Banking Flashcards
Explain credit creation
Let’s take ₹ 1000 as the initial deposit and LRR as 20%. This implies that banks are allowed to keep 20% of the initial deposit and the rest is kept free for lending. In this case 20 % will be ₹200, this amount will be kept as cash reserve and the rest which is ₹800 will be kept for lending.
If the borrower borrows the full amount for making payments then the bank will create a different account( because the bank cannot lend in cash ), then the 20 %of this deposit will be kept as cash reserves (₹160) and the remaining will be kept for lending.
The same way, banks will continue creating deposits and this process is known as credit creation. I
This process ends when LRR is equal to the initial deposit.
Define discount rate. How does it help in controlling credit?
It is the rate at which Central Banks lend money to the Commercial Banks for long term needs.
It has the same effect as Repo Rate, when the bank rate increases the cost of borrowing rises, discourages the borrowers to borrow money which causes the demand to fall and this in turn reduces the ability of the commercial banks to create credit.
What is repo rate?
Repo rate is the rate at which central banks lend money to commercial banks for short term needs. It has the same effect as the bank rate. When the repo rate increases, cost of borrowings also increases which discourages the borrowers and causes the demand to fall. This reduces the ability of the commercial banks to create credit.
Define Bank Rate and explain how it can have an effect in controlling credit
It is the rate at which Central Banks lends money to the Commercial Banks for long term needs.
It has the same effect as Repo Rate, when the bank rate increases the cost of borrowing rises, discourages the borrowers to borrow money which causes the demand to fall and this in turn reduces the ability of the commercial banks to create credit.
What is reverse repo rate?
Reverse repo rate is the rate of interest at which commercial bank can deposit their surplus funds with the central bank for a short period of time.
If the rev repo rate is increased,
It will have a negative impact on the credit creation process. The ability of the commercial banks to create credit will decrease. This is because commercial banks will have less amount to create credit,
What is open market operations?
It refers to buying and selling of govt securities by central bank to or from the public and commercial banks.
It does not matter whether the securities are bought or sold because it will b either deposited or transferred from the bank.
Sale of securities: if the securities are sold by the central bank, then there will b a reduction in the reserves, which will affect the credit creation process, will reduce the ability to create credit.
Purchase of securities: this will increase reserves and hence not reduce the ability of the commercial banks to create credit.
What is legal reserve requirements?
It has 2components
LRR
And SLR
What are margin requirements?
It is the diff between the amount of loan and market value of the security offered by the borrower against the loan.
Increase in MR wil reduce the borrowing capacity and money supply
Decrease in MR will increase the borrowing capacity and money supply
RBI has prescribed diff MR for diff theme of borrowers for the same commodity
It is very necessary because if a bank gives loan equal to the full value of security then the bank will suffer a loss in case of fall in price of security.
List the functions of central bank.
Currency Authority (or bank of issue)
Bankers bank and supervisor
Banker to the govt
Controller of money supply and credit
Explain currency authority or bank of issue
RBI was established on q1st April 1935 under the Rbi act of 1934.
Its most important function is to issue currency notes. It issues all currency notes except one rupee notes and coins. Coins and one rupee notes are issued by the ministry of finance.
One rupee notes bear the signature of the finance secretary and the other notes which are issued by RBI bear the signature of Governor RBI.
It is it’s monetary liability to repay back with assets of equal value to enhance public confidence in paper currency.
Explain banker to the govt
RBI acts as an agent, banker and a financial advisor.
RBI as a banker:
Accepts receipts and makes payments for the govt and carries out exchange, remittances and other banking operations.
it gives loans and advances to the govt for temporary periods. The govt borrows money by selling treasury bills to the central bank.
It also creates a current bank account for keeping their cash balances.
As an agent,
It has the responsibility of managing public debt.
As a financial advisor,
It advises the govt on it monetary, economic and financial matters from time to time.
Bankers bank and supervisor
Custodian of cash reserves:
Commercial banks deposit a certain percentage of deposits with central bank in the form of Cash Reserve Ratio(CRR) . In this way it acts as a custodian of cash reserves.
Lender of last resort:
If the commercial bank faces an financial emergency it approaches the central bank for financial support. The central bank lends money against securities and bills of exchange.
Clearing house:
Since all the deposits are with the central bank. The central bank has the accounts of all the commercial banks. It acts as a clearing house, it settles claims by making and debit and credit entries in their accounts
It also acts as a supervisor,
It regulates and controls the commercial banks.
Explain controller of money supply and credit.
Define CRR also state what will happen if crr is increased.
It is a minimum percentage of net demand and time liabilities that the commercial banks must keep as cash reserves with the central bank.
If CRR is increased then the commercial banks will have less reserves to lend to the borrowers.
This will reduce the ability of the commercial banks to create credit.
Define SLR
It is a minimum percentage of total demand and time liabilities which the commercial banks must keep with themselves in the form of specified liquid assets.
If the SLR is increased ,commercial banks will have more freedom over unapproved securities and can sell or purchase more.
This will reduce the ability of the commercial banks to create credit.
