Exercise Solutions Available
Step-by-step answers for all textbook questions in this chapter
How to Use This Page
These are complete exercise solutions for Samacheer Kalvi 12th Economics Chapter 6 — Banking. Solve each question yourself first, then verify your method and answer below. For numerical problems on credit creation, always show the formula, substitution, calculation steps, and final answer with units.
Key Concepts (Quick Recap)
- Bank: A financial institution that accepts deposits and grants loans, acting as a financial intermediary between savers and borrowers.
- Types of Banks: Commercial banks, cooperative banks, central bank (RBI in India), and specialised banks (EXIM, NABARD, NHB).
- Primary Functions of Commercial Banks: (1) Accepting deposits (demand, savings, fixed, recurring) and (2) Granting loans and advances (cash credit, overdraft, term loans, discounting bills).
- Secondary Functions of Commercial Banks: Agency functions (collection of dividends, payment of bills, etc.) and general utility functions (locker facility, letter of credit, foreign exchange, underwriting).
- Credit Creation: Banks create credit by lending a portion of deposits; the total credit created = Initial Deposit x (1/CRR). The credit multiplier = 1/CRR.
- Reserve Bank of India (RBI): Established in 1935, nationalised in 1949, headquartered in Mumbai. Acts as issuer of currency, banker to the government, banker's bank, controller of credit, and custodian of foreign exchange reserves.
- Monetary Policy — Quantitative Tools: Bank rate, open market operations (OMO), Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Repo rate.
- Monetary Policy — Qualitative Tools: Margin requirements, moral suasion, selective credit controls, direct action.
- CRR vs SLR: CRR is maintained with RBI in cash only; SLR is maintained by the bank itself in cash, gold, or approved securities.
- Commercial Bank vs Central Bank: Commercial banks aim at profit; central bank aims at economic stability. Commercial banks deal with the public; central bank deals with the government and other banks.
I. Choose the Best Answer
Q1. The central bank of India is: (a) State Bank of India (b) Reserve Bank of India ✓ (c) Punjab National Bank (d) Indian Overseas Bank
Q2. Credit multiplier is calculated as: (a) CRR x 100 (b) 1/SLR (c) 1/CRR ✓ (d) CRR/Deposits
Q3. Which of the following is a quantitative tool of monetary policy? (a) Moral suasion (b) Margin requirements (c) Open market operations ✓ (d) Selective credit controls
Q4. The RBI was nationalised in the year: (a) 1935 (b) 1947 (c) 1949 ✓ (d) 1969
Q5. When CRR is increased by the RBI, the credit creation capacity of commercial banks: (a) Increases (b) Decreases ✓ (c) Remains the same (d) Becomes zero
Q6. The bank rate is the rate at which: (a) Commercial banks lend to the public (b) RBI lends to commercial banks ✓ (c) Commercial banks lend to each other (d) RBI borrows from the government
Q7. Which type of deposit allows the depositor to withdraw money at any time without prior notice? (a) Fixed deposit (b) Recurring deposit (c) Demand deposit (current account) ✓ (d) Post office deposit
Q8. SLR requires banks to maintain reserves in: (a) Only cash (b) Cash, gold, and approved securities ✓ (c) Only government bonds (d) Only gold
Q9. The process by which banks create credit is based on: (a) Total capital of the bank (b) Primary deposits received (c) Fractional reserve system ✓ (d) Government directives
Q10. Moral suasion refers to: (a) Legal action by RBI (b) Persuasion and advice by RBI to banks ✓ (c) Direct control over interest rates (d) Raising CRR
II. Fill in the Blanks
1. The Reserve Bank of India was established in the year 1935.
2. The credit multiplier is calculated as 1/CRR.
3. The rate at which RBI lends to commercial banks is called the bank rate.
4. Cash Reserve Ratio (CRR) is the portion of deposits that banks must keep with the RBI in cash form.
5. Statutory Liquidity Ratio (SLR) is the portion of deposits that banks must maintain in cash, gold, or approved securities.
