Revision: Money and Banking >> Banks: Commercial Bank and Central Bank Economics ISC (Commerce) Class 12 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
• 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.”

• “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

• “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

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.

• "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.

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

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

• Modern money = Currency (by RBI) + Deposit Money (by Commercial Banks)
• A bank must perform all three functions: accept deposits + lend + create money
• Credit/money creation is the unique characteristic that separates commercial banks from all other financial institutions
• Banks use fractional reserve banking — keeping a small % as reserves (CRR) and lending the rest
• Money Multiplier = 1/CRR — an initial deposit multiplies through the banking system
• Post Office Savings Bank, LIC, and UTI are non-banking financial institutions — they cannot create money
• Modern banking evolved from goldsmiths, who first issued paper receipts for gold deposits.

• 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.

• 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).

• 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.

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

• Selective methods control who gets credit and for what, not how much credit exists in total
• Margin Requirement is the most important selective instrument
• Moral Suasion is the only informal, non-legal method — it relies on persuasion
• Direct Action is used only against erring (non-compliant) banks — it is punitive
• Publicity works on both banks, and the general public
• Credit Rationing fixes a ceiling on total loans or the ratio of loans to deposits
• Consumer Credit Regulation targets hire purchase finance for durable goods