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Case/Source Based MCQs of Money and Banking chapter class 12

• October 31, 2021
• MCQS , Money & Banking

Looking for Case study or Source-Based MCQs (Multiple Choice Questions) of Money and Banking chapter of Macroeconomics Class 12 CBSE, ISC and other state Board.

I have made a collection of important MCQs

Lets Practice.

Case/Source Based Multiple Choice Questions of Money and Banking Chapter Class 12

Following are the MCQs

1. Based on the passage below, answer the following questions.

The Reserve Bank of India (RBI) is India’s Central Bank, also known as the banker’s bank. The RBI controls the monetary and other banking policies of the Indian government. The Reserve Bank of India (RBI) was established on April 1, 1935, in accordance with the Reserve Bank of India Act, 1934. The role of RBI has undergone a significant change after the introduction of the new Economic Policy in 1991.

The Reserve Bank of India (RBI) is India’s central bank and regulatory body under the jurisdiction of the Ministry of Finance, the RBI is responsible for the issue and supply of the Indian rupee and the regulation of the Indian Banking system. It also manages the country’s main payment systems and works to promote its economic development.

On 8 November 2016, the government of India announced the demonetization of all ₹ 500 and ₹ 1000 banknotes of the Mahatma Gandhi Series on the recommendation of the Reserve Bank of India (RBI).

Answer the following Questions.

1. Why RBI is said to be a banker of the bank. Choose the correct option

a) Lender’s of last resort b) controller of credit c) Decide LRR d) None of the above.

Ans – a)

2. ‘RBI is responsible for issue and supply of Indian Rupee in the economy’. Identify the function of RBI and explain.

a) Central bank has the authority to issue currency in the economy. b) This develops the public faith in the system of note circulation. c) It allows the central bank to supervise and control the money supply. d) All of the above.

Ans – d)

3. Define Demonetisation.

a) it refers to selling the public sector to the private. b) It refers to the release of new coins. c) It refers to the process where currency notes of certain denominations are declared no longer as legal tender. d) None of the Above.

Ans – c)

4. How the role of RBI has changed after the 1991 New Economic Policy.

a) Its role changes from the regulator to facilitator b) Interest rates decision are left with financial institutions c) It only formulates the guidelines and decision-making rights are left with financial institutions d) All of the above.

The Monetary Policy Committee of the Reserve Bank of India kept interest rates on hold Thursday even as it vowed to keep policy sufficiently loose to help revive the coronavirus battered economy. Accepting a key demand of lenders and the corporate sector, the central bank cleared a one-time restructuring of loan accounts to bail out stressed borrowers, including personal, small, and medium loans.

The details of the loan restructuring scheme – expected to kick in after the moratorium on loan repayments ends. August 31 – will be worked out by a committee headed by former ICICI Bank Chairman KV Kamath. The RBI also continued to provide support on the liquidity front and opened a new targeted window for small lenders.

The central bank kept the repo rate unchanged at 4 percent and reduced the reverse repo rate to 3:35 percent.

Answer the following questions on the basis of the above Case.

Q.1 Suppose you are a member of the Monetary Policy Committee of the RBI. You have suggested the ___________ of the money supply be ensured to help revive the coronavirus battered economy.

a) restriction b) release c) doubling d) no change

Ans – b)

Q.2 “The Monetary Policy Committee of the RBI kept interest rates on hold—-“. Which of the following is highlighted above by the term ‘interest rates’?

a) Bank Rate and Repo Rate b) Bank Rate and Lending Rate c) Repo Rate and Reverse Repo Rate d) Bank Rate and Reverse Repo Rate

Q.3 What does the ‘Repo Rate’ mean?

a) Rate at which banks borrow from the RBI for short term b) Rate at which banks borrow from the RBI for long term c) Rate at which banks deposit excess funds with the RBI d) Rate at which banks lend funds to the public

Q.4 ‘Reduction in Repo Rate by RBI’ is likely to _ the demand for goods and services in the economy.

a) increase b) decrease c) double d) not effect

The key indicators of RBI Monetary Policy along with their current rates in the table given below:

On 9th October 2020, RBI has kept the Repo Rate unchanged at 4.00% and reduced reverse repo rate to 3.35%. In addition to that, the bank rate stands at 4.65%. This has been done to limit the damage to the economy caused by the Covid-19 and subsequent lockdowns.

Q.1 What does RBI Monetary Policy 2020 mean?

a) It is the policy formulated by the RBI in 2020 related to expenditure and taxation of the government. b) It is the policy formulated by the RBI in 2020 realted to money matters of the country. c) It is the policy formulated by the RBI in 2020 related to the government budget. d) It is the policy formulated by the RBI in 2020 realted to the distribution of credit among users as well as the rate of interest on borrowing and lending.

Ans – b), d)

Q.2 What does the ‘Bank Rate’ mean?

a) Rate at which banks borrow from the RBI for short term b) Rate at which banks borrow from the RBI for long term c) Rate at which banks deposit excess funds with the RBI d) Rate at which banks lend funds to the public.

Q.3 Which of the following is a quantitative credit control technique of RBI?

a) CRR b) SLR c) Repo Rate d) All of these

Q.4 Cut in Reverse Repo Rate is likely to _ the demand for goods and services in the economy during Covid – 19 lockdowns.

Case Study – 3

Keeping in view the continuing hardships faced by banks in terms of social distancing of staff and consequent strains on reporting requirements, the Reserve Bank of India has extended the relaxation of the minimum daily maintenance of the CRR of 80% for up to September 25, 2020. Currently, CRR is 3% and SLR is 18.50%.

“As announced in the Statement of Development and Regulatory Policies of March 27, 2020, the minimum daily maintenance of CRR was reduced from 90% of the prescribed CRR to 80% effective the fortnight beginning March 28, 2020 till June 26, 2020, that has now been extended up to September 25, 2020,” said the RBI.

Q.1 The full forms of CRR and SLR are:

a) Current Reserve Ratio and Statutory Legal Reserves b) Cash Reserve Ratio and Statutory Legal Reserves c) Current Required Ratio and Statutory Legal Reserves d) Cash Reserve Ratio and Statutory Liquidity Ratio

Q.2 What will be the value of money multiplier?

a) 33.33 b) 5.4 c) 4.65 d) None of these

Q.3 SLR implies:

a) Certain percentage of the total banks’s deposits has to be kept in the current account with RBI b) Certain percentage of net total demand and time deposits has to be kept by the bank with themselves. c) Certain percentage of net demand deposits has to be kept by the banks with RBI d) None of the above

Decrease in CRR will lead to __ .

a) fall in aggregate demand in the economy. b) rise in aggregate demand in the economy c) no change in aggregate demand in the economy d) fall in general price level in the economy

Case Study – 4

Due to Covid – 19, the Reserve Bank of India (RBI), cut Repo Rate to 4.4% the lowest in at least 15 years. Also, it reduced the CRR by 100 basis points. Previously, it was 4%. RBI governor Dr. Shaktikanta Das predicted a big global recession and said India will not be immune. It all depends on how India responds to the situation. Aggregate demand may weaken and ease core inflation.

Q.1 CRR stands for:

a) Cash Reserve Ratio b) Current Reserve Ratio c) Cash Required Rate d) Current Required Rate

Q.2 Cut in Repo Rate by RBI is likely to __ the aggregate demand in the Indian Economy.

“ reduced the CRR by 100 basis points. Previously, it was 4%.” Thus, CRR is reduced to ___ .

a) 5% b) 3% c) 96% d) 104%

Besides reduction in CRR and Repo Rate, What other measures can be taken by the Government of India through its budgetary policy to combat recession?

a) Decrease the bank rate b) Sell government securities in the open market c) Increase margin requirements on secured loans d) Decrease taxes and increase government expenditure

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NCERT Solutions for Class 12 Macro Economics Chapter 3 Money and Banking

NCERT Solutions for Class 12 Economics Chapter 3 Money and Banking – Macroeconomics with Case Study MCQ and important question answers for CBSE 2024-25. Class 12 Macroeconomics chapter 3 solutions are important for all the students of state board also, who are using NCERT Textbook for study.

Class 12 Economics Macroeconomics Chapter 3 Money and Banking Question Answers

• Class 12 Macroeconomics Chapter 3 Solutions
• Class 12 Macroeconomics Chapter 3 MCQ
• Class 12 Macroeconomics Chapter 3 Case Studies
• Class 12 Macroeconomics NCERT Books PDF
• Class 12 Economics all Chapters Solutions
• Class 12 all Subjects NCERT Solutions

Money is the commonly accepted medium of exchange. Suppose there is only one person in an economy, there cannot be any exchange of commodities, and hence, there is no role of money. If there are more than one people in an economy, but they do not take part in market transaction, money has no function to them. For example: The tribes which live in the forests, and has no connection with outer world. They eat what they hunt. They wear animal skin. Their daily need does not include any monetary transaction.

They survive on their hunting skills, and they make their houses with the wood and they use natural resources for their every need. They do not depend or we can say need money to fulfil their daily needs. Similarly, for a family living on an isolated island, money has no function for them. However, as soon as there is more than one economic agent who engage themselves in transactions through the market, money becomes an important thing for facilitating exchanges. Economic exchanges without the mediation of money are referred to as Barter Exchanges. But there are some cons of barter exchanges. Suppose you have a surplus of clothing, and you want to exchange it for rice.

So, first you have to search for a person who has a surplus of rice and also wants clothing in exchange of that. It would be very difficult to find the exact match. Sometimes it may take days or even weeks. Thus, to smoothness the transaction, an intermediate good is necessary which is acceptable to both parties. Such a good is called money. The individuals can sell their produces for money and purchase the commodities of their need using that money. This saves a lot of time as well as cut down the amount of effort made to find the right person to zero.

We all know, the most important role of money is that, it acts as a medium of exchange. It is used to buy and sell things. Money also acts as a convenient unit of account. The value of all everything like commodities and services can be expressed in monetary terms, which means that whatever goods and services in the market are available for sale, they have a price. Barter exchanges becomes extremely difficult in a large economy because it will consume lots of time and costs looking for right persons to exchange their surpluses.

This system has other disadvantages too. It is difficult to calculate one’s wealth under the barter system. For example: If you have produced extra wheat which you do not wish to consume entirely by yourself. You can think or take this stock of wheat surplus as an asset for future purposes. But wheat is an item which cannot be stored beyond a certain period, it will get defected by bugs and insects. To stock this wheat, you will need a lot of space. You may have to spend considerable time and resources looking for people with a demand for wheat when you wish to exchange. This problem can be solved if you sell your wheat for money. Money does not have an expiry date.

Everyone will accept money as an exchange at any point of time. You can say that money is a store of value for individuals. Wealth can be stored in the form of money for future use and its storage costs are also considerably low. But to perform this function, the value of money should be somewhat stable. A rising price level may erode the purchasing power of money. Some assets other than money can also act as a store of value, like: gold, landed property, houses, etc. However, they may not be easily convertible and they are not accepted universally as the medium of exchange.

Demand for money : When people desire a certain amount of money for any transaction, it creates demand for money. The amount of money is determined by the value of transaction the people want to do, as they will need money at least equal to the value of the transaction. For greater transaction values, greater money is required, thus demanded. Since the practicality of transactions to be made depends on income, it is clear that the rise in income will lead to rise in demand for money. Also, when people keep their savings in physical form, rather than putting it in bank, the demand for money rises. But when people put their savings in a bank, they earn interest on their savings. So, the higher the interest rate goes, the demand for money in physical form goes down, as people would want to earn interest on their money by keeping it in the bank.

Supply of money: In modern times, money comprises cash and bank deposits. There are many measures of money depending on what types of bank deposits are included. These are created by a system comprising two types of institutions: Central Bank of the economy and Commercial Banks. Central Bank is a very important institution in a modern economy. Almost every country has its central bank. India got its central bank in 1935, which is ‘Reserve Bank of India’. It has several important functions like; Issuing the currency of the country, Controlling money supply of the country through various methods, etc.

Commercial Banks are the other type of institutions which are a part of the money-creating system of the economy. They accept deposits from the public and lend out part of these funds to those who want to borrow. The interest rate paid by the bank to depositors is lower than the rate charged from the borrowers. The difference between these two types of interest rate is called ‘Spread’, and is the profit earned by the bank.

How to prepare class 12 Macroeconomics chapter 3 for CBSE Board?

Class 12 Economics chapter 3 is broadly related to the determination of equilibrium in the economy. There are two approaches to find equilibrium of national income/ output. However, before trying to understand the two approaches to equilibrium, we first study the meaning and components of aggregate demand and aggregate supply- because these are the basic tools of macroeconomic study. The two approaches of equilibrium are the aggregated demand and aggregate supply approach (C + I approach) and the saving and investment approach (S + I approach). Additionally, we study how saving curve is derived from consumption curve and vice- versa. We study what happens to the economy when equilibrium is disturbed. We also study how equilibrium can be restored. The topic concludes the study of the concept and working of the investment multiplier. In this topic, you will have to solve a variety of numerical questions (just like the topic of National income accounting) and understand at least 5 important diagrams/ graphs.

What are the Important Concepts given in 3rd chapter of Class 12 Macroeconomics?

The following are the important concepts in this topic aggregate demand, aggregate supply, equilibrium of national income, break- even level of economy (the point where APC = C/Y=1 or where saving = 0), The consumption function and the saving functions, investment and its types (induced investment and autonomous investment), types of unemployment (frictional, seasonal, structural). For the information of students, we study types of unemployment because no economy functions at the level of full employment due to some kind of unemployment/ idle resources. We also study the working of multiplier and three formulae associated with it. We also study measures to control situation of excess demand and deficient demand through the use of monetary policies and fiscal policies.

Which questions of 12th Economics chapter 3 are good to revise during the exams?