6. The process of creating credit by commercial banks is called credit creation.
7. RBI acts as the lender of last resort to commercial banks by providing financial assistance during crises.
8. Open market operations refer to the buying and selling of government securities by RBI in the open market.
9. The headquarters of RBI is located in Mumbai.
10. The minimum margin requirement is a qualitative tool of monetary policy.
III. True or False
IV. Match the Following
| Column A | Column B |
|---|---|
| 1. RBI | d. Central bank of India |
| 2. CRR | f. Cash kept with RBI as reserve |
| 3. Bank rate | a. Rate at which RBI rediscounts bills |
| 4. Open market operations | e. Buying and selling of government securities |
| 5. Credit multiplier | b. 1/CRR |
| 6. SLR | g. Reserves in cash, gold, or securities |
| 7. Moral suasion | c. Persuasion by RBI to control lending |
| 8. Fixed deposit | h. Deposit for a fixed period with fixed interest |
Key: 1-d, 2-f, 3-a, 4-e, 5-b, 6-g, 7-c, 8-h
V. Answer Briefly
Q1. What is a bank? Name the types of banks.
A bank is a financial institution that accepts deposits from the public and uses those deposits to grant loans and advances, thereby acting as a financial intermediary between savers and borrowers. Types of banks: 1. Commercial banks — profit-oriented banks that deal with the public (e.g., SBI, IOB). 2. Cooperative banks — banks owned by members on cooperative principles (e.g., urban cooperative banks, PACS). 3. Central bank — the apex institution that regulates the banking system (e.g., RBI). 4. Specialised banks — banks set up for specific sectors (e.g., NABARD for agriculture, EXIM Bank for foreign trade, NHB for housing).
Q2. What are the primary functions of commercial banks?
The primary functions of commercial banks are: I. Accepting Deposits: - Demand deposits (Current accounts): Withdrawable on demand; no interest paid; suitable for businesses. - Savings deposits: Interest-bearing; some withdrawal restrictions; for individuals. - Fixed deposits: Lump-sum deposit for a fixed period; higher interest rate; penalty for premature withdrawal. - Recurring deposits: Fixed monthly deposits for a fixed period; interest compounded quarterly. II. Granting Loans and Advances: - Cash credit: Loan against pledge of goods or securities; interest charged only on the amount drawn. - Overdraft: Facility to withdraw more than the balance in a current account; interest on the excess amount. - Term loans: Loans for a specified period with a repayment schedule. - Discounting bills of exchange: Bank purchases trade bills at a discount; provides immediate funds to the seller.
Q3. What are the secondary functions of commercial banks?
Secondary (ancillary) functions fall into two categories: I. Agency Functions (bank acts as agent for the customer): - Collection of dividends, interest, and rent. - Payment of insurance premiums, bills, and rent. - Acting as executor, administrator, or trustee of customer's estate. - Buying and selling shares and securities on behalf of customers. II. General Utility Functions: - Providing locker (safe deposit vault) facilities. - Issuing traveller's cheques and letters of credit. - Foreign exchange dealings. - Underwriting securities. - Providing financial advice and credit information. - Acting as a referee for financial standing of customers.
Q4. Define credit creation. What is the credit multiplier?
Credit creation is the process by which commercial banks create deposits (money supply) that are a multiple of their initial cash reserves. When a bank receives a deposit, it keeps a fraction as reserves (CRR) and lends out the remainder. The lent amount gets re-deposited in the banking system, and the process continues, creating additional deposits. Credit multiplier (k) = 1 / CRR Where CRR is expressed as a fraction. For example, if CRR = 10% (0.10): k = 1 / 0.10 = 10 Total credit created = Initial deposit x k = Initial deposit / CRR The credit multiplier shows how many times the initial deposit gets multiplied through the banking system. A lower CRR leads to a higher multiplier and more credit creation.
Q5. What is the bank rate? How does it affect credit creation?
The bank rate (also called the discount rate) is the rate at which the Reserve Bank of India lends to commercial banks by rediscounting their bills of exchange or providing advances without collateral. Effect on credit creation: - When RBI increases the bank rate, borrowing from RBI becomes more expensive for commercial banks. Banks raise their own lending rates, making loans costlier for the public. Demand for credit falls, reducing credit creation. - When RBI decreases the bank rate, borrowing from RBI becomes cheaper. Banks lower their lending rates, making loans affordable. Demand for credit rises, increasing credit creation. Thus, the bank rate is a quantitative tool of monetary policy that influences the overall volume of credit in the economy.
Q6. What are open market operations (OMO)?
