Sample PDF Economics-12 Exam Handbook For Term-I Exam 2021

UNIT-2 Money and Banking EXAM HANDBOOK Economics XII 9
(for CBSE Term-I Examination November-December 2021)
Unit 2
6 Marks
Money and Banking
For CBSE Term-I Examination

Rationalised CBSE Syllabus 2021-22 (November - December 2021)

Money - meaning and supply of money - Currency held by the public and net demand
deposits held by commercial banks.

Money creation by the commercial banking system.

Central bank and its functions (example of the Reserve Bank of India): Bank of issue, Govt.
Bank, Banker's Bank, Control of Credit
10 EXAM HANDBOOK Economics XII Shree Radhey Publications (Subhash Dey)
Introduction Money and Banking
Money is the commonly accepted medium of exchange. In an economy which consists of only one individual
there cannot be any exchange of commodities and hence there is no role for money. Even if there is more than
one individual but these individuals do not take part in market transactions,example: 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 instrument for facilitating these
exchanges. We need money in order to carry on daily lives, to pay for things such as riding on a bus, purchasing
a bottle of water or soft drink, buying lunch and so on.
Economic exchanges without the mediation of money are referred to as barter exchanges. However, they presume
the rather improbable double coincidence of wants. 'Double coincidence of wants' means what one person wants
to sell and buy must coincide with what some other person wants to buy and sell. For example, if an individual
has surplus of wheat and needs clothing, he looks for a person who needs wheat and at the same time possesses
clothing. It is very difficult that such coincidence of wants may take place. The problem of double coincidence of
wants arises when there is no medium of exchange. Money has solved the problem by working as a medium of
exchange. The seller can sell the goods in the market in return for money and buy the goods he wants to buy in
return for money.
In a modern economy, money comprises cash and bank deposits. Depending on what types of bank deposits
are being included, there are many measures of money. These are created by a system comprising two types of
institutions: central bank of the economy and the commercial banking system.
Central Bank is a very important institution in a modern economy. Almost every country has one central bank.
India got its central bank in 1935. Its name is the 'Reserve Bank of India'. Central bank has several important
functions. It issues the currency of the country. The Reserve Bank of India is the only institution which can issue
currency in India. The RBI controls the money supply in the economy in various ways. The tools used by the
Central bank to control money supply can be quantitative or qualitative. Quantitative tools, control the extent of
money supply by changing the CRR, or bank rate or open market operations. Qualitative tools include persuasion
by the Central bank in order to make commercial banks discourage or encourage lending which is done through
moral suasion, margin requirement, etc. The Central Bank acts as a banker to the government. It is the custodian
of the foreign exchange reserves of the economy. It also acts as a bank to the banking system.
The currency issued by the central bank can be held by the public or by the commercial banks, and is called the
'highpowered money' or 'reserve money' or 'monetary base' as it acts as a basis for credit creation. 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 banks to depositors is lower than the rate charged from the borrowers. This difference between these two types
of interest rates, called the 'spread' is the profit appropriated by the bank. Since banks earn interest from loans they
make, any bank would like to lend the maximum possible. However, being able to repay depositors on demand
is crucial to the bank's survival. Depositors would keep their funds in a bank only if they are fully confident of
getting them back on demand. A bank must, therefore, balance its lending activities so as to ensure that sufficient
funds are available to repay any depositor on demand.
Commercial banks mediate between individuals or firms with excess funds and lend to those who need funds.
People with excess funds can keep their funds in the form of deposits in banks and those who need funds, borrow
funds in form of home loans,crop loans,etc. People prefer to keep money in banks because banks offer to pay some
interest on any deposits made. Also, it may be safer to keep excess funds in a bank, rather than at home. In the
modern context, given cheques and debit cards, having a demand deposit makes transactions more convenient and
safer, even when they do not earn any interest. (Imagine having to pay a large amount in cash -for purchasing a
house.)
2.1 Money and Supply of Money

Money — Its Meaning
Anything which is commonly accepted as a medium of exchange is called money.
It is usable for undertaking transactions, i.e., receipts and payments. In a modern economy, money comprises cash and
bank deposits. Currency notes and coins can be used for settlement of any economic transactions. Bank deposits, e.g.
the balance in savings and current account deposits with commercial banks, are also used to settle transactions through
cheques, debit cards, etc.
Supply of Money
Meaning
Money supply refers to the total quantity of money in circulation in the economy at a given point of time.
Top Tip
Money supply is a stock variable since the total stock of money in circulation among the public is measured at a particular
point of time.
Components
The basic measure of money supply (M1) has two components — Currency with public and demand deposits of the
public in commercial banks.
1. Currency held by the public (CU)
Money supply consists of currency notes and coins held by the public outside the banks. The Reserve Bank of India (RBI)
is the only institution which can issue currency in India. Currency notes are issued by the RBI. However, coins are issued
by the Government of India.
 The currency issued by the central bank (Reserve Bank of India in India) can be held by the public or by the commercial
banks, and is called the high‑powered money or 'reserve money' or 'monetary base' as it acts as a basis for credit
creation.
 Currency notes and coins are called legal tenders as they cannot be refused by any citizen of the country for settlement
of any transaction.
 Currency notes and coins are called fiat money because 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.
2. Net demand deposits held by commercial banks (DD)
Demand deposits are the deposits which can be withdrawn on demand by the depositors from banks, e.g. current account
and savings account deposits.
 Demand deposits are created by the commercial banks and are called bank money.
 The word 'net' implies that only deposits of the public held by the banks are to be included in money supply. The
inter-bank deposits, which a commercial bank holds in other commercial banks,are not to be regarded as part of
money supply.
Top Tip
Commercial banks also hold time deposits of the public. Time deposits are those deposits in banks which have a fixed
period of maturity,e.g.,Fixed Deposits (FD). However, the basic measure of money supply (M1) includes only demand
deposits, not time deposits.
Additional NCERT Content Extracted from NCERT Book 2021-22

