- Central Bank: Issues currency, controls credit, and acts as banker to the government and other banks (e.g. RBI).
- Commercial Banks: Accept deposits from the public and give short-term loans for trade and business.
- Industrial Banks: Provide long-term loans to industries for machines, buildings, and development.
- Agricultural & Rural Banks: Give short, medium, and long-term loans to farmers and rural people at low interest.
- Co-operative & Savings Banks: Encourage saving habits and provide credit to small farmers, traders, and societies.
- International & EXIM Banks: Provide finance for international trade and development projects (e.g. World Bank, EXIM Bank).
Definitions [6]
Definition: Concept of Bank
- “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
- According to the Indian Companies (Amendment) Act, 2000, banking means:
“Accepting for the purpose of lending or depositing money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft or otherwise.”
Definitions: Commercial Banks
- “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.”
Define Credit Multiplier.
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.
Definition: Credit Creation by Commercial Banks
- “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
Define the following concept.
Open Market Operation
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.
Definitions: Central Bank
- "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
Formulae [1]
Deposit Multiplier Formula
\[\text{Increase in Deposits}=\frac{1}{RR}\times\Delta D\]
Key Points
Key Points: Types of Bank
Key Points: Banking > Functions of Commercial Bank
- Acceptance of Deposits: Banks accept current, savings, and fixed deposits from the public to mobilise savings.
- Advancing Loans and Credit: Banks give loans through cash credit, overdrafts, term loans, and discounting of bills.
- Facilitating Payments: Payments are made easily through cheques, drafts, and electronic transfers.
- Transfer of Funds: Banks help in quick and safe remittance of money from one place to another.
- Agency & Utility Services: Banks collect payments, pay taxes and insurance, deal in shares, provide lockers, cards, and advisory services.
- Credit Creation: Banks create credit by lending more than their actual cash deposits.
Key Points: Role of Commercial Banks in an Economy
- Mobilisation of Savings: Banks encourage people to save and collect small savings, which are safely deposited and earn interest.
- Capital Formation & Investment: Banks convert savings into productive investment, helping in capital formation and economic growth.
- Provision of Credit: Banks provide loans and credit to agriculture, industry, trade, and services, acting as the backbone of commerce.
- Promotion of Economic Development: Banks support priority sectors, backward regions, entrepreneurship, and balanced regional development.
- Support to Government Policies: Banks help in implementing monetary and economic policies like controlling inflation, recession, and unemployment.
- Facilitating Trade (Domestic & Foreign): Banks assist internal and foreign trade through payments, guarantees, and foreign exchange services.
In short, commercial banks are the nerve centre of economic activity and play a crucial role in growth, stability, and development of the economy.
Key Points: Comparison Between Central Bank and Commercial Banks
| Basis | Similarity / Difference | Central Bank | Commercial Banks |
|---|---|---|---|
| Nature | Similarity | Monetary institution dealing in money | Monetary institution dealing in money |
| Credit Creation | Similarity | Involved in credit creation | Involved in credit creation |
| Type of Credit | Similarity | Provides short-term credit | Provides short-term credit |
| Security for Loans | Similarity | Does not accept immovable property as security | Does not accept immovable property as security |
| Position | Difference | Apex authority of banking system | Constituent units |
| Ownership & Objective | Difference | State-owned; social welfare | Public/private; profit motive |
| Dealings with Public | Difference | Does not deal with public | Deals directly with public |
| Note Issue & Control | Difference | Monopoly of note issue; controls banks | No note issue or control |
| Special Functions | Difference | Lender of last resort, banker to government, custodian of foreign exchange | Does not perform these |
| Overall Role | Difference | Controls and guides banking system | Performs day-to-day banking |
Key Points: Central Bank as a Controller of Credit
- The Central Bank controls currency and credit to maintain monetary stability.
- It regulates money supply through quantitative and qualitative credit control measures.
- Credit control helps in achieving price stability, economic stability, and exchange rate stability.
- The ultimate aim is high employment and economic growth (in India, done by the RBI).
Key Points: Quantitative Methods
Quantitative methods control the overall volume of credit in the economy without discrimination.
Bank Rate / Repo Rate:
- ↑ Rate → borrowing becomes costly → credit contracts (controls inflation)
- ↓ Rate → borrowing becomes cheaper → credit expands (controls deflation)
Open Market Operations:
- Sale of securities → reduces bank reserves → less credit
- Purchase of securities → increases bank reserves → more credit
CRR & SLR:
- ↑ CRR/SLR → banks lend less
- ↓ CRR/SLR → banks lend more
Key Points: Qualitative (Or Selective)
Purpose: Control the use and direction of credit, not its total volume.
Main Methods:
- Consumer Credit Regulation: Controls instalment buying and down payments.
- Margin Requirements: Increases or decreases loan margins to curb speculation.
- Rationing of Credit: Fixes limits or quotas on bank lending.
Other Tools: Moral suasion, publicity, and direct action to guide banks’ lending behaviour.
Important Questions [1]
Concepts [12]
- Concept of Bank
- Types of Bank
- Commercial Banks
- Banking > Functions of Commercial Bank
- Credit Creation by Commercial Banks
- Role of Commercial Banks in an Economy
- Central Bank
- Comparison Between Central Bank and Commercial Banks
- Central Bank as a Controller of Credit
- Methods of Credit Control
- Quantitative Methods
- Qualitative (Or Selective) Methods