Open market operations refer to the buying and selling of government securities by the Reserve Bank of India in the open market. - When RBI buys securities: It pays money to banks and the public, increasing the cash reserves of commercial banks. This enables banks to lend more, increasing credit creation. - When RBI sells securities: It absorbs money from banks and the public, reducing the cash reserves of commercial banks. Banks can lend less, decreasing credit creation. OMO is a quantitative tool of monetary policy. It directly affects the liquidity (money supply) in the economy and is one of the most frequently used tools by RBI.
Q7. Distinguish between CRR and SLR.
| Feature | CRR | SLR |
|---|---|---|
| Full form | Cash Reserve Ratio | Statutory Liquidity Ratio |
| Where maintained | With RBI | By the bank itself |
| Form | Cash only | Cash, gold, or approved securities |
| Purpose | Control credit and ensure liquidity | Ensure solvency of banks and credit control |
| Earns interest | No (RBI pays no interest on CRR) | Yes (securities earn interest) |
| Current role | Active monetary policy tool | Less frequently changed |
Q8. What is the role of RBI as the lender of last resort?
When commercial banks face a financial crisis and cannot obtain funds from any other source, the Reserve Bank of India comes to their rescue as the lender of last resort. - RBI provides financial assistance to commercial banks by rediscounting their bills, granting advances, or providing loans against collateral. - This function prevents bank failures and maintains confidence in the banking system. - Without this safety net, a temporary liquidity crunch could lead to bank runs and systemic collapse. - This role reinforces RBI's position as the apex institution in the banking hierarchy.
VI. Answer in Detail
Q1. Explain the process of credit creation with a worked example.
Credit creation is the most significant function of commercial banks. Banks do not keep all deposits as reserves; they lend out a major portion, which creates additional deposits in the banking system. Assumptions: 1. There is only one bank (or the banking system acts as a single unit). 2. The initial deposit is made in cash. 3. All loans are re-deposited in the banking system (no cash leakage). 4. CRR is fixed by the RBI. Process (with CRR = 10%): | Round | New Deposit (₹) | CRR (10%) | Loan / New Deposit (₹) | |---|---|---|---| | 1 | 10,000 | 1,000 | 9,000 | | 2 | 9,000 | 900 | 8,100 | | 3 | 8,100 | 810 | 7,290 | | 4 | 7,290 | 729 | 6,561 | | ... | ... | ... | ... | | Total | 1,00,000 | 10,000 | 90,000 | Calculation: - Credit multiplier (k) = 1 / CRR = 1 / 0.10 = 10 - Total deposits created = Initial deposit x k = 10,000 x 10 = ₹1,00,000 - Total credit (loans) created = Total deposits - Initial deposit = 1,00,000 - 10,000 = ₹90,000 Limitations of credit creation: 1. Cash leakage: Not all loans are re-deposited; people may hold cash. 2. Excess reserves: Banks may keep more than the minimum CRR for safety. 3. Availability of creditworthy borrowers: Banks can only lend if there is demand from creditworthy borrowers. 4. Business conditions: During recession, demand for credit falls, limiting credit creation. 5. RBI controls: CRR, SLR, and bank rate changes can restrict or expand credit creation.
Q2. Describe the functions of the Reserve Bank of India.
The Reserve Bank of India (established 1935, nationalised 1949) performs the following key functions: 1. Issuer of Currency: - RBI has the sole right to issue currency notes (except one-rupee notes and coins, which are issued by the Government of India). - This is called the monopoly of note issue, which ensures uniformity and control over the money supply. - Currency is issued against minimum reserve system (holding ₹200 crore in gold and foreign securities). 2. Banker to the Government: - Receives payments, makes payments, and manages funds on behalf of the central and state governments. - Acts as an agent for the government in borrowing through treasury bills and government securities. - Provides Ways and Means Advances (WMA) to bridge temporary mismatches in government receipts and payments. - Advises the government on financial and economic matters. 3. Banker's Bank (and Lender of Last Resort): - Commercial banks maintain accounts with RBI; RBI can lend to them during crises (lender of last resort). - Rediscounts bills of exchange for commercial banks. - Prescribes CRR and SLR that banks must maintain. - Conducts clearing house operations for inter-bank settlements. 4. Controller of Credit: - Uses quantitative tools (bank rate, CRR, SLR, OMO, repo rate) to regulate the volume of credit. - Uses qualitative tools (margin requirements, moral suasion, selective credit controls, direct action) to regulate the direction and purpose of credit. 5. Custodian of Foreign Exchange Reserves: - Maintains India's foreign exchange reserves. - Administers the Foreign Exchange Management Act (FEMA). - Stabilises the exchange value of the rupee by buying and selling foreign currencies. 6. Other Functions: - Publication of financial data and reports (e.g., RBI Bulletin, Annual Report). - Promotion of banking habits and financial inclusion. - Regulation and supervision of banks and non-banking financial companies (NBFCs).