 MONEY
Money is the commonly accepted medium of exchange. In an economy which consists of only one individual there cannot
be any exchange of commodities and hence there is no role for money. Even if there is more than one individual but these
individuals do not take part in market transactions, example: 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 instrument for facilitating these exchanges. Economic exchanges without the
mediation of money are referred to as barter exchanges. However, they presume the rather improbable double coincidence
of wants. Consider, for example, an individual who has a surplus of rice which she wishes to exchange for clothing. If she
is not lucky enough she may not be able to find another person who has the diametrically opposite demand for rice with a
surplus of clothing to offer in exchange. The search costs may become prohibitive as the number of individuals increases.
Thus, to smoothen the transaction, an intermediate good is necessary which is acceptable to both parties. Such a good
is called money. The individuals can then sell their produces for money and use this money to purchase the commodities
they need.
 SUPPLY OF MONEY
In a modern economy, money comprises cash and bank deposits. Depending on what types of bank deposits are being
included, there are many measures of money. These are created by a system comprising two types of institutions: central
bank of the economy and the commercial banking system.
Central bank: Central Bank is a very important institution in a modern economy. Almost every country has one central bank.
India got its central bank in 1935. Its name is the ‘Reserve Bank of India’. Central bank has several important functions. It
issues the currency of the country. It controls money supply of the country through various methods, like bank rate, open
market operations and variations in reserve ratios. It acts as a banker to the government. It is the custodian of the foreign
exchange reserves of the economy. It also acts as a bank to the banking system. From the point of view of money supply,
we need to focus on its function of issuing currency. This currency issued by the central bank can be held by the public or by
the commercial banks, and is called the ‘high-powered money’ or ‘reserve money’ or ‘monetary base’ as it acts as a basis for
credit creation.
Commercial Banks: Commercial banks are the other type of institutions which are a part of the money-creating system of the
economy. In the following section we look at the commercial banking system in detail. 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 banks to depositors is lower than the
rate charged from the borrowers. This difference between these two types of interest rates, called the ‘spread’ is the profit
appropriated by the bank.
Commercial banks mediate between individuals or firms with excess funds and lend to those who need funds. People with
excess funds can keep their funds in the form of deposits in banks and those who need funds, borrow funds in form of home
loans, etc. People prefer to keep money in banks because banks offer to pay some interest on any deposits made. Also, it
may be safer to keep excess funds in a bank, rather than at home. In the modern context, given cheques and debit cards,
having a demand deposit makes transactions more convenient and safer, even when they do not earn any interest. (Imagine
having to pay a large amount in cash – for purchasing a house.)
What does the bank do with the funds that have been deposited with it? Assuming that not everyone who has deposited funds
with it will ask for their funds back at the same time, the bank can loan these funds to someone who needs the funds at interest
(of course, the bank has to be sure it will get the funds back at the required time). So the bank will typically retain a portion of
the funds to repay depositors whenever they demand their funds back, and loan the rest. Since banks earn interest from loans
they make, any bank would like to lend the maximum possible. However, being able to repay depositors on demand is crucial to
the bank’s survival. Depositors would keep their funds in a bank only if they are fully confident of getting them back on demand.
A bank must, therefore, balance its lending activities so as to ensure that sufficient funds are available to repay any depositor on
demand.
 BALANCE SHEET OF A COMMERCIAL BANK
Conventionally, the assets of a commercial bank are recorded on the left hand side and liabilities on the right hand side.
In case of a bank, apart from buildings, furniture, etc., its assets are loans given to public. When the bank gives out loan of
`100 to a person, this is the bank’s claim on that person for `100. Another asset that a bank has is reserves. Reserves are
deposits which commercial banks keep with the Central bank, Reserve Bank of India (RBI) and its cash. These reserves are
kept partly as cash and partly in the form of financial instruments (bonds and treasury bills) issued by the RBI. Reserves are
similar to deposits we keep with banks. We keep deposits and these deposits are our assets, they can be withdrawn by us.
Similarly, commercial banks like State Bank of India (SBI) keep their deposits with RBI and these are called Reserves.
Liabilities for any firm are its debts or what it owes to others. For a bank, the main liability is the deposits which people keep with it.
The accounting rule states that both sides of the account must balance. Hence, if assets are greater than liabilities, they are
recorded on the right hand side as Net Worth. (Net Worth = Assets – Liabilities)
Assets Amount (`) Liabilities Amount (`)

Reserves xxx Deposits xxx
Net Worth xxx
Total xxx Total xxx
 THE SUPPLY OF MONEY : VARIOUS MEASURES

In a modern economy money consists mainly of currency notes and coins issued by the monetary authority of the country.
In India currency notes are issued by the Reserve Bank of India (RBI), which is the monetary authority in India. However,
coins are issued by the Government of India. Apart from currency notes and coins, 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. Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits.
Though a hundred-rupee note can be used to obtain commodities worth `100 from a shop, the value of the paper itself is
negligible – certainly less than `100. Similarly, the value of the metal in a five-rupee coin is probably not worth `5. Why
then do people accept such notes and coins in exchange of goods which are apparently more valuable than these? The
value of the currency notes and coins is derived from the guarantee provided by the issuing authority of these items. 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 a
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.
Legal Definitions: Narrow and Broad Money
Money supply is a stock variable. The total stock of money in circulation among the public at a particular point of time is
called money supply. RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are
defined as follows:
M1 = Currency notes plus coins held by the public (CU) + Net demand deposits held by commercial banks (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 organisations (excluding National Savings Certificates)
The word ‘net’ implies that only deposits of the public held by the banks are to be included in money supply. The interbank
deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of 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 most liquid and easiest for transactions whereas M4 is least liquid of all. M3 is the most commonly used
measure of money supply. It is also known as aggregate monetary resources.
Money Creation by Commercial Banking System: Working of

2.2
Money Multiplier/ Lending Process of Banks
Process of Money Creation by Commercial Banks
Commercial banks receive deposits from the public. The depositors are free to withdraw, in part or in full,their deposit
amounts by writing cheques. The banks use the money in these deposits to give loans. These functions of the commercial
banking system are the basis of money creation. Note that money creation is also called 'deposit creation' or 'credit creation'.
Commercial banks cannot use the total deposits for giving loans. It is legally compulsory for the banks to keep a certain
minimum fraction of net total demand and time deposits as legal reserves. The fraction is called the Legal Reserve Ratio (LRR).
LRR is the minimum reserve that a commercial bank must maintain as per the instructions of the central bank.
Top Tip
Legal Reserve Ratio is also called Reserve Ratio or Required Reserve Ratio or Reserve Deposit Ratio or Legal Reserve
Deposit Ratio.
The LRR is fixed by the Central Bank. It has two components:

(i) Cash reserve ratio (CRR): It is the fraction of net total demand and time deposits that commercial banks must
keep as cash reserves with the Central Bank.
(ii) Statutory liquidity ratio (SLR): It is the fraction of net total demand and time deposits that commercial banks
must keep with themselves in the form of specified liquid assets.
How much are the deposits created is determined by primary deposits and Legal Reserve Ratio (LRR). Primary deposits refer
to initial deposits with the commercial banks.
Given the amount of primary deposits (or initial deposits) and the legal reserve ratio (LRR), total deposits creation (or
credit creation or money creation) will be:
Total credit creation (or money creation) = Initial deposits × 1/Legal Reserve Ratio
Money creation (or deposits creation or credit creation) is a process by which a commercial bank creates total deposits
number of times the primary deposits.
Process of money creation (or deposits creation or credit creation) is based on the following assumptions:
(i) There is single banking system in the economy.
(ii) All transactions are routed through banks. One who makes payment does it by writing cheque. The one who
receives payment deposits the same in his deposit account.
Numerical Example
Suppose customer deposits `10,000 in bank and the legal reserve ratio (LRR) proposed by the Central Bank is 20%. Bank has
to pay interest on this amount for which bank should lend this money to someone.
A part of the amount is to be retained with bank to meet its customers' obligations. Since LRR is 20%,the bank will keep
20% of deposits as reserves, i.e., `2,000 and will lend the remaining 80%, i.e. `8,000.
Those who borrow will spend this money and same `8,000 will come back to bank in the form of deposits. This raises the
total deposits to `18,000 now.
Bank again keeps 20% of `8,000,i.e. `1,600 as reserves and lend `6,400 to those who needs. This will further raise the
deposits with bank.
In this way deposits will go on increasing @ 80% of the last deposit.
Top Tip
The deposits creation comes to an end when total reserves become equal to the initial deposit,i.e. `10,000.
Deposits creation by commercial bank (with initial deposits `10,000 and LRR 20%)
Rounds Deposits (`) Loans (`) Reserves (`)