• (i) How is equilibrium level of national income derived by AD/AS approach (C + I approach)? (6 marks)
• (ii) How is equilibrium level of national income derived by saving and Investment approach (C + I approach)? (6 marks)
• (iii) Explain the working of investment multiplier? How is multiplier related to MPC? (6 marks)
• (iv) Draw a straight line consumption curve. Mark upon it a point where APC = 1. From it derived the saving curve. (6 marks)
• (v) What is under-employment equilibrium? (or can an economy be working at less than full employment level and still be equilibrium?) Draw a neatly labelled diagram showing how national income falls at less than full employment. (6 marks)
• (vi) Show by means of a diagram the concept of inflationary gap and deflationary gap. (6 marks)

What are the main Important Abbreviations in class 12 Economics chapter 3?

(i) AD = Aggregate Demand (ii) AS = Aggregate supply/ Aggregate Output (iii) MPC = Marginal Propensity to Consume (iv) APC = Average Propensity to Consume (v) MPS = Marginal propensity to Save (vi) APS = Average propensity to Save

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CBSE 12th Standard Economics Subject Case Study Questions with Solutions

By QB365 on 20 May, 2021

QB365 Provides the updated CASE Study Questions for Class 12 , and also provide the detail solution for each and every case study questions . Case study questions are latest updated question pattern from NCERT, QB365 will helps to get  more marks in Exams 

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Money and Banking Class 12 Important Questions and Answers Macroeconomics Chapter 3

We have given these Economics Class 12 Important Questions Macroeconomics Chapter 3 Money and Banking to solve different types of questions in the exam. Go through these Money and Banking Class 12 Important Questions and Answers Solutions & Previous Year Questions to score good marks in the board examination.

Important Questions of Money and Banking Class 12 Macroeconomics Chapter 3

Question 1. State the two components of M 1 measure of money supply. (April re-exam 2018) Answer: M 1 includes, (any 2)

• currency held by public in form of notes and coins.
• net demand deposit held by commercial banks.
• other deposits held by RBI.

Question 2. Define money supply. (Delhi 2018,2011(C). 2010) Answer: The total stock of money in circulation among the public at a particular point of time is called money supply.

Question 3. State the components of money supply. (Delhi (C) 2015, 2013, 2010: All India 2013) Or What is included in money supply? (Delhi (C) 2012,2011) Or Name the two components of money supply. All India 2010 Answer: The following are included in money supply

• Currency notes held by public.
• Demand deposits of Commercial Banks.

Question 4. What is barter? (Delhi (C) 2013) Answer: Barter is a system of exchange, where goods are exchanged for goods.

Question 5. Define money. (All India (C) 2012.2011) Or Give the meaning of money. (All India 2010) Answer: Money is defined as an object that is commonly accepted as a medium of exchange. It is an intermediate good which is acceptable to both the parties i.e. buyers and sellers.

Question 6. Explain the store of value function of money. (Delhi 2017: All India (C) 2014) Or Explain the store of value as function of money. (Foreign 2014) Answer: Money is an asset that retains its value over time. People store their wealth in the form of money, without fearing for loss in its value. Money overcomes the problem of storing perishable item under barter system of exchange. With money, people hold liquidity and value in a much more convenient manner.

Question 7. State the meaning and components of money supply. (Delhi 2017) Or Explain the concept of money supply. (Delhi (C) 2013) Or Define money supply and explain its components. (Delhi 2014, Foreign 2014) Answer: The total stock of money in circulation among the public at a particular point of time is called money supply. Money supply comprises of the following components:

• Currency (notes and coins) held by the public.
• Net demand deposits and time deposits held by the commercial banks.
• Other deposits held by the Central Bank.
• Total deposits with post office (excluding National Saving Certificates).

Question 8. Explain ‘difficulty in storing wealth problem faced in barter system of exchange. (All India 2017) Answer: In barter system of exchange, goods were exchanged for goods. Due to absence of money in barter system, wealth was stored in terms of goods. Storing of goods carried some problems like cost of storage, loss in value of goods due to passage of time, difficulty to transfer from one place to other, etc. So, it was difficult for people to store their purchasing power under barter system of exchange.

Question 9. Explain the medium of exchange function of money. (All India 2017,2013) Or Explain the significance of medium of exchange function of money. (Delhi 2014) Answer: The primary function of money is, acting as a medium of exchange between two parties involved in a transaction. It avoids the practical problems of wastage of time and resources, involved in the barter system of an exchange and it improves the transactional efficiency. It also promotes allocational efficiency in the trade and production of goods and services. Hence, it can be said that money has separated the acts of sales and purchases.

Question 10. Explain the significance of the unit of account function of money. (All India 2014) Or Explain the ‘unit of account’ function of money. (All India (C) 2014, 2013) Answer: Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

This function of money makes it possible to measure the value of different goods and services in a common value and facilitates the keeping of business accounts. It would not be possible to keep business account unless all business transaction are expressed in terms of money.

Question 11. Explain the significance of standard of deferred payment function of money. (All India 2014, 2012) Answer: Money simplifies the mechanism of deferred payments significantly. Deferred payments means future payment. When we take a loan from somebody, we not only pay the principal amount but also the interest amount. Under barter system of exchange, it was very difficult to make such transactions. As money maintains a standard value over a period of time, provided price remains constant, deferred payments can be easily made.

Question 12. Explain the problem of double coincidence of wants faced under barter system. How has money solved it? (Delhi 2013) Or Explain how money has solved the problem of double coincidence of wants. (Delhi (C) 2013) Answer: Barter system can only work, when both the persons are ready to exchange each other’s goods i.e. person A should have the good person B wants and vice-versa. But usually this type of double coincidence is rare, especially in modem times.

Money eliminates the problem of double coincidence of wants. In modern times, the buyer and the seller exchange goods for money, due to common measure of value function of money. It facilitates exchanges of goods and services and helps in carrying on trade smoothly.

Question 13. Explain the ‘medium of exchange function of money. How has it solved the related problem created by barter? (All India 2016) Answer: Medium of exchange function of money: Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

This function of money has solved the problem of ‘double co-incidence of wants’ created by the barter system of exchange. Under the barter system, it was very rare when the owner of some goods or services could find someone who wanted his goods or services and at the same time, he possessed that goods or services that the first person wanted, e.g. a man wanting rice in exchange of wheat had to find a man wanting wheat in exchange of rice.

This made the exchange of goods and services difficult. But the evolution of money has solved this problem. A person can sell his wheat in the market for money and from that money he can purchase rice. So, the ‘medium of exchange’ function of money has solved the problem of ‘double co-incidence of wants’ related with the barter system of exchange.

Question 14. Explain the ‘standard of deferred payment’ function of money. How has it solved the related problem created by barter? (All India 2016) Answer: Money simplifies the mechanism of deferred payments significantly. Deferred payments means future payment. When we take a loan from somebody, we not only pay the principal amount but also the interest amount. Under barter system of exchange, it was very difficult to make such transactions. As money maintains a standard value over a period of time, provided price remains constant, deferred payments can be easily made.

The related problem created by the barter system of exchange was ‘lack of standard of deferred payments’. In barter system, it was difficult to return value in future in terms of goods of same quantity and quality. Therefore, future payments regarding interest and loans became difficult. But money has solved this problem. Loans can be re-paid back in money and interest payments can also be made in money.

Question 15. Explain the ‘store of value’ function of money. How has it solved the related problem created by barter? (Delhi 2016) Answer: Money is an asset that retains its value over time. People store their wealth in the form of money, without fearing for loss in its value. Money overcomes the problem of storing perishable item under barter system of exchange. With money, people hold liquidity and value in a much more convenient manner.

The related problem of barter which this function of money has solved is the problem of ‘lack of store of value’. Due to absence of money in barter system, wealth was stored in terms of goods. Storing of goods carried sortie problems like cost of storage, loss of value, difficult to transfer from one place to other etc. So, it was difficult for people to store their purchasing power, under the barter system of exchange. But this problem was solved with the emergence of money as a medium of exchange.

Question 16. Explain the ‘unit of account’ function of money. How has it solved the related problem created by barter? Delhi 2016 Answer: Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

The related problem of barter which this function of money has solved is the problem of Tack of common measure of value’.In barter system, there was absence of a common unit of measurement in which the value of goods and services can be measured. In the absence of common unit, proper valuation was not possible.

e.g. cloth is measured in metre (i.e. length) while milk is measured in litre (i.e. capacity), hence both cannot be measured in a single unit, thereby complicating the process of exchange. But the evolution of money has solved this problem, and now every good or service can be measured in terms of money.

Question 17. How does money overcome the problems of barter system? Explain briefly. (All India 2011) Answer: Money overcomes the problem of barter system by replacing the C-C economy with monetary economy, as is explained below.

• In barter system, there was a problem of double coincidence of wants. It was very difficult to match the expectations of two different individuals. Thus, money was evolved to overcome the problem of coincidence of wants, as it was very difficult to find two persons having goods needed by each other in the barter system of exchange.
• When there was no money, it was difficult to give common unit of value to measure goods or services but when money evolved it gave a common unit of account to every goods and services.
• Money facilitates the contractual and future payments i.e. deferred payments which, were very difficult to pay under the barter system.
• Money is also a legal tender which has a general acceptance which was not the case under the barter system.

Question 18. Define ‘money multiplier’. (All India 2019) Answer: Money multiplier refer to the fraction by which money get multiplied in the process by the commerical banks.

Question 19. Define demand deposits. (All India 2019, 2015 (C). 2014, 2012, 2011, 2010; Delhi 2014, 2013, 2012) Answer: Demand deposits are current and savings account deposits with banks or other financial institutions, which are payable on demand.

Question 20. State the role played by the Central Bank as the “lender of last resort”. (All India 2019) Answer: Central Bank functions as a lender of last resort which means, when commercial banks fails to get credit from any other source, Central Bank help commercial banks by lending money.

Question 21. What is reverse repo rate? (All India (C) 2016) Answer: It is the rate at which the Central Bank accepts deposits of commercial banks.

Question 22. Give the meaning of cash reserve ratio. (Delhi (C) 2016) Or What is meant by cash reserve ratio? (All India (C) 2015; All India (C) 2014) Or Define cash reserve ratio. (Delhi 2011) Answer: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.

Question 23. What are time deposits? (All India 2014, All India (C) 2013,2012; Delhi (C) 2014, 2010) Or What are time deposits in banks? (All India (C) 2013) Answer: Time deposits are fixed term and recurring deposits having a fixed period of maturity, where the term of deposit may vary. Cheques cannot be issued against them and they are not payable on demand but these deposits yield interests for the depositor.

Question 24. What is a Central Bank? (Foreign 2014) Answer: The Central Bank is an apex banking institution which controls the entire banking system and money supply of a country. Reserve Bank of India is the Central Bank of India.

Question 25. What is statutory liquidity ratio? (All India (C) 2014) Or Define statutory liquidity ratio. (All India 2011) Answer: Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 26. What is meant by bank rate? (All India (C) 2014) Or What is bank rate? (Delhi (C) 2012) Answer: The rate at which Commercial Banks can borrow funds from Central Bank without any collateral security.

Question 27. Explain the bankers’ bank function of the Central Bank. All India 2017 Or Explain the role of Central Bank as banker’s bank. (All India (C) 2014) Or Explain the banker’s bank function of Central Bank. (Foreign 2016: All India 2015,2014: Delhi (C) 2013, Delhi 2012, All India (C) 2013) Answer: Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

Question 28. Explain the process of credit creation by commercial banks. (All India 2017) Or Explain the process of money creation by bank. (Delhi 2010) Or Explain the process of money creation by Commercial Banks with the help of a numerical example. (Delhi 2011; All India (C) 2010,2010) Answer: Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\) For example, let the LRR be 20% and Initial deposits = Rs 10,000 As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be Money Creation = 10,000 × \(\frac { 1 }{ 20% }\) = Rs 50,000

Question 29. Explain the currency authority function of Central Bank. (Foreign 2014) Or Explain the ‘bank of issue’ function of the Central Bank. (All India 2016; Delhi 2016) Answer: Central Bank of the country has the sole authority of currency issue in the country, which gives it a monopoly in issuing currency. As in India RBI issues the currency, while currency notes are printed by the subsidiaries of RBI and coins are minted by the Central Government of the country. However both currency notes and coins are circulated by RBI, which gives RBI the power to control, supervise and enhance the money supply in the economy.

Question 30. Explain lender of the last resort function of the Central Bank. (Delhi 2014,2010: All India 2013, 2010) Or Explain the role of Reserve Bank of India as lender of last resort. (March 2018: Delhi 2014; All India 2012) Answer: When a Commercial Bank fails to accommodate its financial requirements then it can approach the Central Bank and the Central Bank acts as the lender of last resort. The Central Bank issues loans to a Commercial Bank against specified and approved securities of the bank. In this way, the Central Bank ensures the smooth functioning of Commercial Banks and appropriate flow of credit in the economy.

Question 31. Explain the role of Central Bank as a ‘Banker to the government’. (Delhi (C) 2014) Or Explain the banker to the government function of the Central Bank. (Delhi 2013,2010: All India 2010) Or Explain ‘banker to the government’ function of the Central Bank. (Delhi 2017) Answer: Central Bank acts as a banker, advisor and agent to the Central and State Governments. As the common public keep their cash balance, demand deposits and time deposits with Commercial Banks, in the same way the Central Bank manages the cash reserves and demand deposits of governments in current accounts. It carries out the exchange, remittance and other banking operations on behalf of the government, i.e. the Central Bank maintains same relation with the government as Commerical Banks has with the general public.

Question 32. Explain the meaning of cash reserve ratio and statutory liquidity ratio. (All India 2010) Answer: Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio. Statutory liquidity ratio: Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 33. Distinguish between ‘Qualitative and Quantitative tools’ of credit control as may be used by a Central Bank. (All India 2019) Answer: Central Bank uses different instrument to control money supply. These tools can be broadly classified as (i) Quantitative tools These are those which directly impacts the quantity of money supply in the economy. These tools are very effective to either increase or decrease money supply. These tools includes

• Legal reserve ratio
• Open market operations
• Repo and reverse repo rate

(ii) Qualitative tools These on the other hand, are those which impacts the quality of money supply not volume. These are not much effective tool to control money supply. It includes

• Margin requirement
• Moral suasion
• Selective credit control.

