Revision: Money and Banking: Basic Concepts >> Banking : Commercial Banks and Central Bank Economic Applications (English Medium) ICSE Class 10 CISCE

• “A bank collects money from those who have it to spare or who are saving it out of their incomes and it lends this money to those who require it.” — Crowther
• “Bank means accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft or otherwise.” — According to Indian Companies Act, 1949
• Banking Regulation Act of 1949: “Banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, demand draft, order or otherwise.”
• Prof. Cairncross: “A bank is a financial intermediary, a dealer in loans and debts.”

“Ordinary banking business consists of changing cash for bank deposit and bank deposit for cash, transferring bank deposit from one person to another, giving bank deposit in exchange for government bonds, the recurring promises of businessmen to repay and so forth.” — Prof. Sayer’s

The Credit multiplier is equal to `1/"CRR"` and depicts the number of times the credit is multiplied, with a given amount of initial deposit.

• “Credit may be defined as the right to receive payment or the obligation to make payment on demand or at some future time on account of an immediate transfer of goods.” — Prof. R.P. Kant
• “Commercial banks are the manufacturers of money.” — Prof. Sayers

• "A bank which constitutes the apex of the monetary and banking structure of the country." — De Kock
• "A central bank is "The bank in any country is one which has been entrusted the duty of regulating the volume of currency and credit in that country." — Bank for International Settlements

Open market operations refer to the sale and purchase of government and other approved securities by central bank in the money and capital markets.

Open Market Operations (OMOs) are employed by Central Banks, such as the RBI, to control the money supply. Buying and selling government bonds on the open market changes liquidity, interest rates, and the economy. Central Bank purchases of securities increase market liquidity and lower interest rates. Selling assets reduces market liquidity and raises interest rates.

The goal of the qualitative approach to credit control is to manage and oversee the distribution of credit among different credit users. They are made to control the flow of credit for particular purposes. Moral persuasion and credit rationing are two instances of qualitative credit control techniques.

• Open market operations refer to the buying and selling of government securities. These securities can be bought or sold to the public or to the commercial banks in an open market.
• Open market operations are used by the central bank to affect the money supply in the economy.
• The sale of securities by the RBI drains the extra cash from the economy, thereby limiting the money supply, whereas the purchase of securities by the RBI pumps additional money into the economy, thereby stimulating the money supply.

Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that a commercial bank has to maintain in the form of specified liquid assets with themselves.

Moral persuasion is a method of credit control employed by the Central Bank. It is a method of request and advice to the commercial banks by the Central Bank. 

Cash Reserve Ratio (CRR) is a certain minimum percentage of deposits that commercial bank and has to keep as reserves with the central bank.

Bank rate is the rate at which the central bank provides credit to commercial banks.

The ‘bank rate’ or ‘discount rate’ refers to the interest rate at which the central bank provides loans and advances to commercial banks or rediscounts their approved bills of exchange and government securities. By adjusting this rate, the central bank regulates the amount of credit available in the economy.

A margin is the difference between the loan amount and the market value of the security offered by the borrower against the loan. The central Bank fixes it.

• Dr. M. H. de Kock: “Central bank is one which constitutes the apex of the monetary and banking structure of the country.”
• Prof. W. A. Shaw: “Central bank is a bank which controls credit.”

\[\text{Increase in Deposits}=\frac{1}{RR}\times\Delta D\]

where RR is the required reserve ratio, and ΔD is the initial change in the volume of deposits.
In our example,

New Deposits = `1/(20%)`× 1000

              = `1/(20/100)` ×1000

              = `100/20` × 1000
              = ₹5,000

• Commercial banks are profit-seeking intermediaries connecting savers and borrowers.
• Their primary functions are accepting deposits and granting loans.
• India has 89 scheduled commercial banks divided into PSBs, RRBs, Private Banks, and Foreign Banks.
• Nationalisation in 1969 and 1980 expanded banking access to rural and priority sectors.
• SBI is India's largest bank — 25% market share, 45 crore customers, top 5 globally.
• RRBs serve rural India at lower interest rates and are the backbone of rural credit.
• Private and foreign banks drive technology, innovation, and competition in banking.
• Commercial banks are regulated by the Reserve Bank of India (RBI) and governed by the Banking Regulation Act, 1949.

• Accept Deposits – Main source of funds: Demand Deposits (Current/Savings Accounts) & Time Deposits (Fixed/Recurring Deposits)
• Grant Loans & Advances – Cash Credit, Overdraft, Term Loans, Bill Discounting (banks profit from interest spread)
• Cheque System – Safe payment method using cheques (principal business payment tool)
• Transfer of Funds – Fast/safe money transfer via drafts, pay orders, mail/telegraphic transfers (essential for commerce)
• Credit Creation – Banks multiply money: loans create new deposits (Initial Deposit × 1/CRR formula)
• Financing Trade – Bill discounting + short-term trade loans (facilitates internal/external trade)
• Foreign Exchange & Utility Services – Currency exchange + lockers, travel cheques, mobile banking, agency functions

• Unique Money Creators: Commercial banks are the only financial institutions that can create "deposit money." They don't just lend existing cash; they expand the total money supply.
• Primary vs. Derivative Deposits:
  Primary: Passive cash deposits by the public (doesn't change total money supply).
  Derivative: Active deposits created by banks through loans (increases total money supply).
• The "Loans Create Deposits" Rule: When a bank grants a loan, it doesn't usually hand over cash. Instead, it opens a current account for the borrower, thereby "creating" a new deposit.
• Fractional Reserve Requirement: Banks only keep a small percentage of deposits as cash (the Cash Reserve Ratio) because they know from experience that not all depositors will withdraw their money at the exact same time.
• The Multiplier Effect: Through a chain reaction where one bank's loan becomes another bank's deposit, the banking system as a whole can create total deposits that are multiple times the original cash deposit.
• Critical Limitations: The process isn't infinite. It is limited by the amount of available cash, the Central Bank's policy (interest rates/reserves), public trust, and collateral (securities).

• The central bank is the highest authority in the banking system. It controls, regulates and supervises all banks and manages the country’s monetary system.
• It formulates and implements monetary policy to control inflation, deflation, and overall credit in the economy.
• It acts as a banker, adviser and agent to the government, and also works as a “banker’s bank” by guiding and supporting commercial banks.
• The central bank has the sole authority to issue currency (except small coins/notes in some cases), ensuring a uniform and reliable money supply.
• It supports economic growth by promoting banking, developing financial institutions, managing foreign exchange, and helping priority sectors.

• Credit control = methods used by the central bank to regulate money and credit.
• Two types: Quantitative and Qualitative.
• Quantitative → controls total credit (e.g., Bank Rate, CRR, OMO).
• Qualitative → controls use of credit (e.g., rationing, moral suasion).
• Difference: Quantitative = general control, Qualitative = selective control.