I 10,000 8,000 2,000
II 8,000 6,400 1,600
III 6,400 5,120 1,280
   
Total 50,000 40,000 10,000
Total deposits creation (or credit creation or money creation) = Initial deposits × 1/LRR
= `10,000 × 1/0.2 = `10,000 × 5 = `50,000
How many times the total deposits would be of the initial deposit is determined by the LRR. The multiple called the
money multiplier (or deposit multiplier or credit multiplier) is:
Money multiplier = 1/Legal Reserve Ratio
In our example, Legal Reserve Ratio is 20%, therefore, money multiplier = 1/0.2 = 5
Thus, the total deposit creation is 5 times the initial deposit.
Money Multiplier – Its role in determining credit creation power of banks

Meaning
Money Multiplier (or Credit Multiplier or Deposit Multiplier) is the number by which total deposits can increase due to a
given change in deposits.
Money Multiplier (or Credit Multiplier or Deposit Multiplier) is inversely related to legal reserve ratio.
Money multiplier = 1/Legal Reserve Ratio
Money multiplier measures the amount of money that the banks are able to create in the form of total deposits with every
initial deposit.
Role in determining credit creation power of banks
The credit creation by commercial banks depends on money multiplier. There is a direct relationship between money
multiplier and total credit creation by commercial banks.
Lower the money multiplier, lesser will be total credit creation by the commercial banking system and vice-versa.
Total credit creation = Initial deposits × Money Multiplier (1/LRR)
Numerical Example: Suppose the LRR is 20% and initial deposit is `10,000.
Money multiplier = 1/LRR = 1/0.20 = 5; and Total credit created = `10,000 × 5 = `50,000
Whereas, suppose LRR is increased by the Central Bank to 50% and initial deposits remain the same, i.e. `10,000.
Then, Money multiplier = 1/0.50 = 2; and Total credit created = `10,000 × 2 = `20,000.
Direct relationship between money multiplier and credit creation
Legal Reserve Ratio Money multiplier (= 1/LRR) Credit creation = Initial deposits × 1/LRR
20% 1/0.20 = 5 `10,000 × 5 = `50,000
50% 1/0.50 = 2 `10,000 × 2 = `20,000
Thus, with the same initial deposit total credit creation decreases with a decrease in the value of money multiplier.
Legal Reserve Ratio – Its influence in the process of credit creation by banks
Legal Reserve Ratio (LRR) is the minimum reserves that a commercial bank must maintain as per the instructions of the
Central Bank.
Credit creation is inversely related to the legal reserve ratio.
Total credit creation (or money creation) = Initial deposits × 1/Legal Reserve Ratio
Higher the legal reserve ratio, lesser will be the credit creation by the commercial banking system and vice-versa.
Numerical Example: Suppose the LRR is 20% and initial deposit is `10,000.
Total credit creation = Initial Deposits × 1/LRR = 10,000 × 1/0.2 = 10,000 × 5 = `50,000
Now suppose, if the LRR is increased by the Central Bank to 50% and initial deposits remain the same.
Total credit creation = Initial Deposits × 1/ LRR = 10,000 × 1/0.5 = 10,000 × 2 = `20,000.
Inverse relationship between LRR and credit creation
Legal Reserve Ratio Credit creation = Initial deposits × 1/LRR
20% 10,000 × 1/0.2 = 10,000 × 5 = `50,000
50% 10,000 × 1/0.5 = 10,000 × 2 = `20,000
Thus, any increase in LRR will decrease the credit creation power of the commercial banks (banking system).
Numerical 1
Calculate the value of credit multiplier if the legal reserve deposit ratio is 20%.

Solution: Credit Multiplier = 1/Legal Reserve Deposit Ratio = 1/0.2 = 5
Numerical 2
If the Reserve Ratio is 20% and the primary deposits are `100, what is the value of deposit multiplier and total lending
by the banking system?
Given the same amount of initial deposits, if the RBI increased the Reserve Ratio to 25%, what would happen in the
economy? Explain.
Solution: Deposit multiplier (or Money multiplier or Credit multiplier) = 1/Reserve ratio = 1/20% = 1/0.2 = 5
Credit creation (or Money creation or Deposit creation) = Primary Deposits × 1/Reserve ratio = `100 × 5 = `500
Total lending by the banking system = 500 –100 = `400
If the RBI increases the Reserve Ratio to 25%, total money creation = `100 × 1/0.25 = ` 100 × 4 = `400
Thus, the banking system would now be able to loan `300 only (`400 – `100). It would have to call back some loans
to meet the increased reserve requirements. Hence, money supply would fall.
Numerical 3
Calculate the legal reserve ratio if the initial deposit of ` 10,000 crore lead to a creation of total deposits of ` 1,00,000
crore.
Solution: Deposits creation = Initial deposits × 1/LRR
1,00,000 = 10,000 × 1/LRR
1/LRR = 1,00,000/10,000
1/LRR = 10
LRR = 1/10 = 0.1 or 10%
2.3 Central Bank and Its Functions

Central Bank – Meaning
The Central Bank is the apex institution of a country's monetary system. The design and the control of the country's
monetary policy is its main responsibility.
India got its Central Bank in 1935. Its name is the 'Reserve Bank of India (RBI)'. It is the apex bank engaged in
regulating commercial banks in India.
Functions of the Central Bank

1. Bank of Currency Notes Issue/Authority of Currency Issue
In most of the economies across the world, there exists a centralised system of currency issues. Central Bank of a country
has monopoly over the currency issue. It has the sole responsibility of printing and putting in circulation all types of
currency notes (with a few exceptions).
• This centralised and monopolised system of currency notes issue ensures uniformity of the currency system.
• It also helps in easier control over the monetary system.
• This function of the central bank also builds faith in the currency system of the economy.
2. Banker to the Government/Government’s Bank, Agent and Advisor
The Central Bank acts as a banker to the government (both Central government as well as State governments). Banker to the
government means that the Central Bank gives the same banking facilities to the government which commercial banks give to
the general public. The Central Bank does not give such facilities to the general public.
• As the banker to the government, the central bank provides credit/loans to the government.
• It accepts receipts and makes payments on behalf of the government.
• It keeps accounts of government and accepts deposits from government.
As the agent and advisor to the government, the Central Bank performs following functions:
• It manages the public debts for the government
• It buys and sells government securities in the open market.
• It advises the government regarding the money market, capital market and also on policy matters.
3. Bankers’ Bank and Supervisor/Regulator/Controller
As the banker to the banks, the Central Bank performs the following functions:
• The Central Bank holds surplus cash reserves of commercial banks.
• It gives loans to the commercial banks when they are in need of funds.
• It provides a large number of routine banking functions to the commercial banks, like cheque clearing house facility,
remittance facilities, etc.
In its supervisory/regulatory role, the central bank performs the following functions:
• It makes rules regarding their licensing, branch expansion, liquidity of assets, amalgamation (merging
of banks) and liquidation (the winding up of banks), etc.
• It gives instructions for the smooth functioning of the banking system.
• The control is exercised by periodic inspection of banks and the returns filed by them.
What role of RBI is known as 'lender of last resort'?
When commercial banks need more funds in order to be able to create more credit,they may go to market for such funds
or go to the Central Bank. Central bank provides them funds through various instruments.
‘Lender of Last Resort' refers to the role of the Central Bank (RBI), of being ready to lend to banks, especially when a bank
is faced with unanticipated severe financial crises, and due to this central bank is said to be the ‘lender of last resort’.
If the central bank refuses to extend this help, there is no option for the bank but to shut down.
Top Tip
Commercial banks are legally required to keep only a fraction of deposits as cash reserves. This is because 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 into the banks. Therefore, to meet the daily demand for
withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as cash reserves. However, if suppose all
the account-holders want to withdraw their deposits at the same time,the bank will not have enough funds to satisfy
the need of every accountholder. This situation is called 'bank run'.The bank may approach the Central Bank,which then
lends money to meet its emergent needs.
4. Controller of Credit and Money Supply

