IMRAN SIR SUCCESS POINT
What is Banking?
Banking is directly or indirectly connected with the trade of a country and the life
of each individual.
It is an industry that manages credit, cash, and other financial transactions.
In banking, the commercial bank is the most influential institution for any
country’s economy or for providing any credit to its customers.
In India, a banking company is responsible for transacting all the business
transactions including withdrawal of cheques, payments, investments, etc. In other
words, the bank is involved in the deposit and withdrawal of money, repayable on
demand, savings, and earning a decent amount of profits by lending money.
Banks also help to mobilise the savings of an individual, making funds accessible
to businesses and help them to start a new venture.
However, unlike commercial banks, private sector banks are owned, operated, and
regulated by private investors and have the right to operate according to the market
The word "bank" is commonly regarded as derived from the Italian word banco, a
bench - the Jews यहूदी in Lombardy(a region of north central Italy bordering
Switzerland ) having benches in the market-place for the exchange of money and
bills. When a banker failed, his bench was broken by the populace जनता; and from
this circumstance we have our word bankrupt.
Types of Banking:-Banks are further segregated into four types.
Commercial banks: These banks are regulated by Banking Regulation Act, 1949. They accept
the public deposit from the public for lending or investment.
Cooperative banks: Cooperative banks are undertaken by the State Cooperative Societies Act
and give cheap credit to their members. The rural population is dependent on the cooperative
banks for its financial backup.
Specialised banks: These banks provide financial help to special industries, foreign trade, etc.
Few examples of specialised banks are foreign exchange banks, export and import banks,
development banks, etc.
Central banks: These banks manage, check, and monitor all the activities of the commercial
banks of a country.
What is e-banking? What are its benefits?
It is the method by which the customer conducts transactions electronically via the internet.
Some of the examples of e-banking are managing deposit account, online fund transfer, ATM,
electronic data interchange, etc.
● It provides 24 hours and 365 days of banking services.
● The load on branches can be reduced by having a centralised database for faster processing.
● Customers can make a transaction from anywhere like the home office market, etc.
● It includes recording of every transaction.
● It provides greater customer satisfaction, higher security in terms of money.
A commercial bank is an institution which performs the function of
accepting depositing granting loans and making payments with the aim of
SBI, Panjab National Bank, Allahabad Bank, Canara Bank are some
example of commercial bank.
The two primary characteristics of a commercial bank are lending and
The bank receives the deposits and gives money to various projects to earn
The rate of interest that a bank offers to the depositors is known as the
borrowing rate, while the rate at which a bank lends money is known as the
FUNCTION OF COMMERCIAL BANK
A. Primary Function:-1. Accepting deposits:
The most significant and traditional function of commercial bank is accepting
deposits from the public
They accept deposits in several forms according to requirement of different section
of the society.
The deposits may be of three types: Saving deposits, Current deposits and fixed
Current Account deposit or Demand Deposit:-These deposit refers to those
deposits which are repayable by the bank on demand.
People can withdraw deposits in part or in full at any time he likes without notice
Such deposits are generally maintained by businessmen with the intension of
making transaction with such deposit.
They can be drawn upon by a cheque without any restriction.
Usually no interest is paid on them, because the bank cannot utilise these short-
term deposits. But banks impose service charges for running these accounts.
Fixed Deposit or Time Deposit:- It refers to those deposits in which the amount is
deposited with the bank for a fixed period of time.
These deposits carry a high rate of interest.
A higher rate of interests is paid on the fixed deposits.
Saving Deposits:- Savings deposits are payable on demand and money can be
withdrawn by cheques.
The depositors are given cheque facility to withdraw money from their account.
But there are certain restrictions imposed on the depositors of this account on
number and amount of withdrawals in order to discourage frequent use of saving
They carry a rate of interest which is less than interest rate on fixed deposits.
2. Advancing of loans:
The second important function of the commercial bank is to provide loans against
suitable mortgages to the public to fulfill their needs of money.
The deposit received by banks are not allowed to remain idle. So after keeping
certain cash reserve the balance is given to needy borrowers and interest is
charged from them which is the main source of income for these banks.
Different types of loans and advances made by commercial banks are:-
(a) Cash Credit:- It refers to a loan given to the borrower against his current
assets like shares, stock, bond etc.
A cash credit limit is sanctioned and the amount is credited in his account.
The borrower may withdraw any amount within his credit limit and interest is
charged on the amount actually withdrawn.
(b) Demand Loan:- It refers to those loans which can be recalled on demand by
the bank at any time .
The entire loan is credited to the account and interest is payable on the entire sum.
Short Term Loans:- They are given as personal loans against some collateral
The money is credited to the account of borrower and the borrower can withdraw
money from his account and interest is payable on the entire sum of loan granted.
B. Secondary Function:- 1. Overdraft Facility:-It refers to a facility in which
customer is allowed to overdraw his current account up to an agreed limit.
This facility is generally given to respectable and reliable customer for a short
Customer have to pay interest to the bank on the amount overdrawn by them.