Question 34. Discuss briefly the following functions of a Central Bank. (All India 2019) (i) Banker’s bank (ii) Lender of last resort Answer: (i) Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

(ii) When a Commercial Bank fails to accommodate its financial requirements then it can approach the Central Bank and the Central Bank acts as the lender of last resort. The Central Bank issues loans to a Commercial Bank against specified and approved securities of the bank. In this way, the Central Bank ensures the smooth functioning of Commercial Banks and appropriate flow of credit in the economy.

Question 35. Discuss briefly the ‘credit controller’ function of a Central Bank. (All India 2019) Answer: By credit control, it is meant that flow of credit can be regulated in such a way that it may rise or fall according to the needs of the economy. This is done by the Central Bank by using two types of tools which are stated below (i) Quantitative tools These are those which directly impacts the quantity of money supply in the economy. These tools are very effective to either increase or decrease money supply. These tools includes

Question 36. Explain, using a numerical example, how a reduction in reserve deposit ratio, affects the credit creation power of the banking svstem. (All India 2019) Answer: An increase in bank lending due to decrease in legal reserves should translate to an expansion of a country’s money supply. The size of the multiplier depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is the money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.

To calculate this, start with the amount banks initially take in through deposits and divide this by the reserve ratio. If, for example, the reserve requirement is 20% for every Rs 100, a customer deposits into a bank (from say earlier 25%), Rs 20 must be kept in reserve out of each Rs 100 deposited. However, the remaining Rs 80 can be loaned out to other bank customers. This Rs 80 is then deposited by the customers into another bank account, which in turn must also keep 20% or Rs 16 in reserve, but can lend out the remaining Rs 64.

This cycle continues as more people deposit money and more banks continue lending it until finally the Rs 100 initially deposited creates a total of Rs 500 (Rs 100/0.2) in deposits. As money multiplier is inversely associated with legal reserves ratio, i.e. money multiplier = \(\frac { 1 }{ LRR }\) and money created = Initial Bank Deposits × Money Multiplier.

So, if LRR is 25%, banks will create 4 time more money while if LRR falls to 20%, banks will create 5 times more money and so on.

Question 37. Discuss briefly the credit creation process of the banking system using a hypothetical numerical example. (All India 2019) Or Explain the credit creation role of Commercial Banks with the help of a numerical example. (All India (C) 2014,2013: Delhi (C) 2014) Or How do Commercial Banks create deposits? Explain. Delhi 2013 Or How does a Commercial Bank create money? All India 2010 Answer: Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\) For example, let the LRR be 20% and Initial deposits = Rs 10,000 As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be Money Creation = 10,000 × \(\frac { 1 }{ 20% }\) = Rs 50,000

Question 38. Explain, using a numerical example, how an increase in reserve deposit ratio affects the credit creation power of the banking system. (All India 2019) Answer: Reverse deposit ratio is the rate of interest at which commercial banks can park their surplus funds with the Central Banks for a short period of time. Increase in reverse deposit rate will reduce the credit supply and vice-versa. The following numerical example will make this clear Suppose the reverse deposit ratio is 3%. At this rate, commercial banks are willing to deposit Rs 10 crore with the Central Bank out of total deposits of Rs 50 crore. Assuming legal reserve ratio to be 10%, then Money creation = 40 × \(\frac { 1 }{ 0.1 }\) = Rs 400 crore Now, reverse deposit ratio rises to 5% and at this rate commercial banks are willing to deposit Rs 20 crore with the Central Bank out of total deposits of Rs 50 crore. Now, money creation = 30 × \(\frac { 1 }{ 0.1 }\) = Rs 300 crore. So, we see that as reverse deposit ratio rises, then credit creation falls.

Question 39. Explain the role of reverse repo rate in controlling money supply. (Delhi 2017) Answer: Reverse repo is the rate of interest at which commercial banks can deposit their surplus funds with the Central Bank for a short period of time.

It is an important quantitative tool for controlling money supply in the economy. If the Central Bank wants to increase money supply in the economy, then it reduces the reverse repo rate. With fall in reverse repo rate, the commercial banks reduce the deposits of surplus funds with the Central Bank, thereby increasing the money supply. On the other hand, if the Central Bank wants to decrease money supply, then it increases the reverse repo rate. With rise in reverse repo rate, the commercial banks increase the deposits of surplus funds with the Central Bank, thereby decreasing the money supply.

Thus, reverse repo rate plays an important role in controlling money supply.

Question 40. Explain how repo rate can be helpful in controlling credit creation? (All India 2016) Answer: Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

On the other hand, if the RBI wants to increase the level of credit creation in the economy then it decreases the repo rate which makes the credit cheaper. As the cost of borrowings fall, people’s demand for credit goes up. This leads to increase in the rate of credit creation.

Question 41. Explain the role of cash reserve ratio in controlling credit creation. (All India 2016) Answer: Cash Reserve Ratio (CRR) is the fraction of total deposits that each commercial bank must keep with the Central Bank of the country, as a part of fractional reserve system.

CRR is an important quantitative tool in controlling the credit creation in the country. When the Central Bank wants to decrease the level of credit creation in the economy, it increases the CRR. As the CRR increases, the loanable deposits left with the commercial bank decreases. This reduces the lending powers of the bank and as a result, the process of credit creation falls.

If on the other hand, the Central Bank wants to increase the level of credit creation in the country, it lowers the CRR. As the CRR decreases, the loanable deposits left with the commercial banks increases. This increases the lending powers of the banks and as a result, the level of credit creation in the country rises.

Question 42. Explain how ‘margin requirements’ are helpful in controlling credit creation? (Delhi 2016) Answer: ‘Margin requirements’ refer to the difference between the amount of loan granted and the current value of security offered for loans. It is an important qualitative instrument for controlling credit creation. If the Central Bank of the country wants to expand the process of credit creation, then it lowers the margin requirements. Lowering of margin requirements enables the borrower to borrow more against the security offered. This increases the money supply in the economy and credit creation expands.

On the other hand, if the Central Bank wants to contract the process of credit creation, then it increases the margin requirements. Increasing margin requirements ensures that the borrower is able to borrow less against the security offered. This reduces the money supply in the economy and consequently credit creation contracts.

Question 43. Explain how bank rate is helpful in contrplling credit creation? (Delhi 2016) Or How does the Central Bank control credit creation in the economy through bank rate? Explain. (All India (C) 2014) Or How do changes in bank rate affect money creation by Commercial Banks? (Delhi 2010) Or How do changes in bank rate affect the money supply in an economy? Explain. (Delhi (C) 2015) Answer: The rate at which Commercial Banks can borrow money from RBI, when they run short of reserves, is called bank rate. When the Central Bank increase the bank rate, it increases the cost of borrowing and hence, discourages the borrowers from taking a loan.

Due to this, the process of credit creation and flow of money also reduces. On the other hand, when the Centred Bank decreases the bank rate, it encourages the borrower to take more and more loan. A high demand of loan increases the credit multiplier and credit creation process of the Commercial Banks.

Question 44. Explain how open market operations are helpful in controlling credit creation? (Delhi 2016) Or How does Central Bank control credit creation by Commercial Banks through open market operations? Explain. (All India 2013) Or Explain, how do open market operations by the Central Bank affect money creation by Commercial Banks? (All India 2010) Or Explain the meaning of open market operations. How is it used to reduce money supply in the economy? (All India (C) 2016) Answer: Under open market operations, RBI purchases or sells government securities to general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of public as they deposit or withdraw the money from Commercial Banks. Thus, money creation by Commercial Banks get affected.

Suppose, the Central Bank purchases securities of Rs 1,000 from a bond holder with issuing a cheque. The seller of the bond produces this cheque of Rs 1,000 to his Commercial Bank. The Commercial Bank credits the account of the seller by Rs 1,000 and the deposits of the bank goes up by Rs 1,000, which increase the credit creation capacity of the banks.

Thus, purchase of security increases the money creation of Commercial Banks and similarly, sale of securities decreases the credit creation of Commercial Banks. Thus, the Central Bank controls the process of money creation by Commercial Banks by open market operations.

Question 45. What is Legal Reserve Ratio? Explain its components. (All India (C) 2013) Or Explain the components of Legal Reserve Ratio. (Delhi 2012) Answer: The minimum percentage of a bank’s total demand and time deposits, that is required to be maintained in the form of cash or specified liquid assets by the Commercial Banks with the Central Bank is termed as Legal Reserve Ratio. The components of Legal Reserve Ratio are as follows

• Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.
• Statutory liquidity ratio: Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 46. Explain any two methods of credit control used by Central Bank. (All India 2013) Answer: The Central Bank acts as a controller of money supply and credit, using the following methods (i) Margin requirement It is a qualitative method of credit control. A margin refers to the difference between market value of the security offered for loan and the amount loan offered by the Commercial Banks. During inflation, supply of credit is reduced by raising the requirement of margin. During deflation supply of credit is increased by lowering the requirement of ‘margin’. This measure is often used to discourage the flow of credit into speculative business activities.

(ii) Under open market operations, RBI purchases or sells government securities to general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of public as they deposit or withdraw the money from Commercial Banks. Thus, money creation by Commercial Banks get affected.

Question 47. (a) State any two components of M 1 measure of money supply. (b) Elaborate any two instruments of credit control, as exercised by the Reserve Bank of India. Delhi 2019 Answer: (a) Components of Money Supply: The total stock of money in circulation among the public at a particular point of time is called money supply. Money supply comprises of the following components:

(b) Two instrument of credit control are as follows (i) Repo rate: Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

(ii) Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.

Question 48. Define credit multiplier. What role does it play in determining the credit creation power of the banking system? Use a numerical illustration to explain. (Delhi 2019) Answer: Credit or money multiplier refers to the fraction by which commercial banks would be able to multiply money from their initial level of deposits. It is obtained by the following formula Credit/Money Multiplier = \(\frac { 1 }{ Legal Reserve Rato (LRR) }\)

Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\) For example, let the LRR be 20% and Initial deposits = Rs 10,000 As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be Money Creation = 10,000 × \(\frac { 1 }{ 20% }\) = Rs 50,000

Question 49. Describe any two methods by which Reserve Bank of India can regulate money supply. (Delhi (C) 2016) Answer: (i) Reverse repo rate: It is the rate at which the Central Bank accepts deposits of commercial banks.

(ii) Repo rate: Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

Question 50. Describe any two functions of Central Bank. (Delhi (C) 2016) Or Explain any two main functions of a Central Bank. (All India (C) 2015: Delhi (C) 2015, Delhi (C) 2012) Or Explain any two functions of Central Bank. (All India (C) 2012) Or Explain the following functions of the Central Bank. (All India 2011) (i) Bank of issue (ii) Banker’s bank Answer: (i) Central Bank of the country has the sole authority of currency issue in the country, which gives it a monopoly in issuing currency. As in India RBI issues the currency, while currency notes are printed by the subsidiaries of RBI and coins are minted by the Central Government of the country. However both currency notes and coins are circulated by RBI, which gives RBI the power to control, supervise and enhance the money supply in the economy.

(ii) Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

Multiple Choice Questions

Question 1. Money supply includes (Choose the correct alternative) (All India (C) 2016) (a) all deposits in banks (b) only demand deposits in banks (c) only time deposits in banks (d) currency with the banks Answer: (b) Only demand deposits in banks

Question 2. Who regulates money supply? (Choose the correct alternative) (All India (C) 2016) (a) Government of India (b) Reserve Bank of India (c) Commercial Banks (d) Planning Commission Answer: (b) Reserve Bank of India

Question 3. Which of the following is not a function of money? (Delhi (C) 2015) (Choose the correct alternative) (a) Medium of exchange (b) Price stability (c) Store of value (d) Unit of account Answer: (b) Price stability

Question 4. Which of the following is not a problem of barter system of exchange? (Delhi (C) 2015) (a) Store of value (b) Double coincidence of wants (c) Unit of account (d) Unemployment Answer: (d) Unemployment

Question 5. In order to encourage investment in the economy, the Central Bank may (Choose the correct alternative) (All India 2019) (a) Reduce Cash Reserve Ratio (b) Increase Cash Reserve Ratio (c) Sell Government securities in open market (d) Increase Bank Rate Answer: (a) Reduce Cash Reserve Ratio

Question 6. Credit creation by commercial banks is determined by (April re-exam 2018) (Choose the correct alternative) (a) Cash Reserve Ratio (CRR) (b) Statutory Liquidity Ratio (SLR) (c) Initial deposits (d) All of the above Answer: (d) All of the above

Question 7. The Central Bank can increase availability of credit by (Choose the correct alternative) (March 2018) (a) Raising repo rate (b) Raising reverse repo rate (c) Buying government securities (d) Selling government securities Answer: (c) Buying government securities

Question 8. The ratio of total deposits that a commercial bank has to keep with Reserve Bank of India is called (Choose the correct alternative) (Delhi 2017) (a) Statutory liquidity ratio (b) Deposit ratio (c) Cash reserve ratio (d) Legal reserve ratio Answer: (c) Cash reserve ratio

Question 9. Demand deposits include (Choose the correct alternative). (All India 2017) (a) saving account deposits and fixed deposits (b) saving account deposits and current account deposits (c) current account deposits and fixed deposits (d) All types of deposits Answer: (b) Saving account deposits and current account deposits

Question 10. The definition of money includes (a) currency and foreign exchanges (b) currency demand deposit and other financial assets (c) only currency and coins (d) currency and demand deposits Answer: (b) currency demand deposit and other financial assets

Question 11. Which of the following is an example of plastic money? (a) Prepaid gift card (b) Traveller’s cheque (c) Currency note (d) Demand draft Answer: (a) Prepaid gift card

Question 12. Supply of money is concept. (a) stock (b) flow (c) income (d) All of these Answer: (a) stock

Question 13. measures of money supply issued by RBI are known as broad money. (a) M 1 and M 1 (b) M 2 and M 3 (c) M 3 and M 4 (d) High powered money Answer: (c) M 3 and M 4

Question 14. The difference between lending rates and borrowing rates of a commercial bank, is called (a) capital (b) reserves (c) profits (d) All of the above Answer: (c) profits

Question 15. LRR (Legal Reserve Ratio) includes (a) CRR (Cash Reserve Ratio) (b) Repo (c) SLR (Statutory Liquidity Ratio) (d) Both (a) and (c) Answer: (d) Both (a) and (c)

Question 16. The process of credit/money creation in an economy is affected by (a) initial deposits amount (b) LRR (c) bank rate (d) Both (a) and (b) Answer: (d) Both (a) and (b)

Question 17. If LRR is 20% and initial deposit is Rs 10,000 in a commercial bank, find total money creation amount. (a) Rs 5,000 (b) Rs 5,00,000 (c) Rs 50,000 (d) Rs 2,000 Answer: (c) Rs 50,000

Question 18. Which is not a feature of fixed deposit accounts? (a) Specific period of time (b) Higher interest rate (c) Payable on demand (d) Tax benefit Answer: (c) Payable on demand

Question 19. Central Bank is a banker to (a) State Government (b) Other banks (c) Central Government (d) All of the above Answer: (d) All of the above

Question 20. Commercial banks maintain for liquidity and to honour the demand of cash withdrawals by their customers. (a) SLR (b) margin requirements (c) CRR (d) repo Answer: (a) SLR

Question 21. What can RBI do, if it wants to increase credit in the economy? (a) Decrease repo and CRR (b) Increase repo and CRR (c) Increase repo and decrease CRR (d) Decrease repo and increase CRR Answer: (a) Decrease repo and CRR

Question 22. Functions performed by Central Bank related to government does not include which of the following? (a) RBI manages public debt (b) RBI also sells treasury bills (c) RBI make advances which are repayable within 90 days (d) RBI comes to rescue the other banks in times of financial crises Answer: (d) RBI comes to rescue the other banks in times of financial crises

Commerce Aspirant » Economics Class 12 » Money and Banking Class 12 Notes Economics

Money and Banking Class 12 Notes Economics

Money and Banking class 12 Notes covers various concepts about  (a) Money used in the Indian economy (b) Role of commercial and central banks in supply of money and credit creation.