'Credit control' is the most crucial function played by any Central Bank in the modern times. The primary objective of
credit control is to remove causes responsible for instability in price fluctuations which in turn are related to the supply of
money. By controlling credit, the Central Bank can exercise an effective control over economic activity and mobilise it in
the desired direction.
In India, The RBI controls the money supply in the economy in various ways. The tools used by the Central bank to
control money supply can be quantitative or qualitative.
Quantitative tools control the extent of money supply by changing the Cash Reserve Ratio (CRR) or Statutory Liquidity
Ratio (SLR) or Bank Rate or Repo Rate or Reverse Repo Rate, or through Open market operations (OMO).
1. Bank Rate Policy
Bank Rate is the rate of interest at which Central Bank lends to the commercial banks for long term.
The Central Bank can regulate money supply in an economy by changing the bank rate.
 When the Central Bank has to increase the money supply (during recession/deflation), it lowers bank rate. When
Central Bank lowers bank rate, commercial banks also lower their lending rates. Since borrowing becomes cheaper,
people may borrow more. This leads to increase in credit creation by banks and thus, rise in money supply in the
hands of general public.
 When the Central Bank has to decrease the money supply (during inflation), it raises bank rate. When Central
Bank raises bank rate, commercial banks also raise their lending rates. Since borrowing becomes costly, people may
borrow less. This leads to decrease in credit creation by banks and thus, reduces the money supply in the hands of
general public.
2. Open Market Operations (OMO)
Open Market Operations refers to buying and selling of government securities (bonds) by the Central Bank from/to the
general public. It is an important step which may be undertaken to control money supply in the economy.
 By selling government securities the Central Bank soaks liquidity from the economy because those who buy make
payments by cheques to the Central Bank. This reduces the reserves of commercial banks and adversely affects
bank’s ability to create credit and thus, reduces the money supply in the hands of general public.
 By purchasing government securities, Central Bank releases liquidity in the economy since it pays for it by giving
a cheque. This cheque increases cash reserves with banks and thus increases bank’s ability to create credit and
hence increases the money supply in the hands of general public.
3. Legal Reserve Requirements
Legal Reserve Ratio (LRR) is the minimum reserves that a commercial bank must maintain as per the instructions of the
Central Bank.
There are two components of Legal Reserve Ratio (LRR)– Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). CRR is the fraction of net total demand and time deposits that commercial banks must keep as cash reserves
with the Central Bank. SLR is the fraction of net total demand and time deposits that commercial banks must keep with
themselves in the form of liquid assets.
 When the Central Bank raises CRR or SLR or both, less money is left with commercial banks for lending. As
lending decreases, the money creation decreases and money supply in the economy decreases.
 When the Central Bank reduces CRR or SLR or both, more money is left with commercial banks for lending. As
lending increases, the money creation increases and money supply in the economy increases.
4. Repo Rate
Repo Rate (or Repurchase Rate) is the rate of interest at which Central Bank lends to commercial banks for their short-
term requirements.
 An increase in repo rate will force commercial banks to increase their lending rates. It will make borrowings
costlier to general public. People may borrow less. Thus, credit creation by banks declines and money supply
decreases in the economy.
 A decrease in repo rate will induce commercial banks to decrease their lending rates. It will make borrowings
cheaper to general public. People may borrow more. Thus, credit creation by banks increases and money supply
increases in the economy.
5. 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 Reverse Repo Rate is raised, it encourages the commercial banks to park their funds with the central bank.
This has the negative effect on the lending capability of the commercial banks.
 Lowering Reverse Repo Rate has the opposite effect which raises demand for borrowings from the commercial
banks.
Qualitative tools include persuasion by the Central Bank in order to make commercial banks discourage or encourage
lending which is done through margin requirement, moral suasion, etc.
Margin Requirement on Loan: It refers to the difference between current market value of the security offered and
amount of loan granted by banks.
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.
 Lowering margin requirement enables borrowers to secure larger amount of funds from the banks, thereby
increases money supply in the economy.
 Raising margin requirement forces borrowers to secure less amount of funds from the banks, thereby decreases
money supply in the economy.
Top Tip
The policy adopted by the Central Bank of a country in the direction of credit control or money supply is known as
Monetary Policy. Instruments of Monetary Policy are Bank Rate, Cash Reserve Ratio (CRR), Open Market Operations
(OMO), etc.
RECAP
MONEY AND SUPPLY OF MONEY

