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ECONOMICS, CHAPTER : 17 [Banking System], -----------------------------------------------------------------------------------, , 1. Explain important functions of commercial Bank., , Answer - The functions of commercial banks are classified into two main, divisions., (a) Primary functions, Accepts deposit : The bank takes deposits in the form of saving,, current, and fixed deposits. The surplus balances collected from the firm, and individuals are lent to the temporary requirements of the commercial, transactions., Provides loan and advances : Another critical function of this bank is to, offer loans and advances to the entrepreneurs and business people, and, collect interest. For every bank, it is the primary source of making profits., In this process, a bank retains a small number of deposits as a reserve, and offers (lends) the remaining amount to the borrowers in demand, loans, overdraft, cash credit, short-run loans, and more such banks., Credit cash: When a customer is provided with credit or loan, they are, not provided with liquid cash. First, a bank account is opened for the, customer and then the money is transferred to the account. This process, allows the bank to create money., (b) Secondary functions, Discounting bills of exchange: It is a written agreement, acknowledging the amount of money to be paid against the goods, purchased at a given point of time in the future. The amount can also be, cleared before the quoted time through a discounting method of a, commercial bank.
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Overdraft facility: It is an advance given to a customer by keeping the, current account to overdraw up to the given limit., Purchasing and selling of the securities: The bank offers us with the, facility of selling and buying the securities., Locker facilities: A bank provides locker facilities to the customers to, keep their valuables or documents safely. The banks charge a minimum, of an annual fee for this service., 2. Explain important functions of Central Bank., Answer - Central Bank provides following functions:, (a)Regulator of Currency - The main function of the central bank is, to print currency notes and RBI has the sole right in the country for, this operation., (b)Banker and Advisor to the government - This role of central, bank is of a fiscal agent to the government where the RBI keeps, the deposits of both central and state governments. It also makes, payments on behalf of the government, along with buying and, selling foreign currencies. The various functions of a reserve bank, as an advisor is to tender useful suggestions to the government, regarding monetary policies and other economic matters., (c) Custodian and manager of foreign exchange reserves - To, keep the rates of foreign exchange stable, the reserve bank buys, and sells foreign currencies at international prices. If the supply of, foreign currency decreases in the economy, RBI sells them at, foreign exchanges, and in case of surplus supply, it buys them., RBI is also an official reservoir of foreign currencies and gold. RBI, sells gold to monetary authorities of other countries at fixed prices., (d)Lender of the last resort - The RBI grants accommodation to, commercial banks, financial institutions, bill brokers, etc. in the, form of collateral advances or re-discounts. This step is taken in, times of stress so that the financial structure of the country is
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saved from collapsing. This lending is done on the basis of, government securities, treasury bills, government bonds, etc., (e)Controller of Credit - The Reserve bank of India controls the, credit created by commercial banks. The credit flow in the country, is regulated by means of two methods; quantitative method and, qualitative method. RBI applies tight monetary policies when it, observes that there is enough supply of money which may cause, an inflationary situation. It squeezes the money supply to keep, inflation in check., 3. Explain quantitative credit control measures taken by central, bank., Answer, Following are the quantitative credit control measures taken by central, bank:, i. Bank Rate : Bank rate is the rate charged on the loans offered by the, Central bank to the commercial banks without any collateral. It is, increased at the time of inflation to reduce the money supply in the, economy and vice versa., Repo rate is the rate charged on the secured loans offered by the, Central bank to the commercial banks that includes collateral. It is, increased at the time of inflation to reduce the money supply in the, economy and vice versa., ii. Variable Ratios : Statutory Liquidity Ratio (SLR) refers to liquid, assets that the commercial banks must hold on a daily basis as a, percentage of their total deposits. SLR is determined by the central bank, and is a legal requirement to be fulfilled by the commercial banks. It is, increased at the time of inflation to reduce the money supply in the, economy and vice versa., Cash Reserves Ratio (CRR) refers to the proportion of total deposits of, the commercial banks which they must have keep as cash reserves with, the central bank. The ratio is fixed by the central bank and is varied from, time to time to control the supply of money in the economy depending, upon the prevailing situation of inflation or deflation.
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iii.Open Market Operations: Open market operation (OMO) is a, monetary policy by the central bank in which the bank deals in the sale, and purchase of securities in the open market to control the supply of, money in the economy. By selling the securities, the central bank soaks, liquidity from the economy and by buying the securities, the central bank, releases liquidity., , 4. Explain qualitative credit control measures taken by central, bank., Answer, Following are the qualitative credit control measures taken by central, bank:, , A. Margin Requirement:, Margin requirement refers to the difference between the current value of, the security offered for loan (called collateral) and the value of loan, granted. It is a qualitative method of credit control adopted by the central, bank in order to stabilize the economy from inflation or deflation., B. Rationing of Credit:, Rationing of credit refers to fixation of credit quotas for different business, activities which is introduced when the flow of credit is to be checked, particularly for speculative activities in the economy., C. Moral Suasion:, Moral suasion refers to the persuasion and pressure which central bank, exert on the member banks in order to follow its directives. These are, generally not ignored by the member banks as it comes directly from the, upper authority. The banks are advised to restrict the flow of credit, during inflation and be liberal in lending during deflation.