Money is the basic requirement of all economies . Prior to invention of money,    world  trade was conducted under the barter system of exchange, wherein one  commodity was exchanged for another commodity. You can understand more about this aspect here : –

Money and Banking Class 12 Notes Economics: Overview

What is money .

Money is anything which is generally used as a medium of exchange, measure of value, store of value and means of standard deferred payment. In other words, money has the following characterstics : –

• It can be used as a medium of exchange ;
• It can be used as a measure of value ;
• It can be used as a store of value ; and
• It can be used as a means of standard deferred payment

Money covers all types of money: coins, paper notes, cheques, digital money, plastic money etc…. Money can be used to buy any product, services or other things.  Where a particular form of money is legalised by the Government,  it has to be accepted by everyone. The existence of money, removes the problem of double coincidence of wants , since a person can use money to buy another commodity, as the seller does not need to have a specific need, which can be fulfilled by buyer.

FUNCTIONS OF MONEY

The functions of money are broadly classified as:

• Primary Functions
• Secondary Functions

TYPES OF MONEY

• Legal Tender Money: Money which can be legally used to make payments for some obliged debt is known as legal tender money . It is of two types-
• Limited legal tender money : It is that form of legal money which is used to make payments for the debts up to a certain amount. For example; coins.
• Unlimited legal tender money : It is that form of legal money which can be used to make payment of debts up to any amount. There is no limit fixed. For example; paper/ currency notes.
• Full Bodied Money : It is that form of money in which face value is equal to intrinsic value of money. It means commodity value= money value. For example: gold and silver coins.
• Representative Full Bodied Money : It is that form of full bodied money in which intrinsic value is less than face value of money. It means commodity value< money value. For example: paper notes.
• Credit Money: It is that form of money whose intrinsic value is lower than its face value. It means that money value> commodity value. For example: credit cards, bank deposits etc….

MONETARY SYSTEM IN INDIA

• In India, monetary authority is ‘Reserve Bank of India’.
• Paper currency standard is followed in India.
• Coins are regarded as limited legal tender money.
• RBI has sole monopoly to issue currency in India.
• Ministry of Finance issues 1 rupee coins and notes in India.
• India follows Minimum Reserve System for issuing notes. It means that RBI has to keep a minimum of Rs. 200 crores as gold and foreign exchange with the World Bank for issuing coins and notes.

MONEY SUPPLY

Money supply refers to the total money held by public at a particular point of time in an economy.

It includes money only held by the “public” not the government or banking system. Money supply is a “Stock” concept.

There are 4 measures of money supply. As per money and banking class 12 we need to cover only M 1 measure of money supply.

MEASURES OF MONEY SUPPLY

(i) M 1 : It is the first and basic measure of money supply. It includes currency held by the public, demand deposits of commercial banks and other deposits with the RBI. M 1 = Currency and coins with public+ Demand deposits with commercial banks+ Other deposits with RBI

(ii) M 2 : It is a broader concept of money supply as compared to M 1 . It also includes savings deposits with the post office saving bank. M 2 = M 1 + Savings deposit with Post office saving bank

(iii) M 3 : It also includes net time deposits in addition to M 1 measure of money supply. M 3 = M 1 + Net time deposits with banks

(iv) M 4 : It includes total deposits with post office savings bank in addition to M 3 measure of money supply. M 4 = M 3 + Total deposits with post office saving bank

• M 1 is the most liquid form of money supply while M 4 is the least liquid.
• M 1 and M 2 are considered the narrow concept of money supply while M 3 and M 4 are the broader concept of money supply.

HIGH POWERED MONEY

• High powered money is the money produced by RBI and the government.
• It includes currency held by the public and the cash reserves held by the banks.
• It is denoted by symbol (H).
• It is different from money because money consists of demand deposits while it includes cash reserves which act as a base for generating demand deposits.

There are mainly 2 types of banks, Commercial Banks and Central Banks. In money and banking class 12 we will study about the functions of both banks and the credit creation process of commercial banks.

COMMERCIAL BANKS

A commercial bank is a bank which accepts deposits and advance loans for the purpose of earning profits. For example: SBI, PNB, Canara Bank, Kotak Mahindra Bank etc….

CREDIT CREATION PROCESS

This is an important activity of commercial bank. Through this process, commercial banks create credit, which is created through excess reserves of the initial deposits.

There are two main assumptions

1. The entire banking system is one unit known as “BANK”. 2. All the receipts and payments in the economy is done through the Banks.

For the credit creation, commercial banks are legally required to keep a certain fraction of deposits with RBI and themselves. This fraction is called Legal Reserve Ratio (LRR).

The bank knows that all the customers will not come in one go to withdraw their money and that there is a constant flow of money with the bank. That’s why only a fraction of deposits are kept as reserve.

• Money creation is an important aspect of money and banking class 12. Let us take a hypothetical example to understand this concept.
• Let us assume that LRR= 10% and Initial deposits= Rs. 100.
• Now, the banks will keep 10% of Rs. 100 as reserve and give the rest Rs.90 as loan to the public in round 1.
• In round 2, banks will keep 10% of Rs. 90 as reserve and give Rs. 81 as loan to public.
• This process goes on and on till the reserves are exhausted. In this way, commercial banks create multiple credits with just the initial deposit.
• This gives rise to the concept of “Money Multiplier”.
• “Money Multiplier” or deposit multiplier measures the amount of deposits the commercial banks are able to create through the deposits of public kept with them as reserves. Money Multiplier = 1/LRR
• In this case, money multiplier is 1/10% = 10.

Total Deposits=  = 100*10= Rs. 1000

CENTRAL BANKS

Central bank is the ‘apex’ body that controls, regulates and operates the entire banking system in the country. In India, the central bank is RBI.

FUNCTIONS OF CENTRAL BANK

• Bank of issue: Central bank has the sole authority to issue currency notes and coins (except one rupee notes and coins). The central bank is obliged to keep the reserves in terms of gold equal to the amount of currency issued with the World Bank. It leads to uniformity in note circulation. It gives the power to Central Bank to enhance the money supply. It also helps in maintaining stability in value of money.
• Bankers to Government: The RBI acts as a banker, agent and a financial advisor to the central and state government. As a banker, it carries out all the banking business of the government. As an agent, it manages the public debt. As a financial advisor, it advices the government from time to time in financial and monetary matters.
• Banker’s Bank: Being the apex bank, central bank acts as a banker to all other banks. Other banks in the economy keep their reserves with the RBI. It has same relationship with other banks as the commercial banks have with the public. It obliges the commercial banks to keep CRR with them during the credit creation process.
• Custodian of Foreign Exchange: Central banks keep the reserves of foreign currency with themselves so that there is no excess increase or decrease in price of foreign currency. Central bank does this so that foreign reserves are available to the public.
• Lender of Last Resort: When commercial banks fail to meet the needs of the public, then RBI helps the commercial banks and the public by advancing loans to them and acts as a lender of last resort.
• Clearing House: Central bank has the reserves of commercial banks with themselves. All commercial banks have their accounts with the RBI. Therefore, RBI can make settlement of claims of various banks against each other by editing the entries in their accounts.
• Supervisor: Central bank regulates and controls the commercial banks. It exercises regular inspection and of banks and entries passed by them.

CONTROL OF CREDIT AND MONEY SUPPLY

There are TWO ways of controlling the credit creation in the market: Quantitative measure and Qualitative measures.

QUANTITATIVE MEASURES

• Repo Rate: It is the rate at which central bank gives money to commercial banks for short- term purpose without any collateral. An increase in repo rate reduces the capability of commercial banks to lend money and thus decreases money supply in the economy. A decrease in repo rate increases the money supply in the economy.
• Bank Rate: It is the rate at which central bank lends money to commercial banks for long- term purpose by keeping something as collateral. An increase in bank rate will decrease the lending capacity of commercial banks and thus reduces money supply in the economy. A decrease in bank rate increases the money supply in the economy.
• Reverse Repo Rate: It is the rate at which commercial banks keep their reserves with central bank in order to earn interest willfully. An increase in reverse repo rate induces commercial banks to keep reserves with central bank rather than giving to public. So, money supply decreases in the economy. A decrease in reverse repo rate increases the money supply in the economy.
• Legal Reserve Ratio (LRR): It is the amount of deposits which the commercial banks are obliged to keep with themselves and the central bank for credit creation process. There are two parts of LRR: CRR and SLR.
• Cash Reserve Ratio (CRR): It is the amount of deposits which the commercial banks are obliged to keep with the central bank for creating credit in the economy. An increase in CRR decreases money supply in economy and decrease in CRR increases money supply in the economy.
• Statutory Liquidity Ratio (SLR): It is the amount of deposits which the commercial banks are obliged to keep with themselves for the credit creation process. An increase in SLR decreases money supply in economy and decrease in SLR increases money supply in the economy.

QUALITATIVE MEASURES

• Open Market Operations: It refers to the sale and purchase of securities in the open market by the central bank to/from commercial banks or public. Purchase of securities by central bank increases the bank capacity to give credit as it receives money and thus it increases the money supply in the economy. Sale of securities by commercial banks soaks the excess money from the economy and thus reduces the money supply in the market.
• Margin Requirement: It refers to the difference between the amount of loan and the market value of the securities offered against the loan. An increase in margin reduces the borrowing capacity and reduces the money supply in the economy. A decrease in margin increases the borrowing capacity and increases the money supply in the economy.

DIFFERENCE BETWEEN COMMERCIAL BANK AND CENTRAL BANK

CBSE Economics Class 12 Notes Term I Syllabus

Part A: Introductory Macroeconomics

• Money and Banking Class 12 Notes
• Government Budget and the Economy Notes
• Balance of Payments Class 12 Notes
• Foreign Exchange Rate Notes

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Development Experience (1947-90) and Economic Reforms since 1991:- 12 Marks

• Indian Economy on the eve of Independence Notes
• Indian Economy (1950-90) Notes
• Economic Reforms since 1991 Notes

Current challenges facing Indian Economy – 10 Marks

• Poverty Class 12 Notes
• Human Capital Formation Class 12
• Rural Development Class 12 Notes
• Economics Class 12 Notes
• Business Studies Class 12 Notes
• Accountancy Class 12 Notes
• Economics Class 12 MCQs
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Money and Banking: Class 12 Notes Everything You Need to Know

If you're a student of Class 12, you may be looking for simplified and comprehensive Notes on Class 12 Macroeconomics Chapter 3 Money and Banking that can help you to understand complex concepts and theories. These detailed notes cover all the important topics, from the functions of money to the role of central banks in the modern economy. Whether you're studying for an exam or just trying to deepen your understanding, these notes are a valuable resource.

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The Ultimate Guide to Money and Banking Class 12 Economics Notes

Barter exchange.

Meaning : Economic exchanges without the mediation of money are referred to as barter exchanges.

Disadvantages of Barter Exchange

• Lack of double coincidence of wants : A common problem with the barter system is the lack of double coincidence of wants which means that if one wants to exchange some good with another person then the latter must also be willing to exchange his/her good with the former. For example, let a person wants cloth and he has a stock of wheat with him to exchange for it. In such a case the person can exchange wheat for cloth with another person who has cloth and who also wants wheat.
• Search cost is high.
• Lack of division of goods.
• The problem of storage.
• Loss of value.

Definition: Money is anything that is generally accepted as a means of exchange, a measure and store of value, and which also acts as a standard of deferred payments.

Functions of Money

• Medium of Exchange : Money acts as a medium of exchange for all goods and services. The use of money has greatly facilitated the process of exchange by dividing it into two parts i.e. sale and purchase.
• Unit of Account : The value of all goods and services can be expressed in monetary units. When we say that the value of a certain wristwatch is ₹ 500 we mean that the wristwatch can be exchanged for 500 units of money, where a unit of money is rupee in this case.
• Store of Value : Money is not perishable and its storage costs are also considerably lower. It is also acceptable to anyone at any point of time. Thus money can act as a store of value for individuals. Wealth can be stored in the form of money for future use.
• Standard of Deferred Payments : Deferred payments are payments to be made at some future date. Money serves as a standard of such deferred payments. This function has facilitated borrowing and lending. The function has also led to the creation of financial institutions.

Demand for Money

Meaning: The demand for money tells us what makes people desire a certain amount of money. It is a stock concept.