Anything which is commonly accepted as a medium of exchange is called money.
Money supply refers to the total quantity of money in circulation in the economy at a given point of time. Thus, it is a stock
variable. It has two components:
(i) Currency held by the public (CU): The currency issued by the central bank (Reserve Bank of India) can be held by the
public or by the commercial banks, and is called the high‑powered money.
(ii) Net demand deposits held by commercial banks (DD): Demand deposits are the deposits which can be easily
withdrawable on demand, by cheque or otherwise, by the depositor from his/her bank account, e.g. current account
and savings account deposits.
Demand deposits are created by the commercial banks and are called bank money.
Time deposits are those deposits in banks which have a fixed period of maturity, e.g., Fixed Deposits (FD).
MONEY CREATION BY BANKS
Money creation (or credit creation or deposit creation) by commercial banks is determined by :
1. The amount of the initial deposits/primary deposits.
Primary deposits refer to initial deposits with the commercial banks.
2. Legal Reserve Ratio (LRR)/Reserve Deposit Ratio
LRR is the minimum reserves which a commercial bank must maintain as per the instructions of the central bank.
There are two components of Legal Reserve Ratio (LRR): Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
CRR is the fraction of net total demand and time deposits that commercial banks must keep as cash reserves with the
Central Bank. SLR is the fraction of net total demand and time deposits that commercial banks must keep with themselves
in the form of liquid assets.
Total credit creation = Initial deposits ×1/LRR
Suppose the initial deposits are `10,000 and LRR is 20%. The banks will keep 20% of the deposits i.e. `2,000 as reserves and
will lend the remaining amount of `8000. Those who borrow will spend the money for making payments.
It is assumed that the entire `8000 comes back as secondary deposits to the banking system. Now the banks will again keep
20% of `8000 i.e. `1600 as reserves and lend out `6400.This process continues till total reserves become equal to initial
reserves. Total money creation = Initial deposit × 1/LRR = `10,000 × 1/20% = `10,000 × 5 = `50,000.
Hence, the initial deposit of `10,000 has led to the total money supply of `50,000.
Rounds Deposits (`) Loans (`) Reserves (`)
I 10000 8000 2000
II 8000 6400 1600
III 6400 5120 1280
... ... ... ...
Total 50000 40000 10000
How does legal reserve ratio influence the process of credit creation? Credit creation is inversely related to the legal
reserve ratio.
Total credit creation = Initial Deposits × 1/LRR
For example, suppose LRR is 0.2 and initial deposits are `10,000. = 10,000 × 1/0.2 = 10,000 × 5 = `50,000
Now suppose, if the LRR is increased by the Central Bank to 0.5 and initial deposits remain the same, i.e. `10,000.
Now, total credit creation = Initial Deposits × 1/ LRR
= 10,000 × 1/0.5 = 10,000 × 2 = `20,000.
Thus, any increase in LRR will decrease the credit creation power of the commercial banks (banking system).
Define Money Multiplier. What role does it play in determining the credit creation power of the banking system?
Money Multiplier (or Credit Multiplier or Deposit Multiplier) is the process by which the commercial banks create credit,
based upon the reserve ratio and initial deposits.
The credit creation by commercial banks depends on money multiplier as it is inversely related to LRR.
Money Multipler = 1/Legal Reserve Ratio
Higher the value of money multiplier, higher will be the total credit created and vice-versa.
Total credit creation = Initial deposits × Money Multipler (1/LRR)
For example, suppose the LRR is 0.5 and initial deposit is `10,000. Money multiplier = 1/LRR = 1/0.5 = 2; andTotal credit
created = `10,000 × 2 = `20,000.
Whereas, suppose LRR is decreased by the Central Bank to 0.2 and initial deposits remain the same, i.e. `10,000.
Then, Money multiplier = 1/0.2 = 5; and
Total credit created = `10,000 × 5 = `50,000.
Thus, with the same initial deposit total credit creation increases with an increase in the value of money multiplier.
CENTRAL BANK AND ITS FUNCTIONS

The Central Bank is the apex institution of a country’s monetary system. India’s central bank is the ‘Reserve Bank of India’. It
is the apex bank engaged in regulating commercial banks. Four main functions of Central Bank are:
1. Bank of Currency Notes Issue: In most of the economies across the world, there exists a centralised system of currency
issues. Central Bank of a country has monopoly over the currency issue. It has the sole responsibility of printing and
putting in circulation all types of currency notes (with a few exceptions).
• This centralised and monopolised system of currency notes issue ensures uniformity of the currency system.
• It also helps in easier control over the monetary system.
• This function of the central bank also builds faith in the currency system of the economy.
2. Government’s Bank, Agent and Advisor: Central Bank acts as the Government’s banker (both central as well as state
governments) and performs following functions:
• Provides credit/loans to the government.
• Accepts receipts and makes payments on behalf of the government.
• Keeps accounts of government and accepts deposits from government.
As the agent and advisor to the government, the Central Bank performs following functions:
• Manages the public debts for the government
• Buys and sells government securities in the open market.
• Advises the government regarding the money market, capital market and also on policy matters.
3. Bankers’ Bank and Supervisor/Regulator: As the banker to the banks, the Central Bank performs the following
functions:
• Holds surplus cash reserves of commercial banks.
• Gives loans to the commercial banks when they are in need of funds.
• Provides a large number of routine banking functions to the commercial banks, like cheque clearing house facility,
remittance facilities, etc.
In its supervisory/regulatory role, the central bank performs the following functions:
• Ensures that the commercial banks follow all the rules regarding their licensing, branch expansion etc.
• Gives instructions for the smooth functioning of the banking system.
Central Bank acts as the ‘Lender of Last Resort’: It refers to the role of the Central Bank (RBI), of being ready to lend to banks,
especially when a bank is faced with unanticipated severe financial crises, and due to this central bank is said to be the ‘lender of
last resort’. If the central bank refuses to extend this help, there is no option for the bank but to shut down.
4. Controller of Credit: The primary objective of credit control is to remove causes responsible for instability in price
fluctuations which in turn are related to the supply of money. By controlling credit, the Central Bank can exercise an
effective control over economic activity and mobilise it in the desired direction. Central Bank regulates the volume and
use of credit by using quantitative and qualitative tools.
Quantitative tools control the extent of money supply by changing the Cash Reserve Ratio (CRR) or Statutory Liquidity Ratio
(SLR) or Bank Rate or Repo Rate or Reverse Repo Rate, or through Open market operations (OMO).
Qualitative tools include persuasion by the Central Bank in order to make commercial banks discourage or encourage lending
which is done through margin requirement, moral suasion, etc.
Multiple Choice Questions (MCQs)

1. Value of Money Multiplier _______ with an increase in Cash Reserve Ratio.
(a) increases (b) decreases
(c) remains unchanged (d) None of these
2. Supply of money refers to _________.
(a) currency held by the public
(b) currency held by Reserve Bank of India (RBI)
(c) currency held by the public and demand deposits of the public with commercial banks
(d) currency held in the government account
3. The value of money multiplier is equal to ___________.
(a) 1/Cash Reserve Ratio (b) 1/Legal Reserve Ratio
(c) 1/Statutory Liquidity Ratio (d) All of these
4. Loans offered by commercial banks _________ the money supply in the economy.
(a) increase (b) decrease
(c) does not change (d) All of these
5. __________ is the main source of money in an economy.
(a) Central bank (b) Commercial banks
(c) Both (a) and (b) (d) Government
6. The interest rate paid by the banks to depositors is lower than the rate charged from the borrowers. This difference
between these two types of interest rates is called ______.
(a) Bank Rate (b) Lending Rate
(c) Repo Rate (d) Spread
7. When the banks lend to any person, a new deposit is opened in that person’s name. Thus, money supply in the
economy increases to old deposits plus new deposits plus _______.
(a) Currency held by the public (b) Bank Money
(c) High Powered Money (d) Legal Reserves
8. There is a limit to money or credit creation by banks, and this is determined by the central bank (RBI). The RBI
decides a certain percentage of _______ which every bank must keep as reserves, called Legal Reserve Ratio
(LRR).
(a) Demand deposits (b) Time deposits
(c) Net total demand and time deposits (d) Current account deposits
9. If the Reserve Ratio is 20% and the primary deposits are `100, the total lending by the banking system will be
______.
(a) `500 (b) `400
(c) `100 (d) `20
10. M1 measure of money supply is defined as follows:
M1= CU +DD where, CU is Currency (notes plus coins) held by the public and DD is ‘net’ demand deposits held
by commercial banks. What does word ‘net’ imply here?
(a) Only deposits of the public held by the banks are to be included in money supply.
(b) The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as
part of money supply.
(c) Both (a) and (b)
(d) It implies aggregate monetary resources.
11. The currency issued by the central bank can be held by the public or by the commercial bank, and is called the
______ .
(a) Credit money (b) Bank money
(c) High powered money (d) Fiat money
12. Demand deposits include _______.