Q3. Explain the quantitative and qualitative tools of monetary policy used by RBI.
Monetary policy is the policy by which the RBI regulates the money supply and credit in the economy to achieve price stability, economic growth, and exchange stability. A. Quantitative Tools (General Credit Controls): These affect the overall volume of credit without discriminating between sectors. 1. Bank Rate: - The rate at which RBI lends to commercial banks without collateral. - Increase in bank rate makes borrowing costlier, reducing credit. - Decrease in bank rate makes borrowing cheaper, expanding credit. 2. Open Market Operations (OMO): - RBI buys or sells government securities in the open market. - Buying securities injects money, increasing liquidity and credit. - Selling securities absorbs money, reducing liquidity and credit. 3. Cash Reserve Ratio (CRR): - The percentage of total deposits that banks must keep with RBI in cash. - Increase in CRR reduces available funds for lending, contracting credit. - Decrease in CRR increases available funds, expanding credit. 4. Statutory Liquidity Ratio (SLR): - The percentage of deposits that banks must maintain in cash, gold, or approved securities. - Increase in SLR reduces lendable funds; decrease in SLR expands credit. 5. Repo Rate: - The rate at which RBI lends to commercial banks against government securities as collateral (short-term). - Increase in repo rate makes short-term borrowing expensive, reducing credit. - Reverse repo rate is the rate at which RBI borrows from banks, absorbing excess liquidity. B. Qualitative Tools (Selective Credit Controls): These regulate the direction and purpose of credit, not just its volume. 1. Margin Requirements: - The margin is the difference between the market value of a security and the loan amount. - Increasing the margin reduces the loan amount a borrower can obtain, restricting credit in that sector. - Decreasing the margin makes credit easier to obtain. 2. Moral Suasion: - RBI uses persuasion, advice, and appeal to influence banks' lending behaviour. - Not legally enforceable, but effective given RBI's authority. 3. Selective Credit Controls: - RBI can prescribe minimum margins or set maximum credit limits for specific commodities or sectors. - Example: Imposing higher margins on loans for luxury goods while allowing lower margins for essential goods. 4. Direct Action: - RBI can take direct action against banks that do not comply with its directives. - Includes imposing penalties, restricting lending, or even cancelling a bank's licence.
Q4. Distinguish between a commercial bank and a central bank.
| Feature | Commercial Bank | Central Bank (RBI) |
|---|---|---|
| Objective | Earn profit | Ensure economic and monetary stability |
| Dealings | Deals with the general public | Deals with the government and other banks |
| Note issue | Cannot issue currency notes | Sole authority to issue currency (monopoly of note issue) |
| Ownership | Can be private, public, or cooperative | Owned by the government (after nationalisation) |
| Number | Many commercial banks exist | Only one central bank per country |
| Relationship | Maintains accounts with the central bank | Acts as banker to commercial banks |
| Credit control | Subject to central bank's policies | Formulates and implements monetary policy |
| Lender of last resort | Borrows from central bank in crisis | Acts as lender of last resort |
| Profit motive | Profit is the primary motive | Service and stability are the primary goals |
| Foreign exchange | Deals in foreign exchange as an agent | Custodian of foreign exchange reserves |
Q5. Explain the recent trends in banking in India.