Demand for money depends on :

i. Quantum of transactions: Since money is required to conduct transactions, the value of transactions will determine the money people will want to keep. Since the quantum of transactions to be made depends on income, it should be clear that a rise in income will lead to a rise in demand for money.

ii. Interest rates: When interest rates go up, people become less interested in holding money since holding money amounts to holding less of interest-earning deposits, and thus less interest received. Therefore, at higher interest rates, money demand comes down.

Supply of Money

Meaning: The total stock of money in circulation among the public at a particular point of time is called money supply.

• The money supply is a stock concept.
• In a modern economy, the money supply comprises cash (currency notes and coins) and bank deposits .
• In India currency notes are issued by the Reserve Bank of India (RBI), except coins and ₹ 1 note.
• Coins and ₹ 1 notes are issued by the Government of India (Ministry of Finance).
• ₹ 1 note bears the signature of the Finance Secretary of India.
• Demand Deposit: The balance in savings, or current account deposits, held by the public in commercial banks is also considered money since cheques drawn on these accounts are used to settle transactions. Such deposits are called demand deposits as they are payable by the bank on demand from the account holder.
• Time Deposit: Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits.
• Every currency note bears on its face a promise from the Governor of RBI that if someone produces the note to RBI, or any other commercial bank, RBI will be responsible for giving the person purchasing power equal to the value printed on the note. The same is also true of coins. Currency notes and coins are therefore called fiat money . They do not have intrinsic value like gold or silver coin. They are also called legal tenders as they cannot be refused by any citizen of the country for settlement of any kind of transaction.
• Cheques drawn on savings or current accounts, however, can be refused by anyone as a mode of payment. Hence, demand deposits are not legal tenders.

Depending on what types of bank deposits are included, there are many measures of money.

Measures of Money Supply:

RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are defined as follows:

• M1 = CU + DD
• M2 = M1 + Savings deposits with Post Office savings banks
• M3 = M1 + Net time deposits of commercial banks
• M4 = M3 + Total deposits with Post Office savings organizations (excluding National Savings Certificates)

Here, CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks. The word ‘net’ implies that only deposits of the public held by the banks are to be included in the money supply. The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of the money supply.

• M1 and M2 are known as narrow money.
• M3 and M4 are known as broad money.
• These measures are in decreasing order of liquidity. M1 is the most liquid and easiest for transactions whereas M4 is the least liquid of all.

High-Powered Money : The currency (notes + coins) is created by the central bank (Reserve Bank of India in India) and is called the High-Powered Money /Reserve money/Monetary base.

Bank Money: Demand deposits are created by commercial banks and are called Bank money.

Commercial Banks

Meaning: The commercial bank is a financial institution that is primarily concerned with accepting deposits from the public and lending to the public besides others.

• These banks operate both under the public as well private sectors.
• Some public sector banks include the State Bank of India, Punjab National Bank, and Bank of India among others.
• The private sector commercial banks may include the banks namely HDFC Bank, ICICI Bank, and Axis Bank among others.

Credit Creation by Commercial Banks/The Process of Money Creation:

Basic Terms :

• Cash Reserve Ratio (CRR) : Percentage of deposits which a bank must keep as cash reserves with the Central bank (RBI). It is also known as the ‘Required Reserve Ratio’ or the ‘Reserve Ratio’. [ It is kept with the Central Bank (RBI) ]
• Statutory Liquidity Ratio (SLR) : The bank is also required statutorily to maintain a certain proportion of its total deposits as liquid assets in the form of cash, gold, and certain government-approved securities. This is known as Statutory Liquidity Ratio (SLR). [ It is kept with the bank itself ]
• Legal Reserve Ratio (LRR) : The CRR and SLR together form the LRR which is determined by the central bank of a country (R.B.I. in the case of India)

Why are the banks required to keep only a fraction of deposits as cash reserves? What will banks do if the demand for cash withdrawn is more than cash reserves at some point of time?

There are two reasons:

• First, the banking experience has revealed that not all depositors approach the banks for withdrawal of money at the same time, and also that normally they withdraw a fraction of deposits.
• Secondly, there is a constant flow of new deposits for withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as cash reserve.

Assumptions :

• Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply ‘’banks’.
• Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing a cheque. The one who receives payment deposits the same in his deposit account.

Let us now explain the process. Suppose the initial deposit in banks is ₹ 100 and the LRR is 20% (Note: 20% = 20 / 100 = 0.2). Further, suppose that banks keep only the minimum required i.e. ₹ 20 as cash reserve. Banks are now free to lend the remainder ₹ 80. Suppose they lend ₹ 80. What banks do is to open deposit accounts in the names of the borrowers who are free to withdraw the amount whenever they like. Suppose they withdraw the whole of amount for making payments.

Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposits in banks by ₹ 80. It is 80% of the initial deposit. These deposits of ₹ 80 have resulted on account of loans given by the banks. In this sense, the banks are responsible for money creation. With this round increase in total deposits is now ₹ 180 (=100+80).

When banks receive a new deposit of ₹ 80, they keep 20% of it as cash reserves and use the remaining ₹ 64 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise but by a smaller amount of ₹ 64. The Total deposits now increase to ₹ 244 (=100+80+64).

The deposit creation continues in the above manner. The deposit creation comes to an end when total cash reserves become equal to the initial deposit. The total deposit creation comes to ₹ 500, five times the initial deposit as shown in the table below:

Money Multiplier: It tells us how many times the total deposits would be of the initial deposit.

In our above illustration, the LRR is 0.2,

∴ Money multiplier = 1 / 0.2 = 5

Total Money created = Initial Deposit / LRR = 100 / 0.2 = ₹ 500

Central Bank

The Central Bank is the apex institution of a country’s monetary system. Almost every country has one central bank. India got its central bank in 1935. Its name is the ‘Reserve Bank of India’.

Functions of Central Banks

1. Bank of Issue : The Central Bank is the sole authority for the issue of currency in the country. It promotes efficiency in the financial system. Firstly, this leads to uniformity in the issue of currency. Secondly, it gives the Central Bank direct control over the money supply.

2. Banker to the Government :

The Central Bank acts as a banker to the government - both Central as well as State governments. It carries out all the banking business of the government, and the government keeps its cash balances in a current account with the Central Bank.

As the banker to the government, the Central Bank accepts receipts and makes payments for the government, and carries out exchange, remittance, and other banking operations. The Central Bank also provides short-term credit to the government, so that the government can meet any shortfalls in receipts over disbursements. The government borrows money by selling treasury bills to the Central Bank. The government carries on short-term borrowings by selling ad-hoc treasury bills to the Central Bank.

As the government’s banker, the Central Bank also has the responsibility of managing the public debt. This means that the Central Bank has to manage all new issues of government loans.

The Central Bank also advises the government on banking and financial matters.

3. Bankers’ Bank

As the banker to banks, the Central Bank holds a part of the cash reserves of banks, lends them short-term funds, and provides them with centralized clearing and remittance facilities. The banks are required to deposit a stipulated ratio of their net total liabilities (the CRR) with the Central Bank. The purpose of this stipulation is to use these reserves as an instrument of monetary and credit control. In addition to this, the bank holds excess reserves with the Central Bank to meet any clearing drains due to settlement with other banks or net withdrawals by their account holders. The pool of funds with the Central Bank serves as a source from which it can make advances to banks temporarily in need of funds, acting in its capacity as a lender of last resort.

The Central Bank supervises, regulates, and controls the commercial banks. The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation(merging of banks), and liquidation (the winding up of banks). The control is exercised by periodic inspection of banks and the returns filed by them.

4. Controller of Credit

The Central Bank controls the money supply and credit in the best interests of the economy. The bank does this by taking recourse to various instruments. These are:

• Bank Rate Policy: The bank rate is the rate at which the central bank lends funds to banks. The effect of a change in the bank rate is to change the cost of securing funds from the central bank. An increase in the bank rate increases the costs of borrowing from the central bank. This will reduce the ability of banks to create credit. A rise in the bank rate will then cause the banks to increase the rates at which they lend. This will then discourage businessmen and others from taking loans, thus reducing the volume of credit. A decrease in the bank rate will have the opposite effect.
• Open Market Operations : OMO is the buying and selling of government securities by the Central Bank from/to the public and banks. It does not matter whether the securities are bought or sold to the public or banks because ultimately the amounts will be deposited in or transferred from some bank. The sale of government securities to banks will have the effect of reducing their reserves. When the bank gives the Central Bank a cheque for the securities, the Central Bank collects the amounts by reducing the bank’s reserves by a particular amount. This directly reduces the bank’s ability to give credit and therefore decreases the money supply in the economy. When the Central Bank buys securities from the banks it gives the banks a cheque drawn on itself in payment for the securities. When the cheque clears, the Central Bank increases the reserves of the bank by a particular amount. This directly increases the bank’s ability to give credit and thus increases the money supply.
• Cash Reserve Ratio: Banks are obliged to maintain reserves with the Central Bank. The banks are required to deposit with the Central Bank a percentage of their net demand and time deposits. This minimum percentage is fixed by the Central Bank and is called Cash Reserve Ratio. Varying the CRR is a tool of monetary and credit control. An increase in the CRR has the effect of reducing the bank’s excess funds and thus curtails its ability to give credit.
• Statutory Liquidity Ratio : Banks are also required to maintain a specified percentage of their net total demand and time deposits in the form of designated liquid assets with themselves. This specific percentage is called Statutory Liquidity Ratio (SLR).
• Margin Requirements: A margin is the difference between the amount of the loan and the market value of the security offered by the borrower against the loan. If the margin imposed by the Central Bank is 40%, then the bank is allowed to give a loan only up to 60% of the value of the security. By altering the margin requirements, the Central Bank can alter the amount of loans made against securities by the banks.
• Repo Rate: When commercial banks are in need of funds for a short period, they can borrow from the Central Bank. The rate of interest charged by the Central Bank on such lending is called Repo Rate. Raising Repo Rate makes such borrowings by commercial banks costly. As such when Repo Rate is raised, banks are also forced to raise their lending rates. This has a negative effect on demand for borrowings from commercial banks. Lowering Repo Rate has the opposite effect.
• Reverse Repo Rate: When the commercial banks have surplus funds they can deposit the same with the central bank and earn interest. The rate of interest paid by the Central Bank on such deposits is called Reverse Repo Rate . When this rate is raised, it encourages commercial banks to park their funds with the central bank. This has a negative effect on the lending capability of commercial banks. Lowering Reverse Repo Rate has the opposite effect which raises demand for borrowings from commercial banks.

Demonetization

Demonetization was a new initiative taken by the Government of India in November 2016 to tackle the problem of corruption, black money, terrorism, and the circulation of fake currency in the economy.

Old currency notes of ₹ 500, and ₹ 1000 were no longer legal tender. New currency notes in the denomination of ₹ 500 and ₹ 2000 were launched.

Negative Impacts

• There were long queues outside banks and ATM booths.
• The shortage of currency in circulation had an adverse impact on the economic activities.

Positive Impacts

• It improved tax compliance as a large number of people were bought in the tax ambit.
• The savings of an individual were channelized into the formal financial system. As a result, banks have more resources at their disposal which can be used to provide more loans at lower interest rates.
• It is a demonstration of the State’s decision to put a curb on black money, showing that tax evasion will no longer be tolerated.
• Households and firms have begun to shift from cash to electronic payment technologies.

Hope you liked these notes on Class 12 Economics Money and Banking. Please share this with your friends and do comment if you have any doubts/suggestions to share.

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• Economics /

Money and Banking Class 12 Notes

• Updated on  
• Jun 21, 2023

Money and Banking are important aspects of everyone’s day-to-day life. There is a lot more to the concept of money than we usually understand. The 6th chapter of class 12th macroeconomics talks about money and banking in complete depth. Not only this, the chapter carries a lot of weightage as well. Read this blog further to revise Money and Banking Class 12 notes, summary and NCERT solutions.

Just In: Check out Class 10th and Class 12th Date Sheet

This Blog Includes:

Definition of money, functions of money, what is the barter system, money supply, commercial banks, functions of commercial banks, central banks, credit creation/money creation, what is the legal reserve ratio, what is repo rate, what is reverse repo rate.

Money is defined as a standard of deferred payment and has some value which is accepted as a medium of exchange. 

As per Money and Banking Class 12 notes, the functions of money can be further classified into three categories:

Also Read: Class 12 Forms Of Market And Price Determination

The barter system implies a direct exchange of goods and services without any use of money. For eg. A wants to buy a car from B and B sells that car to A in exchange for his television. This example involves the exchange of goods and services without any exchange of money.

• Lack of divisibility
• Lack of double coincidence of wants
• Lack of standard of deferred payment
• Difficulty in the exchange of goods and services
• Lack of common measure of value

Check Out: Maths Project Class 12

Money supply is defined as the sum total of all the currency as well as other liquid instruments in an economy at a given point in time. According to Money and Banking Class 12 notes, the key question asked is “What are the Measures of Money Supply?”

Measures of money supply : Currency held by the public + net demand deposits held by commercial banks.

M1= currency in the hands of the public + demand deposits of the public with banks + other deposits M2= M1 + post office saving deposits M3= M1 + time deposits of commercial banks M4= M3 + sum total of post office savings saving organisation deposits excluding deposits on NSC.

Here are the major features of Money Supply that you must study in our Money and Banking Class 12 notes:

• The money supply is based on the stock concept which means it calculates the volume of money held by the public at a given point in time. 
• It doesn’t include any money held by the governments, commercial banks or central banks.

Money and Banking Class 12 notes also elaborate on the concept of banking, types of banks, and their functions, amongst others.

Commercial banks are defined as a financial institution which accepts deposits from the general public and then uses those funds to offer advance loans for various purposes with the objective of profit maximisation. 

Here are the primary and secondary functions of commercial banks that we will study in Money and Banking Class 12 notes:

Primary Functions

• Accepting deposits
• Discounting Bill of Exchange
• Advancing loans

Secondary Functions

The secondary functions of commercial banks can be classified further into two categories-

Central banks are defined as the apex financial institutions that have control over the creation and distribution of money as well as credit creation. As per the study notes on Money and Banking, Central banks are responsible for managing the banking system of the whole country as well as working towards creating monetary policies. 