(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
13. Deposit creation by banks comes to an end when _____.
(a) fresh deposits with banks become zero (b) legal reserve ratio becomes zero
(c) money multiplier becomes zero (d) total reserves equal initial deposits
14. The ratio of net total deposits that a commercial bank has to keep with Reserve Bank of India is called:
(a) Statutory liquidity ratio (b) Deposit ratio
(c) Cash reserve ratio (d) Legal reserve ratio
15. Which of the following is not a Quantitative Method of credit control?
(a) Open Market Operation (b) Margin Requirements
(c) Variable Reserve Ratio (d) Bank Rate Policy
16. Who regulates money supply?
(a) Government of India (b) Reserve Bank of India
(c) Commercial Banks (d) Planning Commission
17. Signature of _______ appears on a `2,000 currency note.
(a) The Central Bank (b) Governor of Reserve Bank of India (RBI)
(c) Finance Minister of India (d) Chief Justice of India
18. The formula used for calculating Credit multiplier :
(a) 1/Cash Reserve Ratio (b) 1/Statutory Liquidity Ratio
(c) 1/Legal Reserve Deposit Ratio (d) All of the above
19. Repo rate relates to ________.
(a) Short-term borrowings by commercial banks
(b) Long-term borrowing by commercial banks
(c) Disinvestments
(d) Dis-savings
20. Total deposits created by commercial banks is `20,000 crore and LRR is 20%. Calculate the amount of initial
deposits.
(a) `6000 crore (b) `4000 crore
(c) `5000 crore (d) `3000 crore
21. __________ measures the amount of money that the banks are able to create in the form of deposits with every
initial deposit.
(a) Money supply (b) Demand deposits
(c) Deposit multiplier (d) High powered money
22. If Reserve Deposit Ratio is 12.5%, the value of money multiplier will be:
(a) 2 (b) 5
(c) 8 (d) 10
23. ______________ is the rate of interest at which central bank lends to the commercial banks for long-term.
(a) Bank Rate (b) Repo Rate
(c) Reverse Repo Rate (d) Prime Lending Rate
24. _____ is the agent and adviser to the Government of India.
(a) Central Bank of India (b) State Bank of India
(c) Reserve Bank of India (d) Punjab National Bank
25. _______ are called legal tenders.
(c) Inter-bank deposits (d) Currency notes and coins
65. The value of credit multiplier will be high when __________.

(a) Legal reserve ratio is high (b) Legal reserve ratio is low
(c) Legal reserve ratio is zero (d) Legal reserve ratio is infinity
66. When commercial banks need more funds in order to be able to create more credit, they may go to market
for such funds or go to the Central Bank. Central Bank provides them funds through various instruments. This
role of RBI, that of being ready to lend to banks at all times is a important function of the central bank, and
due to this central bank is said to be the _______________.
(a) Bankers’ Bank (b) The Supreme Power
(c) Lender of last resort (d) None of these
67. The RBI can influence money supply by changing the rate at which it gives loans to the commercial banks for
long-term periods. This rate is called the ___________ in India.
(c) High powered money (d) Lending Rate
68. When the central bank buys the government security through an agreement which has a specification about date
and price of resale of this security. This type of agreement is called a Repurchase agreement . The interest rate at
which the money is lent in this way is called the_____ .
69. When the Central bank sells the government security through an agreement which has a specification about the
date and price at which it will be repurchased. This type of agreement is called a Reverse Repurchase Agreement.
The rate at which the money is withdrawn in this manner is called the (ii)_______ .
(c) Reverse Repo Rate (d) Lending Rate
70. Repo rate is the rate at which
(a) commercial banks purchase government securities from the central bank
(b) commercial banks can take loans from the central bank
(c) commercial banks can keep their deposits with the central bank
(d) short-term loans are given by commercial banks
71. If an economy is to control recession, which of the following can be appropriate?
(a) Reducing Repo Rate (b) Reducing CRR
(c) Both (a) and (b) (d) None of (a) and (b)
72. During deflation, it is advisable to ___________.
(a) Lower the bank rate and purchase of securities in the open market
(b) Increase the bank rate and purchase of securities in the open market
(c) Decrease in bank rate and sale of securities in the open market
(d) Increase in bank rate and sale of securities in the open market
73. To curb inflation, the RBI should____________.
(a) Reduce the bank rate (b) Reduce the Repo rate
(c) Sell the government securities (d) Reduce the Reverse Repo rate
74. To soak the liquidity from the market ___________.
(a) Government securities should be purchased
(b) Government securities should be sold
(c) Repo rate should be decreased
(d) Cash reserve ratio should be decreased
75. If the Reserve Deposit Ratio is 25% and the initial deposits of the public are `2,000, what is the value of deposit
multiplier, total deposit creation and total lending by the banking system?
(a) Deposit multiplier = 4; Total deposit creation = `8,000 and total lending by the banking system `6,000
(b) Deposit multiplier = 5; Total deposit creation = `10,000 and total lending by the banking system `10,000
(c) Deposit multiplier = 4; Total deposit creation = `10,000 and total lending by the banking system `10,000
(d) Deposit multiplier = 5; Total deposit creation = `8,000 and total lending by the banking system `6,000
76. Total deposits created by commercial banks is `12,000 crore and LRR is 25%. The amount of initial deposits was:
(a) `15,000 crore (b) `12,000 crore
(c) `3,000 crore (d) `25,000 crore
77. What will be the legal reserve ratio if the initial deposit of ` 25,000 crore lead to a creation of total deposits of
`1,25,000 crore?
(a) 25% (b) 20%
(c) 125% (d) 12.5%
78. The Reserve Bank of India (RBI), cut Repo Rate to 4.4%, the lowest in at least 15 years. Also, it reduced the
Cash Reserve Ratio (CRR) maintained by the banks for the first time in over seven years. CRR for all banks
was cut by 100 basis points to release `1.37 lakh crores across the banking system. RBI governor Dr. Shaktikanta
Das predicted a big global recession and said India will not be immune. It all depends how India responds to the
situation. Aggregate demand may weaken and ease core inflation.
Cut in Repo rate by RBI is likely to ___________ the demand for goods and services in the economy.
(a) Increase (b) Decrease
(c) Double (d) None of these
Answer Key
1. (b) 2. (c) 3. (b) 4. (a) 5. (c) 6. (d) 7. (a) 8. (c)
9. (b) 10. (c) 11. (c) 12. (b) 13. (d) 14. (c) 15. (b) 16. (b)
17. (b) 18. (c) 19. (a) 20. (b) 21. (c) 22. (c) 23. (a) 24. (c)
25. (d) 26. (c) 27. (c) 28. (d) 29. (b) 30. (b) 31. (a) 32. (b)
33. (c) 34. (a) 35. (c) 36. (b) 37. (d) 38. (b) 39. (d) 40. (b)
41. (c) 42. (a) 43. (d) 44. (a) 45. (c) 46. (b) 47. (c) 48. (c)
49. (b) 50. (c) 51. (b) 52. (b) 53. (c) 54. (d) 55. (a) 56. (a)
57. (b) 58. (c) 59. (d) 60. (c) 61. (d) 62. (c) 63. (a), (b) 64. (b)
65. (b) 66. (c) 67. (a) 68. (b) 69. (c) 70. (b) 71. (c) 72. (a)
73. (c) 74. (b) 75. (a) 76. (c) 77. (b) 78. (a)
Case Study
Case-based Multiple Choice Questions (MCQs)

