Saving accounts cater to the needs of those individuals who wish to save a part of their income and earn interest on the amount saved. Account holders of saving accounts can deposit cheques, drafts, etc. However, there is a limit on withdrawal.

(ii) Fixed deposit accounts

As the name suggests, fixed deposit accounts imply deposits are kept for fixed periods of time; for example, Rs.500 per month for 5 years. The period has to be decided in advance, while opening the account. Holders of these accounts do not enjoy the cheque facility. Higher the time period, higher will be the interest rate, which is decided by RBI.

(iii) Current deposits accounts

Current deposit accounts are also called ‘demand deposits’ as the depositor can withdraw money at any time through cheques. Businessmen use this account to make many transactions in a single day; however, they do not earn interest on the deposits. Banks provide account statements to the current account holders at regular intervals.

2. Granting loans and advances

The second most important function of the commercial banks is to give loans and advances. The rate of interest charged by the banks on loans is higher than the rate of interest paid by the banks on demand deposits and saving deposits. Loans granted by commercial banks are generally for long term and are given against securities. Advances are given by a bank only for a short span of time.

3. Agency functions

The commercial banks perform various agency functions with the prime purpose of acceptance of deposits and granting of loans. Their functions include:

(i) Transfer of funds − The banks provide easy flow of funds from place to place via mail transfers, demand drafts, etc.

(ii) Collection of funds − The banks also collect funds on behalf of its customers through bills, cheques, etc.

(iii) Banks collect insurance premiums, dividends, interest on debentures, etc.

(v) Banks assist in the process of tax payment by the accountholders.

(vi) Banks also play the role of trustees or executors.

4. Discounting bills of exchange

Commercial Banks provide financial assistance to the business community by discounting bills of exchange. The banks purchase these bills, produced by customers, by deducting interest from the face value of the bill, thus providing easy finances to the business community when required.

5. Credit creation

Commercial banks create credit in the economy through demand deposits. Credit creation paves the path for the growth of the economy.

6. Other functions

(i) Providing locker facility

(ii) Purchase and sale of foreign exchange

(iii) Issue of gift cheques

(iv) Underwriting of shares and debentures

(v) Providing information and statistical data useful to customers

Question - 2 : - What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier?

Answer - 2 : - Money multiplier is the ratio of the stock of money to the stock of high powered money in an economy

Where, MM is the money multiplier

M represents stock of money

H represents high powered money

The value of money multiplier is always greater than 1.

The value of money multiplier can be derived as follows:

We know that M = C + DD = (1 + cdr) DD

Where,

M = Money supply

C = Currency held by people

cdr = Currency deposit ratio

DD = Demand deposits

Let treasury deposits of government be D

We know, High powered money = Currency + Reserve money

Or, H = C + R

= cdr D + rdr D

= D (cdr + rdr) (Taking D common)

Money multiplier

So, the ratio of money supply to high powered money

becomes

But rdr < 1

So,

The currency deposit ratio (cdr) and the reserve deposit ratio (rdr) play an important role in determining the money multiplier.

The currency deposit ratio (cdr) is the ratio of the money (currency) held by public to that they hold in bank deposits.

That is,

The reserve deposit ratio (rdr) is the proportion of the total deposits kept by the commercial banks as reserve.

Question - 3 : - What are the instruments of monetary policy of RBI? How does RBI stabilize money supply against exogenous shocks?

Answer - 3 : -

1. Principal instruments of Monetary Policy or credit control of the Central Bank of a country(RBI) are broadly classified as:

(a) Quantitative Instruments,

• Bank Rate

• Repo rate

• Reverse Repo rate

• Open Market Operations (OMO)

• Varying Reserve Requirements (fa) Qualitative Instruments

• Imposing margin requirement on secured loans

• Moral Suasion

• Selective Credit Controls (SCCs)

2. RBI stabilize money supply against exogenous shocks in the following manner:

(a) Bank Rate (Discount Rate)

• Bank rate is the rate of interest at which central bank lends to commercial banks without any collateral (security for purpose of loan). The thing, which has to be remembered, is that central bank lends to commercial banks and not to general public.

• In a situation of excess demand leading to inflation,

> Central bank raises bank rate that discourages commercial banks in borrowing from central bank as it will increase the cost of borrowing of commercial bank.

> It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans, which discourages investment.

> Again high rate of interest induces households to increase their savings by restricting expenditure on consumption.

> Thus, expenditure on investment and consumption is reduced, which will control the excess demand.

• In a situation of deficient demand leading to deflation,

> Central bank decreases bank rate that encourages commercial banks in borrowing from central bank as it will decrease the cost of borrowing of commercial bank.

> Decrease in bank rate makes commercial bank to decrease their lending rates, which encourages borrowers from taking loans, which encourages investment.

> Again low rate of interest induces households to decrease their savings by increasing expenditure on consumption.

> Thus, expenditure on investment and consumption increase, which will control the deficient demand.

(b) Open Market Operations (OMO)

• It consists of buying and selling of government securities and bonds in the open market by central bank.

• In a situation of excess demand leading to inflation, central bank sells government securities and bonds to commercial bank. With the sale of these securities, the power of commercial bank of giving loans decreases, which will control excess demand.

• In a situation of deficient demand leading to deflation, central bank purchases government securities and bonds from commercial bank. With the purchase of these securities, the power of commercial bank of giving loans increases, which will control deficient demand.

• Business and traders get credit from commercial bank against the security of their goods. Bank never gives credit equal to the full value of the security. It always pays less value than the security.

• So, the difference between the value of security and value of loan is called marginal requirement.

• In a situation of excess demand leading to inflation, central bank raises marginal requirements. This

discourages borrowing because it makes people gets less credit against their securities.

• In a situation of deficient demand leading to deflation, central bank decreases marginal requirements. This encourages borrowing because it makes people get more credit against their securities.

(d) Moral Suasion

• Moral suasion implies persuasion, request, informal suggestion, advice and appeal by the central banks to commercial banks to cooperate with general monetary policy of the central bank.

• In a situation of excess demand leading to inflation, it appeals for credit contraction.

• In a situation of deficient demand leading to deflation, it appeals for credit expansion.

Question - 4 : - Do you consider a commercial bank ‘Creator of money’ in the economy?

Answer - 4 : -

Yes, commercial bank acts as a ‘Creator of money’ in the economy. It can be explained with the help of Credit creation process:

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 cheque. The one who receives payment deposits the same in his deposit account.
Suppose initially people deposit Rs 1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank.
Let us now explain the process, suppose the initial deposits in banks is Rs 1000 and the LRR is 10 percent. Further, suppose that banks keep only the minimum required, i.e., Rs 100 as cash reserve, banks are now free to lend the remainder Rs 900. Suppose they lend Rs 900. What banks do 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 deposit in banks by Rs 900. It is 90 per cent of the initial deposit. These deposits of Rs 900 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 Rs 1900 (=1000 + 900).
When banks receive new deposit of ?900, they keep 10 per cent of it as cash reserves and use the remaining Rs 810 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 Rs 810. It is 90 per cent of the last deposit creation. The total deposits now increase to Rs 2710 (=1000 + 900 + 810). The process does not end and continues till total deposit creation comes to ? 10000, ten times the initial deposit as shown in the table below.

Question - 5 : - What role of RBI is known as ‘Lender of last Resort’?

Answer - 5 : -

As banker to the banks, the central bank acts as the lender of the last resort.
In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances.
The central bank assists such banks through discounting of approved securities and bills of exchange.

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