Q. Explain why the Central Bank is called ‘banker’s bank’. (2016/2017) (3marks)
-> The Central bank is the apex bank in the banking structure of the country. As the supreme bank it performs some important functions for the banks n the following capacities:
- Custodian of cash reserves of the bank- The Central Bank acts as the custodian of cash reserve of the banks. The Central Bank maintains this cash reserve as the custodian and grants money to the commercial bank in times of emergency. This centralisation of cash reserves results in several advantages for the country:-
- It is a source of strength to the banking system of a country and reinforces the confidence of the public in the banking system.
- It results in more effective utilisation of the cash reserve of the country.
- It enables the Central bank to extend financial assistance to the banks in times of emergency.
- It enables the Central bank to control credit by varying the cash reserves to keep by banks.
- Lender of last resort- The Central Bank is the lender of the last resort of the commercial banks. When the other banks lack funds, then they can approach the Central bank for financial assistance. The Central bank greatly benefit the banks in the following ways:-
- It enables the commercial banks to conduct business with limited cash reserves.
- It enables the banks to secure financial help from the Central bank at a time of crisis.
- It helps the banks to maintain the liquidity of their financial resources as the banks are assured of financial assistance from the Central bank.
- It helps the Central bank to establish control over the banking system of the country.
- Clearing agent- The Central bank as the custodian of cash reserves of the bank acts as the national clearing house. A clearing house is an institution where interbank claims are settled. Central bank’s clearing house function provide the following advantages:-
- It economises the use of cash by banks.
- It minimises the necessity of holding large cash balances by banks.
- It keeps the Central bank informed about the state of liquidity of banks.
Q. Explain why Central Bank is called ‘lender of last resort’. (2017/2019) (3marks)
-> The Central Bank is the lender of the last resort of the commercial banks. When the other banks lack funds, then they can approach the Central bank for financial assistance. The Central bank greatly benefits the banks in the following ways:-
a) It enables the commercial banks to conduct business with limited cash reserves.
b) It enables the banks to secure financial help from the Central bank at a time of crisis.
c) It helps the banks to maintain the liquidity of their financial resources as the banks are assured of financial assistance from the Central bank.
d) It helps the Central bank to establish control over the banking system of the country.
Q. Explain the principles of note issue followed by RBI. (2015/2016/2018/2019) (5marks)
-> The Central bank follows different systems of note issue according to the currency or banking regulations. The main systems of note issue which may be used by a Central bank are discussed below:-
- Simple deposit system- Under this system the paper currency note is backed by the reserves of gold or silver or both. This system is also known as a full reserve system. This system is based on the currency principle of note issue.
The main merit of this system is that it enjoys public confidence and there is no danger of over issue of currency notes. However this system lacks elasticity because money supply cannot be increased as and when required. It is also very costly.
- Fixed fiduciary system- Under this system, the Central bank issues currency notes up to a certain limit against reserves of government securities. This is one of the oldest systems of controlling note issues. Under this system, a country can issue a certain quantity of notes without any reserve. The upper limit to this quantity is called fiduciary limits beyond which there has to be a hundred percent metallic reserve. This system was introduced in England in 1884.
This system inspires public confidence, ensures convertibility of currency notes and is without any danger of over issue of notes by the Central bank.
- Proportional Reserve system- Under this system currency notes are issued against both metallic and securities reserves. A certain proportion of currency notes are backed by gold and silver reserve and the remaining part of the note issue by approved securities. India adopted this method up to 1956.
Here, the note issue on a percentage basis will be backed by gold and other securities such as foreign currency, say, 40% with gold and 60% with foreign currency. This percentage will vary according to the availability of gold and foreign currency.
- Minimum reserve system- Under this system the Central bank is authorised to issue notes up to any limit by keeping a statutory minimum reserves of gold and securities.
In India, Rs. 200 crores is the minimum reserve limit which will have Rs. 85 crores in foreign currency. This gives enough elasticity for increasing the supply of currency. But RBI cannot issue any amount of currency, as beyond the limit of Rs. 200 crores, there should be other security such as government treasury bills, to back the issue of money.
- Maximum reserve system- This is a system under which the Central bank authorised to issue notes up to a certain limit without any gold reserves and foreign currency. This system gave maximum powers to the Central bank and this was adopted by France till 1928.