1 Case Study Read the following News Report and answer Q. 1-4 on the basis of the same:
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 per cent and reduced the reverse repo rate to 3.35 per cent.
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
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.
(c) double (d) not affect
RBI Monetary Policy 2020

The key indicators of RBI Monetary Policy along with their current rates in the table given below:
Indicator Current Rate
CRR 3%
SLR 18.50%
Repo Rate 4.00%
Reverse Repo Rate 3.35%
Bank Rate 4.65%
n 9th October 2020, RBI has kept the Repo Rate unchanged at 4.00% and reduced reverse repo rate to 3.35%. In
O
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.5 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 related 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 related to the distribution of credit among users as well as
the rate of interest on borrowing and lending.
Q.6 What does the ‘Bank Rate’ mean?
Q.7 Which of the following is a quantitative credit control technique of RBI?
(a) CRR (b) SLR
(c) Repo Rate (d) All of these
Q.8 Cut in Reverse Repo Rate is likely to __________ the demand for goods and services in the economy during
Covid-19 lockdowns.
RBI extends CRR and SLR relaxations for three more months.
Keeping in view the continuing of 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 Developmental 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.9 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.10 What will be the value of money multiplier?
(a) 33.33 (b) 5.4
(c) 4.65 (d) None of these
Q.11 SLR implies:
(a) Certain percentage of the total bank’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
Q.12 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
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 how India responds to the situation. Aggregate demand
may weaken and ease core inflation.
Q.13 CRR stands for:
(a) Cash Reserve Ratio (b) Current Reserve Ratio
(c) Cash Required Rate (c) Current Required Rate
Q.14 Cut in Repo Rate by RBI is likely to _____________ the aggregate demand in the Indian economy.
Q.15 “... reduced the CRR by 100 basis points. Previously, it was 4%.” Thus, CRR is reduced to ___________.
(a) 5% (b) 3%
(c) 96% (d) 104%
Q.16 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
Answer Key
1. (b) 2. (c) 3. (a) 4. (a) 5. (b), (d) 6. (b) 7. (d) 8. (a)
9. (d) 10. (c) 11. (b) 12. (b) 13. (a) 14. (a) 15. (b) 16. (d)
Multiple Choice Questions (MCQ) on Assertion-Reasoning Type
Read the following statements-Assertion (A) and Reason (R), and select the correct alternative in each case:
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion
(A).
(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A)
(c) Assertion (A) is true but Reason(R) is false.
(d) Assertion (A) is false but Reason(R) is true.
1. Assertion (A): Currency created by the Central Bank Is called bank Money.
Reason (R): Central Bank of a country has monopoly over the currency issue. It has the sole responsibility of
printing and putting in circulation all types of currency notes (with a few exceptions).
2. Assertion (A): An increase in Legal Reserve Deposit Ratio increases the credit creation power of the commercial
banks (banking system).
Reason (R): Credit creation = Primary deposits × 1/ Legal Reserve Ratio
3. Assertion (A): Currency notes and coins are called fiat money.
Reason (R): RBI is responsible for giving the bearer of the currency equal purchasing power.
4. Assertion (A): Currency notes and coins are called legal tenders.
Reason (R): They cannot be refused by any citizen of the country for settlement of any kind of transaction.
5. Assertion (A): Money supply is a flow variable.
Reason (R): Money supply is the total stock of money in circulation among the public point of time.
6. Assertion (A): Statutory liquidity ratio is the ratio of demand deposits of a commercial bank which it has to
keep in the form of specified liquid assets.
Reason (R): Statutory liquidity ratio is a component of legal reserve ratio, which affects the credit creation in the
economy.
7. Assertion (A): Reverse repo rate is the rate at which the Central Bank lends funds to banks.
Reason (R): When Reverse Repo Rate is raised, it encourages the commercial banks to park their funds with the
central bank.
8. Assertion (A): To increase the money supply in the economy, Central Bank reduces the margin requirement.
Reason (R): Decrease in margin requirements enhances the borrowing capacity of public, which raises the
money supply in the economy.
9. Assertion (A): Demand deposits are not legal tenders.
Reason (R): Demand deposits are the deposits which can be easily withdrawable on demand, by cheque or
otherwise, by the depositor from his/her bank account.
10. Assertion (A): In a modern economy, money comprises cash and bank deposits.
Reason (R): Money supply includes currency held by the public and net demand deposits held by commercial
banks.
11. Assertion (A): Besides central bank, commercial banks are the other type of institutions which are a part of the
money-creating system of the economy.
Reason (R): Commercial banksaccept deposits from the public and lend out part of these funds to those who
want to borrow.
12. Assertion (A): Quantitative tools include persuasion by the central bank in order to make commercial banks
discourage or encourage lending.
Reason (R): Quantitative tools control the extent of money supply by changing the Cash Reserve Ratio (CRR)
or Statutory Liquidity Ratio (SLR) or Bank Rate or Repo Rate or Reverse Repo Rate, or through Open market
operations (OMO).
13. Assertion (A): Qualitative credit control tools control the extent of money supply.
Reason (R): Qualitative tools discourage or encourage lending which is done through margin requirement,
moral suasion, etc.
14. Assertion (A): M1 measure of money supply is defined as follows: M1 = CU +DD,where CU is Currency (notes
plus coins) held by the public and DD is ‘net’ demand deposits held by commercial banks. The word ‘net’ here
implies that only deposits of the public held by the banks are to be included in money supply.
Reason (R): The interbank deposits, which a commercial bank holds in other commercial banks, are not to be
regarded as part of money supply.
15. Assertion (A): Credit creation is inversely related to the legal reserve ratio.
Reason (R): Credit creation = Initial Deposits × 1/LRR .Any increase in LRR will decrease the credit creation
power of the commercial banks (banking system).
16. Assertion (A): Credit creation is inversely related to money multiplier.
Reason (R): Credit creation = Initial deposits × Money Multipler (1/LRR)
With the same initial deposit total credit creation decreases with a decrease in the value of money multiplier.
Answer Key
1. (d) 2. (d) 3. (a) 4. (a) 5. (d)
6. (d) 7. (d) 8. (a) 9. (b) 10. (a)
11. (a) 12. (d) 13. (d) 14. (a) 15. (a)
16. (d)
Self Assessment Test 3
Money and Banking