2. Agency Function:-.
1. Transfer of funds 2. Collection and payment of various items.
3. Purchase and sales of foreign exchange 4. Purchase and sales of securities
5. Trustee and Executer 6. Income tax consultancy
3.Discounting Bill of Exchange:- It refers to a facility in which holder of a bill of
exchange can get the bill discounted with bank before the maturity.
After deducting the commission bank pays the balance to the holder. On maturity
bank gets its payment for the party which had accepted the bill.
4. General Utility Function:-
1. Locker facility 2. Traveller’s cheques 3. Letter of credit
4. Collection of securities.
MONEY CREATION OR CREDIT CREATION
It is one of the most important activities of commercial banks. Through the process
of money creation, commercial banks are able to create credit, which is in far excess
of the initial deposits.
This process can be better understood by making two assumptions:
(i) The entire commercial banking system is one unit and is termed as ‘Banks’.
(ii) All receipts and payments in the economy are routed through the Banks, i.e. all
payments are made through cheques and all receipts are deposited in the banks. The
deposits held by Banks are used for giving loans. However, banks cannot use the
whole of deposit for lending.
It is legally compulsory for the banks to keep a certain minimum fraction of their
deposits as reserves. The fraction is called the Legal Reserve Ratio (LRR) and is
fixed by the central bank. Banks do not keep 100% reserves against the deposits.
They keep reserves only to the extent indicated by the Central Bank.
Why only Fraction of deposits is kept as Cash Reserves?
Banks keep a fraction of deposits as Cash Reserves because a prudent banker,
by his experience, knows two things:
(i) All the depositors do not approach the banks for withdrawal of money at the same
time and also they do not withdraw the entire amount in one go.
(ii) There is a constant flow of new deposits into the banks.
So, to meet the daily demand for withdrawal of cash, it is sufficient for banks to keep only
a fraction of deposits as cash reserve. It means, if experience of the banks show that
withdrawals are generally around 20% of the deposits, then it needs to keep only 20% of
deposits as cash reserves (LRR).
Let us now understand the process of Money Creation through an example:
1. Suppose, initial deposits in banks is Rs 1,000 and LRR is 20%. It means, banks are
required to keep only Rs 200 as cash reserve and are free to lend Rs 800. Suppose they
lend Rs 800. Banks do not lend this money by giving amount in cash. Rather, they open
the accounts in the names of borrowers, who are free to withdraw the amount whenever
2. Suppose borrowers withdraw the entire amount of X 800 for making payments. As all
the transactions are routed through the banks, the money spent by the borrowers comes
back into the banks in the form of deposit accounts of those who have received this
payment. It will increase the demand deposits of banks by X 800.
3. With new deposits of X 800, banks keep 20% as cash reserves and lend the balance Rs
640. Borrowers use these loans for making payments, which again comes back into the
accounts of those who have received the payments. This time, banks deposits rise by Rs
4. The deposits keep on increasing in each round by 80% of the last round deposits. At the
same time, cash reserves also go on increasing, each time by 80% of the last cash reserve.
Deposit creation comes to end when total cash reserves become equal to the initial deposit.
It is an apex(supreme) body that controls operates regulates and directs the entire
banking and monetary structure of the country.
It occupies the top most position in the monetary and banking system of the
All the financially developed countries have their own central bank.
India’s Central Bank is the Reserve Bank of India (RBI) was established in April 1
1935 under Reserve Bank of India Act passed in 1934.
In UK as bank of England and in USA, it is known as Federal Reserve System.
FUNCTION OF CENTRAL BANK
FUNCTION OF CENTRAL BANK
1. Currency Authority or Bank of Issue:- It has the sole authority of currency in
In India RBI has the sole right of issuing paper currency notes (except one rupees
notes and coins which are issued by Minister of Finance).
The one Rupee note bears the signature of Finance secretary, while other currency
notes bear the Signature of RBI Governor.
Advantages of Sole authority of Note issue with RBI
(a) It leads to uniformity in note circulation.
It gives the central bank power to influence money supply because currency with
public is a part of money supply.
It ensure public faith in the currency system.
It helps in stabilization of internal and external value of currency.
It enables the government to have supervision and control over the RBI with
respect to issue of notes.
2. Banker साहूकार to the Government:-Central banks everywhere act as bankers,
fiscal agents and advisers to their respective governments.
As a banker it carries out all banking business of the government.
(a) It maintains a current account for keeping their cash credit.
(b) It accepts receipts and make payments for the government and carries out
exchange remittance and other banking operations.
As a fiscal agent, the central bank makes short-term loans to the government for a
period not exceeding 90 days
The central bank also advises the government on such economic and money
matters as controlling inflation or deflation, devaluation or revaluation of the
currency, deficit financing, balance of payments, etc.
3.Banker’s Bank and Supervisor:- There are number of commerical banks in a
country. There should be some agency to regulate and supervise their proper
The RBI acts as the banker to other banks. In this sense it bears the same
relationship with commercial banks as the latter maintain with the general public.
As the bankers to banks the RBI function in three capacities.
a. Custodian संरक्षक of cash reserve:- Commercial banks are required to keep
a certain proportion of their deposit (known as CRR) with the central bank.
b. Lender उधारदाता of the Last Resort अंततम आश्रय :-When commercial banks
fails to meet their financial requirements from other sources.
