Economics [2 Mark Question Answer]

The central bank is the sole authority for the issue of currency in the country. All the currency issued by the central bank is its monetary liability. Notes issued by the central bank are circulated as legal tender money.
The monopoly of issuing notes promotes efficiency in the financial system because
(i) it brings about uniformity in currency notes circulation
(ii) It gives the Central Bank direct control over one of the components of money supply.

Open market operations refer to the buying and selling of government securities in the open market by the Central Bank (RBI) from/to the public and banks.
Open Market Operations: The Central Bank (RBI) controls credit through its open market operations. Under it, the central bank buys or sells the government securities in the open market. Sale of securities by central bank reduces the reserves of commercial banks which adversely affects bank's ability to create credit. And purchase of securities from the open market increases the resources of banks and hence their lending capacity

As Lender of the Last Resort
As banker to the banks, the central bank (The Reserve Bank of India) acts as the lender of the last resort. In case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans. The central bank gives loans to such banks through discounting of approved securities and bills of exchange.

Cash Reserve Ratio (CRR) : It refers to the minimum percentage of net demand and time deposits to be kept by commercial banks with the central bank. A change in CRR affects the power of commercial banks to create credit. Increase in CRR: An increase in CRR reduces the excess reserves of commercial banks and limits their lending power. In other words, the reserves of commercial banks are reduced and they give less credit. CRR is raised during inflation. The volume of aggregate demand will decrease.
Decrease in CRR: During the period of deflation (or deficient demand) the central bank decreases the cash reserve ratio. A decrease in CRR has the effect of increasing the banks excess reserves and thus, increases their lending ability. Banks now give more credit. Thus, when credit or money supply is to be expanded, CRR is reduced.

As govt. agent, the central bank undertakes sale and purchase of the goverment securities and also manages the public debt (national debt) and foreign debt.

(i) As a banker's bank: Under the banking law, commercial banks are required to deposit cash reserves with the Central Bank. It gives loans to commercial banks as a lender of the last resort.
(ii) As a supervisor: The central bank supervises, regulates and controls the commercial banks. The regulation may be related to their licensing, branch expansion, amalgamation etc. It also includes periodic inspection of banks.

The Central Bank is the apex institution of a country's monetary system.
Two Reasons for setting up the Central Bank are:
(i) Central Bank is set up to control the supply of money and credit in the country.
(ii) Every Central Bank is set up to control the entire banking system of a country.

Since Indian economy is a cash dependent economy, where half of the population uses cash for transactions, demonetisation has heavily affected trade, business and consumption. This resulted in job losses, decline in farm incomes and social disruption. Most of the daily wage workers were left with no jobs and their daily income had stopped because employers were unable to pay their daily wage.

A margin is the difference between the amount of loan and the market value of the security offered by the borrower against the loan. It is fixed by the Central Bank.
Example: Suppose the central bank fixes a margin of 30%, then the bank is allowed to give a loan only up to 70% of the value of the security.

Legal Reserve Ratio (LRR) is the minimum ratio of deposits, legally required to be kept as cash reserves. The LRR is fixed by the Central Bank.
Cash Reserve Ratio (CRR) is the minimum percentage net demand and time deposits to be kept by the commercial banks with the central bank.

Two Reasons for setting up the Central Bank are:
(i) Central Bank is set up to control the supply of money and credit in the country.
(ii) Every Central Bank is set up to control the entire banking system of a country.

(a) Cash Reserve Ratio : Cash Reserve Ratio (CRR) is the minimum percentage net demand and time deposits to be kept by the commercial banks with the central bank.
(b) Margin Requlrements : A margin is the difference between the amount of loan and the market value of the security offered by the borrower against the loan. It is fixed by the Central Bank.
Example: Suppose the central bank fixes a margin of 30%, then the bank is allowed to give a loan only up to 70% of the value of the security.

Cheap credit policy.

(i) Central bank issues currency notes.
(ii) Central bank is the lender of the last resort.