Time allowed : 45 min Maximum Marks : 20
Q.1 Read the following statements-Assertion (A) and Reason (R):
Assertion (A): Credit creation is inversely related to money multiplier.
Reason (R): Credit creation = Initial deposits × Money Multipler (1/LRR)
With the same initial deposit total credit creation decreases with a decrease in the value of money multiplier.
Select the correct alternative:
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
Q.2 Read the following statements-Assertion (A) and Reason (R):
Assertion (A): M1 measure of money supply is defined as follows: M1 = CU +DD,where CU is Currency (notes
plus coins) held by the public and DD is ‘net’ demand deposits held by commercial banks. The word ‘net’ here
implies that only deposits of the public held by the banks are to be included in money supply.
Reason (R): The interbank deposits, which a commercial bank holds in other commercial banks, are not to be
regarded as part of money supply.
Select the correct alternative:
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
Q.3 The formula used for calculating Credit multiplier :
(a) 1/Cash Reserve Ratio (b) 1/Statutory Liquidity Ratio
(c) 1/Legal Reserve Deposit Ratio (d) All of the above
Q.4 If Reserve Deposit Ratio is 12.5%, the value of money multiplier will be:
(a) 2 (b) 5
(c) 8 (d) 10
Q.5 ______________ is the rate of interest at which central bank lends to the commercial banks for long-term.
(c) Reverse Repo Rate (d) Prime Lending Rate
Q.6 _____ is the agent and adviser to the Government of India.
(a) Central Bank of India (b) State Bank of India
(c) Reserve Bank of India (d) Punjab National Bank
Q.7 _______ are called legal tenders.
(c) Inter-bank deposits (d) Currency notes and coins
Q.8 Supply of money refers to quantity of money ____________ .
(a) as on 31st March (b) during any specified period of time
(c) as on any point of time (d) during a fiscal year
Q.9 Which of the following is not a function of the Reserve Bank of India?
(a) It issues the currency of the country.
(b) It acts as a bank to the banking system.
(c) It is the custodian of the foreign exchange reserves of the economy.

(d) None of the above
Q.10 The RBI can influence money supply by changing the rate at which it gives loans to the commercial banks for
long-term periods. This rate is called the ___________ in India.
Q.11 The ratio of net total demand and time deposits that a commercial bank has to keep with Reserve Bank of India
is called:
(a) Statutory liquidity ratio (b) Deposit ratio
(c) Cash reserve ratio (d) Legal reserve ratio
Q.12 Which of the following is not a Quantitative Method of credit control?
(a) Open Market Operations (b) Margin Requirements
(c) Variable Reserve Ratio (d) Bank Rate Policy
Q.13 ____________ is the only institution which can issue currency notes in India.
(a) State Bank of India (SBI) (b) Reserve Bank of India (RBI)
(c) Central Bank of India (CBI) (d) Government of India (GOI)
Q.14 Apart from the CRR, banks are also required to keep some reserves in liquid form in the short term. This ratio
is called __________________.
(a) Reserve Ratio (b) Legal Reserve Ratio
(c) Statutory Liquidity Ratio (d) Reserve Deposit Ratio
Q.15 To soak the liquidity from the market ___________.
(a) Government securities should be purchased
(b) Government securities should be sold
(c) Repo rate should be decreased
(d) Cash reserve ratio should be decreased
Q.16 If the Reserve Deposit Ratio is 25% and the initial deposits of the public are `2,000, what is the value of deposit
multiplier, total deposit creation and total lending by the banking system?
(a) Deposit multiplier = 4; Total deposit creation = `8,000 and total lending by the banking system `6,000
(b) Deposit multiplier = 5; Total deposit creation = `10,000 and total lending by the banking system `10,000
(c) Deposit multiplier = 4; Total deposit creation = `10,000 and total lending by the banking system `10,000
(d) Deposit multiplier = 5; Total deposit creation = `8,000 and total lending by the banking system `6,000
Q. 16 Total deposits created by commercial banks is `12,000 crore and LRR is 25%. The amount of initial deposits was:
(a) `15,000 crore (b) `12,000 crore
(c) `3,000 crore (d) `25,000 crore
Read the following News Report and answer Q. 17-20 on the basis of the same:
RBI Monetary Policy 2020
The key indicators of RBI Monetary Policy along with their current rates in the table given below:
Indicator Current Rate
CRR 3%
SLR 18.50%
Repo Rate 4.00%
Reverse Repo Rate 3.35%
Bank Rate 4.65%
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.17 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 related 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 related to the distribution of credit among users as well as
the rate of interest on borrowing and lending.
Q.18 What does the ‘Bank Rate’ mean?
Q.19 Which of the following is a quantitative credit control technique of RBI?
(a) CRR (b) SLR
(c) Repo Rate (d) All of these
Q.20 Cut in Reverse Repo Rate is likely to __________ the demand for goods and services in the economy during
Covid-19 lockdowns.
(a) increase (b) decrease (c) double (d) not affect
Answers to Self Assessment Tests Questions

1. (d) 2. (b) 3. (c) 4. (a) 5. (c) 6. (d) 7. (a) 8. (c)
9. (b) 10. (b) 11. (c) 12. (a) 13. (b) 14. (b) 15. (b) 16. (b)
17. (b) 18. (c) 19. (a) 20. (b)
1. (b) 2. (c) 3. (c) 4. (b) 5. (d) 6. (c) 7. (b) 8. (b)
9. (b) 10. (a) 11. (b) 12. (c) 13. (c) 14. (a) 15. (a) 16. (a)
17. (d) 18. (a) 19. (a) 20. (d)

1. (d) 2. (a) 3. (c) 4. (c) 5. (a) 6. (c) 7. (d) 8. (c)
9. (d) 10. (a) 11. (c) 12. (b) 13. (b) 14. (c) 15. (b) 16. (a)
17. (d) 18. (d) 19. (d) 20. (a)

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UNIT-2 Money and Banking EXAM HANDBOOK Economics XII 9

(for CBSE Term-I Examination November-December 2021)

For CBSE Term-I Examination

Introduction Money and Banking

2.1 Money and Supply of Money

Additional NCERT Content Extracted from NCERT Book 2021-22

Assets Amount (`) Liabilities Amount (`)

 THE SUPPLY OF MONEY : VARIOUS MEASURES

Money Creation by Commercial Banking System: Working of

The LRR is fixed by the Central Bank. It has two components:

Rounds Deposits (`) Loans (`) Reserves (`)

Money Multiplier – Its role in determining credit creation power of banks

2.3 Central Bank and Its Functions

Functions of the Central Bank

4. Controller of Credit and Money Supply

MONEY AND SUPPLY OF MONEY

CENTRAL BANK AND ITS FUNCTIONS

Multiple Choice Questions (MCQs)

12. Demand deposits include _______.

65. The value of credit multiplier will be high when __________.

RBI Monetary Policy 2020

Q.5 What does RBI Monetary Policy 2020 mean?

Multiple Choice Questions (MCQ) on Assertion-Reasoning Type

Self Assessment Test 3

Money and Banking

(c) It is the custodian of the foreign exchange reserves of the economy.

Answers to Self Assessment Tests Questions

Self Assessment Test 1

Self Assessment Test 3

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