Functions of Central Banks

• Oversee the monetary system of the whole country
• Issue of currency
• Bank of issue
• Lender of last resort to commercial banks
• Lender of last resort to the government
• Credit Controller
• Custodian of foreign exchange services

As already discussed above, banks accept deposits and use these deposits in order to advance loans for various purposes with the objective of profit maximisation. The next topic in our Class 12 notes on Money and Banking is Credit Creation or Money Creation which is simply the process of advancing loans to the general public.

The process of credit creation/money creation by commercial banks depends on the following two factors- 

• Amount of primary deposits
• Legal reserve ratio

The legal reserve ratio is defined as the minimum ratio of the deposits which is legally required to keep in cash by the banks. The Class 12 chapter on Money and Banking notes that the Legal reserve ratio can further be divided into two sub-categories-

• Cash Reserve Ratio- cash reserve ratio is that part of the legal reserve ratio that the banks have to keep with the central bank.
• Statutory Liquidity Ratio- statutory liquidity ratio is that part of the legal reserve ratio that the banks have to keep within their bank itself.

The repo rate is defined as the rate at which the central bank of the country lends money to commercial banks in case of a shortage of funds so as to maintain liquidity. To simplify in our Class 12 notes on Money and Banking, the percentage of the amount which the commercial banks have to pay to the central bank is called the repo rate. 

Central banks usually increase the repo rate during inflation which ultimately helps in reducing the money supply and helps in controlling inflation.

The reverse repo rate is defined as the rate at which central banks borrow from the commercial banks of the country. It is a mechanism to absorb the liquidity so as to reduce the powers of the investors. The amount which the central banks have to pay to the commercial banks is known as the reverse repo rate.

Central banks generally increase the reverse repo rate when there is a need for reducing the money supply in the market as this gives commercial banks an incentive to park their funds with the central bank.

Check Out: Economics Project for Class 12

The formula for money and banking class 12 is Deposit Multiplier = 1/LRR Total Deposit creation = Initial deposit X 1/LRR.

All the currency notes are issued by the Reserve Bank of India.

Economists differentiate among three different types of money:  commodity money, fiat money, and bank money . Commodity money is a good whose value serves as the value of money.

Thus, we hope that our study notes on Class 12 Money and Banking help you prepare for this chapter in a comprehensive way. Hoping to pursue a career in economics? Get in touch with Leverage Edu experts to get complete assistance in choosing the right course and getting admission to your dream university. Sign up for a free session with us now!

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Money & Banking Class 12 Previous Year Question Paper PDF

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Money & Banking Class 12 Previous Year Question Paper

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Various reasons such as assistance in better exam preparation, confidence boost, etc. are the reasons behind the importance of Money & Banking Class 12 PYQs. For a detailed overview of why they are important, go through the points mentioned below:

• Helps Boost Confidence: One of the important aspects of having the PDF file of the Class 12 previous year question paper for Money & Banking is that it helps boost confidence. The confidence to answer any kind of question asked in the chapter and to solve them regardless of the difficulty levels.
• Gives Students Assistance in Board Exam Preparation: The board exam preparation process is crucial and even a single mistake can result in a great loss, however, solving the PYQs on Class 12 Money & Banking can give students assistance in board exam preparation to decide which question to cover first and how to solve them.
• Provides Opportunity to Practise Several Questions: Also, the Money & Banking Class 12 previous year question paper provides students with the opportunity to practice several questions and enables them to get step-by-step answers to all those questions. 

PYQs on Class 12 Money & Banking With Solutions

For comprehensive exam preparation, our subject-matter experts provide the Money & Banking Class 12 PYQs with accurate solutions. After a careful analysis of each and every question, these answers are prepared for the benefit of students. By reviewing these solutions, students can understand the rationale behind each question and increase their conceptual knowledge. 

How to Download Class 12 Previous Year Question Paper For Money & Banking PDF?

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• Then, find “ CBSE Previous Year Question Paper ” and click on that.

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Methods to Prepare for Money & Banking Class 12 Previous Year Question Paper

Every single student should know these methods to prepare for the Money & Banking Class 12 previous year question paper.

• Complete the Chapter Money & Banking: The very first step is to complete the chapter. Completing this will enable students to develop a conceptual understanding and be prepared to answer the majority of questions not only Money & Banking Class 12 PYQs.
• Go Through Chapter-End Questions: After completing the lesson, students should go through the chapter-end questions that will help them practice a variety of easy to difficult questions in the Class 12 previous year question paper for Money & Banking. Solving such questions will ensure students have gained a good command of the lesson. It will also give them confidence and the opportunity to build a habit of solving such questions.
• Clear Doubts and Confusion: No doubt and confusion should remain with students because any unclear understanding of the chapter will cause them issues to answer. Therefore, all the students should ask their teacher to clear their doubts about the topics. Students can also take help of the YouTube and other online study resources to clear their doubts before solving the PYQs on Class 12 Money & Banking PDF.
• Then Solve Money & Banking Class 12 previous year question paper: After reading the lesson, solving its Chapter-end questions, and clearing all doubts and confusion, a student is ready to attempt the Money & Banking Class 12 PYQs and prepare for the Class 12 Board examination.

3 Most Important Times to Use Money & Banking Class 12 PYQs

Although students can use the Class 12 previous year question paper for Money & Banking anytime they want, these three times are essential and all the students must solve the question paper at these times:

• After Finishing the Lesson: One of the ideal times to solve PYQs on Class 12 Money & Banking is after finishing the lesson. It is considered an ideal time because it facilitates students to solve questions easier and quicker because of having fresh learning.
• At the time of Board Exam Preparation: Solving Money & Banking Class 12 previous year question paper at the time of Board exam preparation is also a very useful moment. However, it is essential to keep in mind that, the board examination times are very delicate with having less spare time to focus on one thing, so solving all the question papers is ideal but try to focus on other subjects too.
• During Revision Time: Setting a revision time such as a weekly basis and monthly basis is a great way to master the topic and at the same time solve some of the random questions from the Money & Banking Class 12 PYQs is very helpful.

Best Practices for Effective Use of PYQs on Class 12 Money & Banking With Solutions

There are three best practices for the effective use of the Class 12 previous year question paper for Money & Banking that we have discussed in this section.

• Be Regular with Practising PYQs on Class 12 Money & Banking: Students should maintain regularity in their studies not only for general study but also to practice the previous year's questions. Being regular in practice helps students keep their learning fresh for longer and enable them to improve. Being regular in practice also enables students to deepen their understanding of the concepts discussed in the chapter.
• Self-Assess Often: In order to analyze and evaluate the grip on the chapter, students should refer to the PDF file of Money & Banking Class 12 previous year question paper that Selfstudys.com is providing here on this page. The PDF file enables students to test their level of preparation in the topic as well as enables them to find out their weaknesses in the subject.
• Use Solutions: One of the most useful stuff in Money & Banking Class 12 PYQs is its solutions which are prepared by subject matter experts following the board exam pattern and the word limit standard.

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• Find weak areas in the topic using the PDF file of PYQs on Class 12 Money & Banking: The PDF file is an all-in-one study resource that helps students check their weaker points in the chapter. Getting access to such questions enables students to not only prepare well for the exam but increase their knowledge and therefore, it is a solid reason to use the PDF Files from SelfStudys.
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• Build habits, and master methods to answer and boost confidence: It is another solid reason because the PDF file contains numerous sets of Money & Banking Class 12 PYQs along with answers that help students in doing the self-study too.

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NCERT Solutions for Class 12 Macro Chapter 3 - Money And Banking

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Class 12 NCERT Solutions Macro Economics - Money and Banking - Free PDF Download

NCERT Solutions for CBSE Class 12 Macro Economics Chapter 3 - Money and Banking are available in Vedantu. These NCERT Solutions are created as per the latest Syllabus of NCERT Macro Economics  for Class 12. This PDF Covers solutions for all questions that are covered in the CBSE Class 12 Macro Economics textbook in Chapter 3. All the solutions are explained in a step by step manner. Students can refer to these solutions for learning the important questions and prepare for their board exams. These NCERT Solutions for CBSE Class 12 Macro Economics Chapter 3 Money and Banking are available in a PDF format and can be downloaded for free.

Topics Covered in Class 12 Money and Banking Solutions are as follows:

Barter system

Barter economy

Difficulties of Barter System

Functions of money

Related Chapters

Access NCERT Solutions for Class 12 Macro Economics Chapter - 3 Money and Banking

Cbse class 12 macroeconomics chapter 3 solutions.

The solutions and exercise of NCERT solutions for Class 12 Macroeconomics Chapter 3 give the reason why money is an essential factor in India and how it facilitates exchange under RBI’s control.

The fourteen questions in the solution deal with functions of money demand and equations related to it.

1. What is a barter system? What are its drawbacks? 

Ans: In ancient times, the barter system was used to exchange things. It was a method of exchanging one commodity, product, or set of goods for another. For example, if a person has 1 kg of sugar and wants 1 kg of jaggery in trade, he can do so if someone else is prepared to exchange sugar for jaggery. A commodity for commodity exchange was the name given to this activity. It was also supplanted by the monetary system. 

The following are some of the disadvantages of the barter system:

1. Double Coincidence of Wants: It is one of the assumptions that led to the downfall of the barter system. The double coincidence of wants indicates that two individuals will only exchange commodities and services if they both require the goods of the other.

2. Indivisibility of Goods: This refers to another significant disadvantage of the barter system. In the event of items that lose their utility when divided into components, the barter system of exchange was not applicable.

3. Common Measure of Value: One of the most significant causes for the barter system's collapse. Because there is no universal measure of worth in the barter system, determining a set ratio for exchanging commodities and services is problematic.

4. Store of Value:   Refers to one of the reasons for the barter system's collapse. In the barter system, value is stored in the form of commodities including cereal grains and livestock.

2. What are the main functions of money? How does money overcome the shortcomings of a barter system? 

Ans: The most liquid of all assets is money. It is globally accepted and may thus be easily swapped for other commodities. Money is defined as something that is widely recognised by people as a medium of exchange for goods and services.

 Function of money are divided into two categories:

1. Primary Function.

2. Secondary Function.

Primary or Main Functions:

a. Medium of Exchange: Money is a medium of exchange, which means it can be used to buy and sell products and services. Goods were swapped for goods in the absence of money. This necessitated a two-fold alignment of desires. As a result, communication was difficult and so limited. The act of sale and purchase are now separated by the introduction of money, and the double coincidence of desires is no longer required. Exchange is now considerably easier and, as a result, limitless. This has increased an economy's total level of economic activity. Rather than being subsistence-oriented, production is now market-oriented.

b. Measure of Value: Money is a unit of account that acts as a measure of value. The worth of each commodity or service is quantified in monetary units, which is referred to as the unit of account. In the barter system, where one commodity was valued in terms of the other, determining value was extremely difficult.  There was no universal monetary unit. The introduction of money has alleviated this problem.

Secondary of Substantiary functions: 

Standard of Deferred Payments: Standard of deferred payments: Deferred payments are those that are made at some point in the future. Deferred payments, for example, have never been easier than they are now. When we borrow money from someone, we must pay back both the principal and the interest. Making such transactions in terms of products and services is tough. Because money retains a constant value over time, using it as a standard for postponed or delayed payments greatly simplifies borrowing and lending processes.

Store of Value: Money can be used to transmit purchasing power from the present to the future. Money is a form of wealth storage. Although wealth can be held in other ways, money is the most cost-effective and practical option. Individuals can use it to cover unexpected expenses, such as medical bills, and to pay off future debts.

Money has been able to overcome the disadvantages of the barter system in the following ways:

Money, as a means of exchange, has solved the major problem of the barter system i.e. double coincidence of wants. It distinguishes between the activities of selling and buying goods and services, allowing both parties to achieve maximum pleasure.

Various items had different values under the Barter system, and there was no standard nomenclature to describe their exchange ratios. Money, on the other hand, is the yardstick by which the value of other goods is expressed. The relative values of any two commodities become easy to compare.

It is extremely difficult to store items for future use in a barter economy. The majority of the commodities are perishable, necessitating a large amount of storage space and transit costs. Money, on the other hand, may be easily saved for later use. It is the most practical and cost-effective method of storing profits and capital. It has the advantage of widespread acceptance and a consistent value when compared to other items.

The lack of a sufficient standard for deferred payments in the barter system makes credit transactions problematic. At the time of repayment, the borrower may not be able to obtain products of the same quality. Future payments, on the other hand, are expressed in terms of money due to its widespread acceptance. Money has made borrowing and lending easier, as well as encouraging capital production.

3. What is transaction demand for money? How is it related to the value of transactions over a specified period of time?

Ans: The desire for conducting or meeting day-to-day transactions is referred to as transaction demand for money. This motive can be viewed from the perspective of consumers, who require money to carry out their daily business operations, i.e., income motive, and businesspeople, who require money to carry out their daily business activities, i.e., a commercial motive In the context of current individual and business unit transactions, the transaction motive relates to the demand for money. People earn money at different times of the year, but they consume the same amount throughout the year. People are more prone to keep money for transactional purposes as a result of this. 

The following is an explanation of the relationship between transaction value and transaction demand for money: 

In an economy $\left(\mathrm M_{\mathrm T}^{\mathrm D}\right)$, the transaction demand for money can be stated as:

$\left(\mathrm M_{\mathrm T}^{\mathrm D}\right)=\mathrm{KT}\\\Rightarrow\dfrac1{\mathrm K}\mathrm M_{\mathrm T}^{\mathrm D}=\mathrm T\\\Rightarrow\mathrm{vM}_{\mathrm T}^{\mathrm D}=\mathrm T $

$v = \dfrac1{\mathrm K}$, represents velocity of circulation of money

T = Total value of transaction in the economy over a period of time

K is a positive fraction

$\mathrm M_{\mathrm T}^{\mathrm D}$= Stock of money held by people at a particular point of time.

The total value of transactions is favourably associated to the transaction demand for money, but the velocity with which money is moved is adversely related.

