CBSE Economics Notes Money & Banking Important Terms
- Money is defined as anything that is generally accepted as a medium of exchange and at the same time acts as a measure and a store of value.
- Money supply is stock of money in circulation in the country, at a particular point of time.
- It includes currency with the public and demand deposits with the banks.
- It also includes coins and notes with the public on a specific day.
- It May be noted that only net demand deposits with the commercial banks are included in money supply. Inter-bank deposits are not included in the definition of money supply. The components of money supply are currency with the public and demand deposits with the banks.
- Banks are important and essential institutions in a modern society. The supply of money in a country depends on banking system as a whole. (CBSE Economics Notes)
- A commercial bank is a financial institution which accepts deposits from the general public and makes advances money deposits.
- Credit creation/deposit creation/money creation is considered as one of the important function of commercial banks. Commercial banks advance loans on the basis of initial or primary deposits. Creation of secondary deposits/derivative deposits on the basis of primary deposits is called credit creation or deposit creation.
- Credit creation by commercial banks is determined by the amount of initial fresh deposits and legal reserve ratio.
- Given the amount of fresh deposit and LRR, the total money/credit creation/deposit creation formula is:
Money /credit /deposit creation =Initial deposits × □(1/LRR) Thus, the total deposit created by the commercial banks is equal to initial deposits multiplied by reciprocal of legal reserve ratio. Credit multiplier is equal to the reciprocal of legal reserve ration.
- Lower legal reserve ratio leads to higher credit creation whereas higher legal reserve ratio leads to lower credit creations.
- The ability of the commercial banks to create credit is not unlimited. It is subject to a number of limitations like legal reserve ratio, total fresh deposits, and monetary policy of the Central Banks. CBSE Economics Notes
- Central bank is an apex institution that controls and regulates the monetary and banking system of the country. It is the sole agency of note-issue in a country. It serves as a banker to the banks and government, and controls the supply of money in the country. In other words, central bank is an institution which controls the entire monetary and banking system of a country.
- The central bank is called by different names in different countries. In India, it is called by the name Reserve Bank of India, in England-Bank of England and in America-Federal Reserve System etc.
- Central bank differs from the commercial banks in the following respects: ( CBSE Economics Notes )
- A central bank is a government institution whereas a commercial bank is a government or a private institution.
- A central bank does not work for profit motive whereas the major aim of a commercial bank is to earn maximum profit.
- A central bank does not directly deal with the public but a commercial bank directly deals with the public.
- A central bank has the monopoly of note issue. This power is not enjoyed by a commercial bank.
- A central bank controls credit in a country whereas a commercial bank creates credit in a country.
- There is only one central bank in a country, but there could be many commercial banks.
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