1. Electronic Banking (E-Banking): - Internet banking, mobile banking, NEFT, RTGS, IMPS, and UPI have revolutionised fund transfers and payments. - Reduces the need for physical branch visits and enables 24/7 banking. 2. Non-Banking Financial Companies (NBFCs): - NBFCs provide financial services similar to banks but do not hold a banking licence. - E-NBFCs (like Bajaj Finance, Muthoot Finance) have expanded credit access, especially in underserved areas. - RBI regulates NBFCs but with lighter requirements than commercial banks. 3. Digital Banking and Fintech: - Payment banks (e.g., Airtel Payments Bank, India Post Payments Bank) offer limited banking services digitally. - Fintech companies provide lending platforms, digital wallets, and robo-advisory services. - The Digital India initiative and Jan Dhan Yojana have expanded financial inclusion. 4. Core Banking Solutions (CBS): - All branches are interconnected, allowing customers to access their accounts from any branch. - Enables real-time transaction processing and centralised data management. 5. ATM and Card Banking: - Widespread ATM networks provide 24/7 cash access. - Debit cards, credit cards, and prepaid cards reduce dependence on cash. 6. Pradhan Mantri Jan Dhan Yojana (PMJDY): - Launched in 2014 to provide universal access to banking facilities. - Over 50 crore bank accounts opened, promoting financial inclusion and direct benefit transfers. 7. Banking Reforms: - Bank consolidation (merger of associate banks with SBI, merger of PSU banks). - Introduction of Insolvency and Bankruptcy Code (IBC) for faster resolution of NPAs. - Strengthening of banking regulation and governance.
Q6. Explain the organisation of the Reserve Bank of India.
Establishment: The RBI was established on 1 April 1935 under the Reserve Bank of India Act, 1934. It was nationalised on 1 January 1949. Headquarters: Mumbai (originally in Kolkata, shifted to Mumbai in 1937). Organisational Structure: 1. Board of Directors: - The RBI is governed by a Central Board of Directors. - Governor: The chief executive, appointed by the Government of India. The Governor has the power to supersede the board in certain matters. - Deputy Governors: Not more than four, nominated by the Central Government. - Directors: Up to 10 directors nominated by the Government, and one government official (usually from the Ministry of Finance). - Directors represent agriculture, industry, and other sectors of the economy. 2. Local Boards: - Four local boards for the four regions: Western, Eastern, Northern, and Southern. - Each local board has five members appointed by the Central Government. - They advise the Central Board on regional matters and represent territorial economic interests. 3. Offices: - RBI has offices across India, including banking ombudsman offices. - The RBI also has a branch in every state capital and major cities. 4. Subsidiaries: - National Bank for Agriculture and Rural Development (NABARD) — established 1982. - Deposit Insurance and Credit Guarantee Corporation (DICGC) — established 1962. - Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL) — for currency printing. Tenure: The Governor and Deputy Governors hold office for terms not exceeding five years and are eligible for reappointment.
Common Mistakes to Avoid
1. Confusing CRR with SLR: Remember — CRR is kept with RBI in cash only; SLR is maintained by the bank itself in cash, gold, or approved securities. Both control credit but operate differently.
2. Confusing bank rate with repo rate: The bank rate is the rate at which RBI lends without collateral (longer term). The repo rate is the rate for short-term lending against government securities as collateral. They are distinct policy rates.
3. Forgetting that credit multiplier depends on CRR, not SLR: The formula for credit multiplier is 1/CRR. SLR affects the amount available for lending but the standard formula uses CRR.
4. Saying RBI deals with the general public: RBI is the banker to the government and banker's bank. It does not open accounts for or provide direct banking services to ordinary citizens. Commercial banks serve the public.
5. Confusing quantitative and qualitative tools: Quantitative tools (bank rate, CRR, SLR, OMO, repo rate) control the overall volume of credit. Qualitative tools (margin requirements, moral suasion, selective credit controls, direct action) control the direction and purpose of credit. Do not mix them up.
6. Writing only the final answer in numericals: Always show the formula (k = 1/CRR), substitute values, calculate step by step, and state the final answer with rupee symbol and units. Examiners award marks for each step.
Exam Checklist
- [ ] I can define a bank and name the four types (commercial, cooperative, central, specialised).
- [ ] I can list and explain the primary functions of commercial banks (deposits + loans/advances).
- [ ] I can explain credit creation with the formula k = 1/CRR and work out numericals.
- [ ] I can list and explain all five functions of RBI (issuer of currency, banker to government, banker's bank, controller of credit, custodian of forex).
- [ ] I can distinguish between CRR and SLR in a comparison table.
- [ ] I can explain quantitative tools (bank rate, OMO, CRR, SLR, repo rate) and qualitative tools (margin, moral suasion, selective credit controls, direct action).
- [ ] I can distinguish between a commercial bank and a central bank in a comparison table.
- [ ] I can discuss recent trends in Indian banking (e-banking, NBFCs, digital banking, PMJDY, bank consolidation).