4. Suppose a bond promises Rs. 500 at the end of two years with no intermediate return. If the rate of interest is 5 percent per annum what is the price of the bond?

Ans: Let the price of the bond be Rs. p

$\mathrm A=\mathrm p\left(1+\dfrac{\mathrm r}{100}\right)^{\mathrm n}$

It is given that

A = Rs. 500

n = 2 years

Substituting the values in the formula

$500=\mathrm p\left(1+\dfrac5{100}\right)^2\\500=\mathrm p\left(1+\dfrac1{20}\right)^2\\500=\mathrm p\left(1+\dfrac{21}{20}\right)^2\\500=\mathrm p\left(\dfrac{441}{400}\right)\\\mathrm p=\dfrac{200000}{441}=453.51\;$

So, p = Rs. 453.51

Therefore, the price of the bond is Rs. 453.51.

5. Why is speculative demand for money inversely related to the rate of interest?

Ans: The inverse relationship between speculative demand for money and the rate of interest is that when interest rates rise, speculative demand for money falls, and vice versa. As a result, the speculative demand for the money curve slopes downward to the right. There are two possibilities:

People will convert their money into bonds if the market rate of interest is very high and predicted to diminish in the future, i.e. the price of a bond rises, anticipating capital gain from bond-holding. As a result, there is little speculative demand for money.

People change their bonds into money in order to avoid future capital loss if interest rates are low and people anticipate that they will rise in the future, i.e. decreasing bond prices anticipating capital loss from bond ownership. They keep cash on hand because they believe that non-monetary assets such as bonds will generate little income, lowering the cost of money keeping.

6. What is a 'liquidity trap'?

Ans: The liquidity trap occurs when an expansionary monetary policy fails to raise interest rates or income, and hence fails to encourage economic growth. The liquidity trap is monetary policy's most extreme effect. It's a circumstance in which the general population is willing to hold on to whatever amount of money is offered at a particular interest rate. They do so because of dread of negative outcomes such as deflation and conflict.

In that circumstance, open market activities used to implement monetary policy have no effect on the interest rate or the level of income. The interest rate is unaffected by monetary policy in a liquidity trap. At short-term zero percent interest rates, there is a liquidity trap. When the interest rate is zero, the public will not want to keep any bonds because money, which pays zero percent interest as well, has the advantage of being useful in transactions.

Therefore, if there is no interest rate, an increase in money supply will not persuade anyone to buy bonds, lowering the rate of interest on bonds below zero. 

$\mathrm M_{\mathrm s}^{\mathrm d}=\dfrac{{\mathrm r}_\max-\mathrm r}{\mathrm r-{\mathrm r}_\min}$

7. What are the alternative definitions of money supply in India? 

Ans: The total stock of money of all forms - currency as well as demand deposits - held by the inhabitants of a country at any given time is referred to as the money supply.

Features of Money Supply:

It contains money held solely by the public. The term "public" refers to the money-using sector, which includes both individuals and businesses. It excludes the money-creating sector, namely the government and banking system, because their cash balances do not enter actual circulation in the country.

It's a 'Stock Concept,' meaning it's about a specific point in time.

Money supply in India is quantified in a variety of methods, including ${\mathrm M}_1,{\mathrm M}_2,{\mathrm M}_3, and {\mathrm M}_4$ measurements. Every measurement has its own set of components, ranging from the most liquid to the most hard.  

${\mathrm M}_1,{\mathrm M}_2,{\mathrm M}_3, and\; {\mathrm M}_4$ are listed in order of descending liquidity. To put it another way, ${\mathrm M}_1$ has the most liquidity whereas ${\mathrm M}_4$ has the least.

So, ${\mathrm M}_1=\;\mathrm C\;+\mathrm{DD}\;+\mathrm{OD}$

C = Public currency

DD = Net demand deposits of the bank

OD = Other deposits held by RBI

${\mathrm M}_2={\mathrm M}_1+\;\mathrm{Savings}\;\mathrm{of}\;\mathrm{the}\;\mathrm{people}\;\mathrm{with}\;\mathrm{Post}\;\mathrm{offices}$

${\mathrm M}_2$ includes the components of ${\mathrm M}_1$ as well as the savings of the people of the Post office.

${\mathrm M}_3={\mathrm M}_4+\mathrm{Net}\;\mathrm{time}\;\mathrm{deposits}\;\mathrm{with}\;\mathrm{commercial}\;\mathrm{banks}$

${\mathrm M}_3$ is the most commonly used measure of money of ${\mathrm M}_1$ commercial banks.

$\;{\mathrm M}_4={\mathrm M}_3+\;\mathrm{Total}\;\mathrm{deposits}\;\mathrm{with}\;\mathrm{post}\;\mathrm{offices}\;\mathrm{excluding}\;\mathrm{National}\;\mathrm{Savings}\;\mathrm{Certificate}$

8. What is a ‘legal tender’? What is ‘fiat money’?

Ans: The term "legal tender" or "legal money" refers to money that is subject to the laws of the land. It is money that is issued by a monetary authority or the government and cannot be denied as payment for transactions by anyone. The government issues an order defining money, and that money becomes legal currency. Everyone is obligated to accept it in exchange for products and services, as well as for the repayment of obligations.Legal tender money includes currency, paper notes, and coins, which cannot be refused as payment for transactions or as a means of exchange.

The currency that a government declares to be legal tender is called fiat money but is

not backed by a physical asset. The value of fiat money is determined by the connection between supply and demand rather than the worth of the commodity used to make the money.

9. What is High Powered Money?

Ans: High Powered Money is  the money that the RBI and the government create, with the public holding the currency and banks holding the cash reserves. It is distinct from money in that money is made up of demand deposits, whereas cash reserves are used to create demand deposits.

So, to sum up, high powered money is H = C + R

H = High powered money

C = Currency

R = Cash Reserves of Commercial Banks

10. Explain the Functions of a Commercial Bank.

Ans: A commercial bank is a type of financial organisation that handles all transactions involving the deposit and withdrawal of money for the public, as well as the provision of loans for investment purposes and other similar activities.

Accept Deposits: Deposits are accepted at the bank in the form of savings, current, and fixed deposits. Surplus funds received from businesses and people are lent to meet the short-term needs of commercial operations.

Credit Cash: When a customer receives credit or a loan, they do not receive liquid cash. The customer's bank account is opened first, and then the funds are sent to the account. The bank is able to manufacture money through this technique.

Provides Loan and Advances: Another important duty of this bank is to provide loans and advances to entrepreneurs and business persons, as well as collect interest. It is the most important source of earnings for any bank.

Overdraft Facility: This is a loan offered to a customer in exchange for keeping their current account open and allowing them to overdraw up to a certain limit.

Discounting Bills of Exchange : A discount bill of exchange is a written agreement that acknowledges the sum of money to be paid for products acquired at a future date. A commercial bank's discounting strategy can also be used to clear the payment before the quoted period.

Locker Facilities: Customers can use a bank's locker facilities to store their valuables or papers discreetly. This service is charged at least once a year by the banks.

Purchasing and Selling Securities: The bank provides you with the option of buying and selling securities.

11. What is money multiplier? What determines the value of this multiplier?What ratios play an important role in the determination of the value of the money multiplier?

Ans: The money multiplier is the amount of money generated by banks for every dollar of reserves. The amount of deposits that the Federal Reserve must hold rather than lend is referred to as a reserve. In an economy, it is the ratio of money stock to high-powered money stock.

In an economy, the money multiplier is the ratio of the stock of money to the stock of high-powered money:

${\mathrm M}_{\mathrm M}=\dfrac{\mathrm M}{\mathrm H}$

Where, ${\mathrm M}_{\mathrm M}$ is the money multiplier

M = Stock of money 

The value of multiplier is always more than one, and it can be calculated as follows:

  = (1 + cdr)DD

M= Money supply

C= Currency held by people 

cdr= Currency deposit ratio

DD = Demand deposits

High powered money = Currency + Reserve money

cdrD + rdrD

D(cdr +rdr)

So, $\dfrac{\mathrm M}{\mathrm H}=\dfrac{1+\mathrm{cdr}}{\mathrm{cdr}+\mathrm{rdr}}$ which is > 1

When calculating the money multiplier, the reserve deposit ratio and currency deposit ratio are key factors to consider. The cdr is the proportion of money held by the general population compared to money held in bank deposits. The rdr is the percentage of total deposits held as reserve by commercial banks.

12. What are the instruments of monetary policy of the RBI?

Ans: The central bank's policy on the use of monetary tools within its authority to fulfil the Act's goals is referred to as monetary policy. The Reserve Bank of India (RBI) is charged for implementing monetary policy in India. The Reserve Bank of India Act, 1934, expressly mandates this obligation. 

The instruments of monetary policy of the RBI are as follows:

1. Quantitative Measures

Varying Reserve Ratios:

Cash Reserve Ratio (CRR): It is a portion of a bank’s total deposits that the Reserve Bank of India requires to be kept with the latter as liquid cash reserves.

Statutory Liquidity Ratio (SLS): It is essentially the reserve requirement that banks must maintain before extending credit to customers. It is essentially the reserve requirement that banks must maintain before extending credit to customers.

Bank Rate: The interest rate charged by a nation’s central bank to its domestic banks in order for them to borrow money is referred to as its bank rate. The interest rates charged by central banks are meant to stabilise the economy.

High Powered Money: It is the money created by the RBI and the government, in

which the public holds the currency, and the banks hold the cash reserves. It differs from money for that money consists of demand deposits, whereas cash reserves serve as a foundation for creating demand deposits.

2. Qualitative Measures

Open Market Operation: It refers to the central bank’s selling and purchase of

securities on the open market to and from commercial banks or the general public.

Bank Rate Policy: It refers to the central bank’s manipulation of the discount rate

in order to influence the economy’s credit condition.

Sterilisation by RBI: The RBI’s market-based strategy in neutralising a portion or the whole monetary impact of foreign inflows is known as sterilising.

Moral Suasion: The RBI uses this strategy to persuade commercial banks to assist in regulating the money supply in the economy.

The Reserve Bank of India (RBI) is a key player in the management of external shocks. Assume a foreigner decides to put money into Indian bonds. The foreign currency is then exchanged into Indian rupees by the bond seller at a commercial bank. The same commercial bank deposits money in the RBI, increasing assets and liabilities on the balance sheet; but, the overall reserves of the commercial bank remain unaltered.

13.  Do you consider a commercial bank ‘creator of money’ in the economy?

Ans: Yes, commercial banks play a significant role in the economy as "money creators." They are able to generate credit by way of demand deposits. Demand deposits provide credit in excess of the initial deposits. As a result, banks build credit by making loans.

Using a bank XYZ as an example, the process of money production can be discussed. A depositor makes a Rs.20,000 deposit in his savings account, which the bank treats as a demand deposit. Based on the presumption that not all clients will withdraw their deposits on the same day, the bank keeps a minimum cash reserve of 10% of demand deposits. It extends credit to other consumers for the remaining amount of Rs.18000. This generates more deposits for the XYZ bank. As a result, the credit multiplier is:

Credit multiplier = $\dfrac{1}{CRP} =\dfrac1{10\%}= 10$

The amount of credit multiplier will enhance the money supply.

14. What role of RBI is known as ‘lender of last resort’?

Ans: When a commercial bank is faced with a financial crisis and is unable to secure funds from other sources, the central bank steps in as a "lender of last resort," providing financial assistance in the form of credit. The central bank's role saves the commercial bank from failure. As a result, the central bank acts as a guarantor for commercial banks, ensuring that the financial system in the economy is sound and healthy.

NCERT Solutions for Class 12 Macroeconomics Chapter 3 Money and Banking

For all-round development of young children, the chapter is broadly categorized into topics like functions of money, barter system and fiat money and repo rate. Moreover, there are topics like a supply of money, banking system, credit creation by commercial banks, demonetization etc.

Macroeconomics Class 12 Chapter 3 includes chapters designed under expert supervision to enhance knowledge of how money works. The standard medium of exchange holds both primary and contingent functions to run a healthy economy.

The solutions deal with these ideas and offer questions to sharpen the reasoning and logical skill of students. Moreover, this solution of Chapter 3 of Macroeconomics Class 12 by Vedantu is available in PDF format to ease out the learning process.

You can refer to these solutions for revision to score high flying grades in board exams.

Important Questions from Macro Economics (Short, Long & Practice)

Short answer type questions.

1. What is meant by the term money supply?

2. What is meant by credit creation?

3. What is the cash reserve ratio (CRR)?

4. What is statutory liquidity ratio (SLR)?

Long Answer Type Questions

1. What do you mean by credit/money creation? Explain the process of Money creation by the commercial banks with the help of a numerical example.

2. Money acts as a yardstick of standard measure of value to which all other things can be compared. Discuss it.

3. Central bank performs the function of a clearing house. How?

Practice Questions

1. All the currency issued by the central bank is its monetary liability. How?

2. Explain the ‘Medium of Exchange’ function of money?

3. Explain the ‘Lender of Last Resort’ function of the central bank.

Key Features of NCERT Solutions for CBSE Class 12 Macro Economics Chapter 3

Solutions are written accurately to help students in quickly finding solutions.

Concepts are explained in detail for all questions from NCERT textbook.

All solutions are easy to understand and learn as they are thoroughly prepared by subject experts to match the curriculum.

NCERT solutions for CBSE Class 12 Macro Economics Chapter 3 help in developing a strong conceptual foundation for students, which is important in the final stages of preparation for board and competitive exams.

These solutions are absolutely free and available in a PDF format.

Marks Distribution of Class 12th Macroeconomics Chapter 3

The Macroeconomics Class 12 Chapter 3 is divided into knowledge (30%), understanding (50%) and application (20%). This chapter money and banking carry a total of 8 marks where two marks are rewarded for four short answer type questions.

Benefits of Referring to NCERT Solutions Class 12 Macroeconomics Chapter 3

Referring to the NCERT solution for board exam will benefit a student in the following ways -

Practice of crucial topics related to money and banking.

An in-depth understanding of the complexity of Indian economics and its policy.

Questions and solutions prepared under expert supervision.

Readily downloadable in PDF format.