Q. Explain the function of the Central Bank as a Bank of note issue. (2015/2018) (5marks)
-> Functions of central bank as bank of note issue: The central bank of a country is granted the privilege of note issue. In India, the Reserve Bank of India issues currency notes of all denominations except one rupee coin which are issued by the ministry of finance, government of India. Currency note are printed at four note presses:-
Currency note press- Nashik
Bank note press- Dewas
Modernised currency note press- Mysore
Modernised currency note press- Salboni
The first two presses are owned by the Central government and presses of Mysore and Salboni are owned by the Bharatiya Reserve Bank Mudran Limited, a wholly owned subsidiary of RBI. The coins are minted at four places- Mumbai, Kolkata, Hyderabad, Noida. The Central banks follow different methods or systems according to the currency or banking regulations to issue notes. These systems are:
A. Simple deposit system- Under this system the paper currency note is backed by the reserves of gold or silver or both. This system is also known as a full reserve system. This system is based on the currency principle of note issue.
The main merit of this system is that it enjoys public confidence and there is no danger of over issue of currency notes. However this system lacks elasticity because money supply cannot be increased as and when required. It is also very costly.
B. Fixed fiduciary system- Under this system, the Central bank issues currency notes up to a certain limit against reserves of government securities. This is one of the oldest systems of controlling note issues. Under this system, a country can issue a certain quantity of notes without any reserve. The upper limit to this quantity is called fiduciary limits beyond which there has to be a hundred percent metallic reserve. This system was introduced in England in 1884.
This system inspires public confidence, ensures convertibility of currency notes and is without any danger of over issue of notes by the Central bank.
C. Proportional Reserve system- Under this system currency notes are issued against both metallic and securities reserves. A certain proportion of currency notes are backed by gold and silver reserve and the remaining part of the note issue by approved securities. India adopted this method up to 1956.
Here, the note issue on a percentage basis will be backed by gold and other securities such as foreign currency, say, 40% with gold and 60% with foreign currency. This percentage will vary according to the availability of gold and foreign currency.
D. Minimum reserve system- Under this system the Central bank is authorised to issue notes up to any limit by keeping a statutory minimum reserves of gold and securities.
In India, Rs. 200 crores is the minimum reserve limit which will have Rs. 85 crores in foreign currency. This gives enough elasticity for increasing the supply of currency. But RBI cannot issue any amount of currency, as beyond the limit of Rs. 200 crores, there should be other security such as government treasury bills, to back the issue of money.
E. Maximum reserve system- This is a system under which the Central bank authorised to issue notes up to a certain limit without any gold reserves and foreign currency. This system gave maximum powers to the Central bank and this was adopted by France till 1928.
Q. What is credit control? Explain the objectives of credit control. (2015/2016/2018/2019) (2+6=8)
-> Credit control is the system used by businesses and central banks to make sure that credit is given only to borrowers who are likely to be able to repay it. The regulation of credit creation capacity of the commercial banks and other banking institutions by the Central Bank to achieve some definite objectives is known as Credit Control.
The objectives of credit control are:-
- To eliminate cyclical fluctuations in the production, employment and prices of goods.
- To establish stability in the internal price level by adjusting the supply of credit.
- To maintain stability in the foreign exchange rates by eliminating fluctuations in the exchange rates.
- To stabilize the money market of the economy.
- To achieve full employment of resources and accelerate economic growth with stability.
Q. State any two selective credit control techniques adopted by Reserve bank of India. (2016/2017) (5marks)
-> Selective Methods: These are basically the selective and general methods of credit control. These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in the economy. These methods are:-
a. Direction
b. Margin Requirement
c. Consumer Credit Regulations
d. Publicity
e. Credit Rationing
f. Moral Suasion
g. Direct Action.
a) Direction- Sec. 21 of the Banking Regulation Act gives wide power to the RBI for controlling granting of advances by an individual bank or by banking as a whole. The RBI can give directors to any particular bank or all banks in general in regard to the purposes for which amount of advances to any individual, firm or company etc.
b) Margin requirement- Margin means the difference between the market price of security and loan amount. Changing margin requirements is another credit control method followed by the RBI. This system was introduced in 1956. By requiring higher margin while accepting a commodity as a security, the RBI can decrease the flow of credit to particular sectors or vice versa.
