted from the bank account of the purchaser later on by the bank.
Q.19. Central bank is the apex bank of the country. What is the necessity of having a central bank?
Ans: Nowadays, the central bank is considered indispensable in every country. Central bank is necessary because of the following reasons:
Monetary system requires control and regulation: Money cannot maintain itself. The paper standard which is in operation in every country has to be maintained or directed by some central authority.
Banking system requires control and regulation: Banks of a country, being private institutions, act by profit motive. Because they are competitive concerns and they cannot follow a common policy according to national requirements. The result is either creation of too much credit or too les of credit. Therefore, the country needs to have a central controlling authority called CENTRAL BANK.
Q.20. Explain the function of giving loans and advances by commercial banks.
Ans: This is an important function of a commercial bank. It provides loans and advances to businessmen and entrepreneurs and thereby earns interest. This is the main source of income for the bank. A bank keeps a certain portion of the deposits and gives the balance to the borrowers as loans, and advances in the following forms.
Cash credit: An eligible borrower is first sanctioned a credit limit and within that limit, he is allowed to withdraw a certain amount on the given security. Interest is charged by the bank on the drawn or utilised portion of credit.
Demand loans: A loan which can be recalled on demand is called demand loan. There is no stated maturity. The entire loan amount is paid in lump sum, by crediting it to the loan account of the borrower.
Short- term loans. Short-term loans are given against some security as personal loans to finance working or as priority sector advances. The entire amount is repaid either in one installment or in a number of installments over the period of loan.
Q.21. Explain the various agency functions of a commercial bank.
Ans: The bank acts as an agent of its customers and earns commission for performing agency functions as follows:
a. Transfer of funds: It provides facility for cheap and easy remittance of funds from place to place through demand drafts, mail transfers, telegraphic transfers etc.
b. Collections of funds: It collects funds through cheques, bills, Hundis and demand drafts on behalf of customers.
c. Payments of various items: It makes payment of taxes, insurance premium, and electricity and telephone bills etc. as per directions of its customers.
d. Purchase and sale of shares and securities: It buys sells and keeps in safe custody the securities and shares on behalf of its customers.
e. Collection of dividends and interest: Bank collects dividends and interest of shares and debentures on behalf of its customers.
f. Acts as trustee and executor: Commercial bank acts as a trustee and executor of property of it’s’ customers on advice of its customers.
Ans: Barter system faced certain problems like:
a. Lack of double coincidence of wants: Simultaneous fulfillment of mutual wants by buyers and seller is known as double coincidence of wants. There is lack of double coincidence of wants of buyers and sellers in the barter exchange. For example, the producer of jute may want shoes in exchange of jute. But he may find it difficult to get a shoemaker, who is willing to exchange his shoes for jute. Thus, a seller has to find out a person, who wants to buy seller’s goods and at the same time, who must have what the seller wants. This is called double coincidence of wants.
b. Absence of common measure of value: In the barter system, there is no common measure (unit) of value. Even if two people are ready to exchange their goods, the problem arises in what proportion the goods are to be exchanged. Absence of a common measure of value creates many difficulties.
c. Lack of divisibility: Lack of divisibility makes barter exchange impossible. For instance, if a person wants to purchase cloth, equal to the value of half his cow, he cannot do so without killing his cow.
d. Difficulty in storing wealth: It is difficult for the people to store wealth or generalize purchasing power for future use in the form of goods like cattle, wheat, potatoes etc. Holding of stocks of such goods, involve heavy cost.
Ans: Commercial banks collect the surplus balance of individuals and finance the temporary needs of commercial transactions. The first task is therefore, collection of the savings of the public. This is done by accepting deposits from its customers. Deposits are of 3 types –
a. Current account deposits: Such deposits are payable on demand and can be withdrawn by the depositors at any time. That is why, these are called demand deposits. The bank does not pay any interest on such deposits but provides cheque facility for withdrawal.
b. Fixed term deposits: These are deposits for fixed terms, i.e. period of time ranging from few days to few years. These are neither payable on demand nor the cheque book facility is provided. These can be withdrawn only after a certain period. These carry high rate of interest.
c. Saving account deposits: These are deposits, whose main objective is to encourage savings. These combine the features of current account and fixed deposits. These are payable on demand and also withdrawable by cheque. But bank gives this facility with some restrictions, e.g., a bank may allow only 5to 7 cheques in a month.
Ans: In India the Reserve Bank of India is the central bank of the country. Main function of the Central Bank is to act as a governor of the machinery of credit in order to secure stability of prices. It regulates the volume of credit and currency. It provides money in circulation in case of shortage and withdraws money when there is an excess of it. Broadly, a central bank has two departments namely, issue department and banking department. The main functions of central banks are -
a. It issues currency.
b. It acts as a banker to the government.
c. It is banker's bank and supervisor.
d. It acts as a controller of credit and money supply.
e. It acts as a lender of last resort.
f. It controls exchange rate.
g. It acts as the custodian of foreign exchange or balance.
h. It performs the functions of clearing house.
i. It performs the functions of collection and publication of data
Q.25. Commercial bank is an important source of money in the economy. How do commercial banks create credit?
Ans: Commercial banks create credit in the form of demand deposits. Demand deposits are many times more than the cash reserves. If cash reserves are Rs 2,000 and demand deposits are Rs 20,000, then the commercial banks are creating credit 10 times of their reserves. The logic behind is that-
a. The bank knows that all the depositors would not withdraw all their deposits at the same point of time.
b. Suppose Withdrawals are generally 10% of the deposits and so the bank needs to keep only 10% of the deposits as cash reserves. This is known as CRR.
c. If CRR = 10%, total cash reserves of Rs 1000 allows the bank to offer loans up to Rs 10000 as per the formula – Demand deposits =Cash Reserves x CRR