Economics requires students to study the chapters thoroughly and understand the concepts by following proper study materials. Therefore, Macroeconomics Class 12 Chapter 3 solution is a smarter way to secure an excellent grade in the exam.

The NCERT Solutions for Class 12 Macro Chapter 3 - Money and Banking offer a comprehensive and easy-to-understand guide to this important topic. These solutions provided by Vedantu help students grasp the concepts of money, its functions, and the intricate workings of the banking system. By studying these solutions, students can gain a deeper understanding of how money circulates in the economy, the role of banks, and the significance of monetary policy. These resources not only aid in academic excellence but also equip students with valuable knowledge about the financial world, which is essential in today's globalized economy. So, use these NCERT solutions wisely, and you'll be well-prepared to tackle the complexities of money and banking in the real world.

FAQs on NCERT Solutions for Class 12 Macro Chapter 3 - Money And Banking

1. How to Score Well in Class 12th Macroeconomics Chapter 3 for Boards?

To ace in Economics exam, one needs to have a quantitative and qualitative study which involves attending crucial lectures, taking notes, devoting time for revision, practising from the question paper and grasping definitions. If a student answers the questions with a graph and follows a mark scoring pattern of answering then scoring well will be easy.

A good technique of smart answering is to highlight the significant points and use bullet points to enhance visibility. Selecting the questions with internal choices to attempt, and marking them beforehand will be beneficial. Again referring to NCERT books and solutions will be fruitful for a 12 th class student.

2. What is the Demand and Supply of Money?

The money supply is the total amount of monetary assets available in an economy at a period. Moreover, the demand for money involves the desired holding of financial assets which is recorded as it affects the inflation, exchange rate, price level of goods, and the business cycle.

It also expands the supply of money more slowly than average. This process is implemented to deal with unemployment and inflation of a country.  Bonds, GDP, flat money, demand deposits, etc. also determines the working of money and supply.

3. What do you Mean by Demonetization?

The act of stripping a currency unit of its status as a legal tender of a country is called  Demonetization. It has been used as a tool to steady the currency and fight inflation for a smooth flow of economy and trade. This is a way to replace the old money with new currency and keep a check on black and grey markets.

The Indian government in 2016 decided to demonetize the 500 and 1000 rupee notes. Without warning, Prime Minister Narendra Modi announced the two prominent denominations of a currency system to be stopped and exchange them for newly introduced 2000 rupee and 500 rupee bills.

4. What is Macro?

Macro is the truncated name used for a division of the subject Economics, known as Macroeconomics. Macro basically means ‘large’ and as a subject, it relates to the monetary issues of the world as a whole. This is where the concept of large comes in. This branch of the subject deals with the economic and monetary behaviour of the country, its decision-making policies, and the structural setup as a whole.

5. What are the main concepts covered in Macro?

Macroeconomics makes a student aware about the economy of a country, the monetary structural setup, the economic hierarchies of how the cash flows in a country, and various ideals and policies of the Government. Students are expected to know about foreign policies, demonetisation, banking systems, and barter systems. The answers to all the questions from Chapter 3 of the Class 12 Macroeconomics are given in the NCERT Solutions provided by Vedantu at free of cost.

6. Do I need to practice all the questions provided in NCERT Solutions of Class 12 Macroeconomics Chapter 3?

Students should practice all the questions provided in Class 12 Macroeconomics Chapter 3 NCERT Solutions because the questions are structured to cover all the important topics from the Chapter and help students understand the concepts better by getting a proper idea. They can refer to these solutions to get an idea about how to write the answers in the exam. This will also help you to score good marks in your board exams since the NCERT Solutions follow the same pattern as boards. The PDFs of these NCERT Solutions can also be downloaded from the Vedantu app for free.

7. From where can I download the NCERT Solutions of Class 12 Macroeconomics Chapter 3?

If you want to download the NCERT Solutions of Class 12 Macro Chapter 3, you can follow these steps:

Visit the page NCERT Solutions for Class 12 . Choose the desired chapter.

You will find the NCERT Solutions for Chapter 3 of Class 12 Macroeconomics on this page.

You can click on the Download PDF button to download the pdf of these solutions to refer them offline.

Once it redirects you to the next page,  you will find the link to download the PDF.

8. What is a Barter System?

The barter system is referred to as a system of exchange in which goods are exchanged without the involvement of money. Though it is an age-old system of goods exchange, it is also applicable in the economic setup in present times where the economy is exchanged without any monetary transaction. The barter system is used in a scenario where the demand for two commodities is equally present, which is a coincidence of commodities.

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12th Class Economics Money And Banking Question Bank

Done case based mcqs - money and banking total questions - 15.

A) It is a legal tender done clear

B) It is a medium of exchange done clear

C) Both [a] and [b] done clear

D) Neither [a] nor [b] done clear

question_answer 2) Government removed the legal tender status of Rs. 500 and Rs. 1,000 currency notes during the demonetisation. These currency notes are also known as …….. .

A) Limited Legal Tender done clear

B) Unlimited Legal Tender done clear

C) Commodity Money done clear

D) None of these done clear

A) Assertion [A] is true and Reason [R] is a correct reason of Assertion [A] done clear

B) Assertion [A] is true and Reason [R] is not a correct reason of Assertion [A] done clear

C) Assertion [A] is false, but Reason [R] is true done clear

D) Both are false done clear

question_answer 4) With the help of which of the following authorities, demonetisation was implemented?

A) Commercial Banks done clear

B) State Government done clear

C) Central Bank done clear

D) All of these done clear

question_answer 5) Which of the following notes are not in circulation post demonetisation?

A) Rs. 500  done clear

B) Rs. 1,000 done clear

C) Rs. 2,000  done clear

A) Commodity money done clear

B) Precious metals done clear

C) Coinage done clear

D) Currency notes done clear

question_answer 7) Evolution of money has ......... the size of market.

A) Expanded done clear

B) Contracted done clear

C) Eliminated done clear

question_answer 8) Which of the following is not a component of quantitative instrument of RBI?

A) Marginal requirement done clear

B) Cash reserve ratio done clear

C) Reporate done clear

D) Bank rate done clear

question_answer 9) How the domestic money supply will change if there is an increase in foreign investment?

A) Increase done clear

B) Decrease done clear

C) Remain constant done clear

question_answer 10) Central Banks Monetary Mechanism is comprised of

A) Qualitative tools done clear

B) Quantitative tools done clear

B) Central Bank done clear

C) Government  done clear

D) Both [b] and [c] done clear

question_answer 12) The apex banking institution in the country is known as ......... .

A) Commercial Bank done clear

B) General Government done clear

question_answer 13) Which of the following is known as the creator currency in the country?

question_answer 15) Which of the following functions is not performed by Central bank in the country?

A) Lender of last resort done clear

B) Credit creation done clear

C) Issue of currency done clear

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Case Based MCQs - Money and Banking

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Class 12 Economics Money and Banking Important Questions

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Class 12 Economics Money and Banking Important Questions. myCBSEguide has just released Chapter Wise Question Answers for class 12 Economics. There chapter wise Practice Questions with complete solutions are available for download in  myCBSEguide   website and mobile app. These test papers with solution are prepared by our team of expert teachers who are teaching grade in CBSE schools for years. There are around 4-5 set of solved Economics Test Papers from each and every chapter. The students will not miss any concept in these Chapter wise question that are specially designed to tackle Board Exam. We have taken care of every single concept given in CBSE Class 12 Economics syllabus  and questions are framed as per the latest marking scheme and blue print issued by CBSE for class 12.

CBSE Class 12 Economics Extra Questions

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Practice Questions for Class 12 Economics

• Money and Banking

The broad definition of money is based on ( 1)

• Medium of payment function
• Transferability of money
• Store of value function

The process of money creation or credit creation is done by ( 1)

• commercial banks
• Central bank

Bank rate is for ( 1)

• Commercial banks by the government
• Commercial banks by the central bank
• Central banks by the central bank
• Central bank by the commercial banks

One of the functions of Central Bank among the following is ( 1)

• Custodian of banks
• Custodian of deliveries
• Custodian of foreign exchange
• Custodian of securities

State the components of money supply. ( 1)

What is included in money supply? ( 1)

Give the meaning of cash reserve ratio. ( 1)

What is reverse repo rate? ( 1)

Explain any two functions of a Central Bank. ( 3)

Explain the “Bankers’ Bank function” of the central bank. ( 3)

Explain how open market operations are helpful in controlling credit creation. ( 4)

Explain ‘banker to the government’ function of the Central Bank. ( 4)

What is meant by statutory liquidity ratio (SLR)? State the effect of rise in rate of SLR on creation of credit. ( 4)

Explain the problem of double coincidence of wants faced under barter system. How has money solved it? ( 6)

How does the Central Bank control credit creation in the economy through open market operation and bank rate? Explain. ( 6)

• Store of value function,  Explanation:  Broad money is less liquid. So ,based on store of value function.
• commercial banks,  Explanation:  The LRR (Legal reserve ratio) allows commercial banks to keep a certain fraction of their deposits as reserve and use the rest for giving credit. The cycle of transations that happen in this proocess help create money.
• Commercial banks by the central bank,  Explanation:  Central bank is a wholesaler of money and commercial bank is its retailer
• Custodian of foreign exchange,  Explanation:  It stabilises foreign exchange rate via this function .
• currency (coins and notes) with the public.
• Demand Deposits with banks
• Currency notes held by the public and demand deposits of Commercial Banks are included in the money supply.
• The Cash Reserve Ratio refers to a certain percentage of total deposits the commercial banks are required to maintain in the form of cash reserve with the Central bank.
• Reverse repo rate is the rate at which the central bank borrows from the commercial banks. It is a monetary policy instrument which can be used to control money supply in the country.
• Bank of issue: The central bank is given the sole monopoly of issuing currency in order to secure control over the volume of currency and credit. These notes circulate throughout the country as legal tender money. It has to keep a reserve in the form of gold and foreign securities as per statutory rules against the notes issued by it.
• Banker’s bank: Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relationship with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called banker’s bank.
• As the banker to the banks, the central Bank is the custodian of the cash reserves of commercial banks. From these reserves it lends to commercial banks when they are in need of funds. Central bank also provides cheque clearing and remittance facilities to the commercial banks. Central bank is the lender of last resort.
• Under open market operations, RBI purchases or sells government securities to the general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of the public as they deposit or withdraw the money from Commercial Banks. Thus, money creation by Commercial Banks gets affected. Suppose, the Central Bank purchases securities of Rs.1,000 from a bondholder with issuing a cheque The seller of the bond produces this cheque of Rs.1,000 to his Commercial Bank. The Commercial Bank credits the account of the seller by Rs.1,000 and the deposits of the bank go up by Rs.1,000, which increase the credit creation capacity of the banks. Thus, purchase of securities increase the money creation of Commercial Banks and similarly, the sale of securities decreases the credit creation of Commercial Banks Thus, the Central Bank controls the process of money creation by Commercial Banks by open market operations. The Reserve Bank of India has frequently resorted to the sale of government securities to which the commercial banks have been generously contributing. Thus, open market operations in India have served, on the one hand as an instrument to make available more budgetary resources and on the other as an instrument to syphon off the excess liquidity in the system.
• Central Bank acts as a banker, advisor and agent to the Central and State Governments. It carries out all banking business of the government. Government keeps their cash balances in the current account with the central bank. Similarly, central bank accepts receipts and makes payment on behalf of the governments. Also, the central bank carries out the exchange, remittance and other banking operations on behalf of the government. Central bank gives loans and advances to governments for temporary periods, as and when necessary and it also manages the public debt of the country. Further, we should remember that the central government can borrow any amount of money from RBI by selling its rupees securities to the latter.
• “Money performs the following four functions: A medium, a measure, a standard, a store”.
• Under barter system, there was lack of double coincidence of wants. It was difficult to find a person who had the product that we meeded and who needed our product. So the exchange was very much restricted.
• With money as a medium exchange individual can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences.
• A buyer can buy goods for money and seller can sell goods for money.
• Under barter system, there was no common measure of value. The exact value of the commodities being exchaned could not be measured. Money has also solved this difficulty.
• As Geoffrey Crowther puts it, “Money acts as a standard measure of value to which all other things can be compared.” Money measures the value of economic goods.
• Money works as a common denominator into which the values of all goods and services are expressed.
• When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.
• Under barter system it was very difficult to store wealth for future use.
• Most of the goods are perishable and their storage requires huge space and transportation costs and they will get spoiled also.
• Wealth can be conveniently stored in the form of money.
• Money can be stored without loss in value.
• Money can easily be stored for future use.
• Under barter system, transactions on deferred payments are not possible.
• With money, the debtors make a promise that they will make payments on some future dates. In those situations money acts as a standard of deferred payments.
• It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.
• Buying and selling of government securities in the open market by the central bank is known as open market operations.
• Open market operations have a impact on the lending capacity of the banks.
• It is an important mean of controlling the money supply.
• During inflation or excess demand situation, the main motive of the Central Bank is to reduce the money supply. To suck excess liquidity from the market the Central Bank sells bonds, government securities and treasury bills.
• Due to low money supply, there is fall in the volume of investment, income and employment resulting in lower demand.
• During deflation the main motive of the Central bank is to increase the money supply and to increase the money supply the Central Bank buys bonds, government securities and treasury bills.
• It refers to the rate at which the central bank lends money to commercial banks as the lender of the last resort.
• The central bank advances loans against approved securities or eligible bills exchange.
• An increase in bank rate increases the costs of borrowing from the central bank. It forces the commercial banks to increase their lending rates, which discourage borrowers from taking loans.
• It reduces the ability of commercial banks to create credit. A decrease in the bank rate will have the opposite effect.

Chapter Wise Practice Test for Class 12 Economics

• National Income and Related Aggregates
• Determination of Income and Employment
• Government Budget and the Economy
• Balance of Payments & Foreign Exchange
• Indian Economy on the Eve of Independence
• Indian Economy 1950-90
• Economic Reforms Since 1991
• Human Capital Formation in India
• Rural Development
• Employment Growth Informational and other Issues
• Infrastructure
• Environment Sustainable Development
• Development Experiences India & Neighbours

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