In case of a financial emergency they approach the central bank to give loans and
advances as lender of the last resort.
c. Clearing houses तनकासी गृह :-As central bank holds the cash reserve of all the
commercial banks, it becomes easier and more convenient for it to act as their
All commercial banks have their accounts with central bank. Therefore the central
bank can easily settle claims of various banks against each other, by making debit
and credit entries in their accounts.
As a supervisor central bank regulates and control the commercial banks. The
regulations of banks may be related to their licensing, branch expansion , liquidity,
management merging winding up etc.
4. Controller of Money Supply and Credit:- The RBI is empowered to regulate
the money supply in the economy through its monetary policy.
It is policy adopted by the central bank of an economy in the direction of credit
control or money supply.
As RBI has the sole monopoly in currency issue, it can control credit and supply of
(a) Repo (Repurchase) Rate:- Is the rate at which the central bank of a country
(RBI in case of India) lends money to commercial banks to meet their short term
The central bank advances loans against approved securities or eligible bills of
An increase in repo rate increase the cost of borrowing from the central bank.
It forces the commercial banks to increase their lending rates which discourages
borrowers from taking loans.
It reduces the ability of commerical banks to create credit .
(b) Bank Rate (or Discount Rate):- It is the rate at which the central bank of a
country lends money to commercial banks to meet their long term needs.
RBI has been actively using bank rate to control credit.
An increase in Bank rate increases the cost of borrowing from the central bank,
which leads to increase in lending rates by commercial banks. It discourages
borrowers from taking loans, which reduces the ability of commercial banks to
(c) Reserve Repo Rate:- (Reserve Repurchase rate):- It is the rate of interest at
which commercial banks can deposit their surplus funds with the central bank for a
relatively shorter period of time.
It is the rate of interest at which central bank accepts deposits from the commercial
When reserve repo rate is raised it encourages the commercial banks to deposit
their funds with the central bank.
(d) Open Market Operation:- It is one of the most important ways of monetary
control that is exercised by the central banks
Under this system, the central bank sells securities in the market when it wants to
reduce the money supply in the market.
It is done to increase interest rates. This policy is also known as the contractionary
when the central bank wants to increase the money supply in the market, it will
purchase securities from the market.
This step is taken to reduce the rate of interest and also to help in the economic
growth of the country. This policy is known as the expansionary monetary policy.
There are two types of open market operations:- Outright and repo
Outright open market operations are permanent in nature.
In repo market operation there is a promise of repurchase and resale of securities.
Frequently Asked Questions on Open Market Operations
How does open market operations work?
Open market operations work by selling and buying government securities by the
central bank of a nation. To increase the money supply, the central bank buys back
securities, while to reduce the money supply it sells securities to the commercial banks.
What is an example of open market operations?
Central banks conduct open market operations in order to regulate the money supply in
the economy. For example, in India, open market operations are undertaken by the
Reserve Bank of India or RBI.
Why are open market operations used the most?
Open market operations are used mainly to regulate the money supply in an economy.
It impacts both the supply and demand for credit.
What are the two types of open market operations?
The two types of open market operations are contractionary and expansionary
functions. Contractionary function reduces the money supply in an economy while
expansionary function eases the money supply.
(e) Legal Reserve Requirement:- Legal reserve requirements refer to the
minimum percentage of total deposits (time deposits and demand deposits),
required to be kept by the commercial banks with themselves and with the central
It is a very quick and direct method form controlling the credit creating power of
Commercial banks are required to maintain reserve on two accounts:-
(a) Cash Reserve Ratio:- It refers to the minimum percentage of net demand and
time liabilities to be kept by commercial banks with the central bank.
(b) Statutory Liquidity Ratio:- It refers to the minimum percentage of net demand
and time liabilities which commercial banks are required to maintain with
Every bank is required to maintain a fixed percentage of its assets in the form of
liquid assets called SLR.
This liquid assets include:- Cash , Gold, unencumbered भाररहित approved securities
The rate of SLR is fixed by the RBI and is varied form time to time .
To decrease the money supply during inflation the Central bank increases SLR.
(f) Margin Requirement :- It is the difference between the amount of loan and
market value of the securities offered by the borrower against the loan.
If the margin fixed by the central bank is 40% then commercial banks are allowed
to give a loan only up to 60% of the value of securities.
An increase in margin reduces the borrowing capacity and money supply.
Margin is necessary because if a bank gives a loan equal to the full value of
securities then bank will suffer a loss in case of fall in price of security.
Credit control instrument of RBI
1. Moral Suasion:- This is a combination of persuasion धारणा and pressure that
central bank applies on other bank in order to get them act, in manner in line with
It is like rendering an advice to the commercial banks by the RBI to follow its
The banks are advised to restrict loans during inflation and be liberal in lending
2. Selective credit control:- Under selective credit controls the RBI gives
directions to other banks to give or not to give credit for certain purpose to
This method can be applied in both positive and negative manner.
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