Students can read the important questions given below for Money and Banking Class 12 Economics. All Money and Banking Class 12 Notes and questions with solutions have been prepared based on the latest syllabus and examination guidelines issued by CBSE, NCERT and KVS. You should read all notes provided by us and Class 12 Economics Important Questions provided for all chapters to get better marks in examinations. Economics Question Bank Class 12 is available on our website for free download in PDF.
Important Questions of Money and Banking Class 12
Question. What is Money?
Ans. Money is anything that has the general acceptability as a common medium of exchange & as a common measure of the value of the commodities.
Question. What is Barter system?
Ans. It refers to the exchange of goods for goods. In other words, it refers to the direct exchange of goods & services with another.
Question. Define the term Money Supply & state its constituents.
It refers to the total stock of money in an economy at any point of time, held by the general public i.e. the private individuals and business firms (money is in disposable form). In other words, it is the amount of money which is in circulation in an economy at a given point of time. The two constituents of money supply are currency held by the general public & demand deposits of general public held by the Commercial Banks. Thus, M1 = C + DD+O
Q. Define margin requirement.
Ans. Margin requirements refer to the difference between market value of the security offered for loans and the amount banks of loans offered by the commercial banks.
Q. How is quantitative credit control different from qualitative credit control?
Ans. Quantitative credit control refers to overall credit control in the economy, affecting all sectors of the economy equally and without discrimination. Qualitative credit control refers to selective credit control that focuses on allocation of credit to different sector of economy. Flow of credit is encouraged to the priority sectors, while it is discouraged to the non-priority sectors.
Question. Define money.
Ans. Money may be defined as anything which is acceptable as a medium of exchange.
Question. What determines money multiplier?
Ans. Legal reserve ratio
Question. State any two components of M1 measure of money supply.
Ans. Currency with public and demand deposits with banks.
Question. What are demand deposits?
Ans. Demand deposits are the deposits which are payable by the banks on the demand by the customers at any time.
Question. Define Barter system.
Ans: Barter system of exchange is a system in which goods are exchanged for goods.
Question. What is meant by double coincidence of wants?
Ans: Double coincidence of wants means that goods in possession of two different persons must be useful and needed by each other.
Question. Define commercial bank.
Ans: Commercial bank is a financial institution which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit.
Question. Define money multiplier/credit multiplier/deposit multiplier.
Ans: When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.
Question. Define central bank.
Ans: The central bank is the apex institution of a country’s monetary system. The design and the control of the country’s monetary policy is its main responsibility. India’s central bank is the Reserve Bank of India.
Question. What will be the effect of a rise in bank rate on the money supply?
Ans: Money supply will reduce.
Question. Give meaning of money supply. State its components.
Ans. Money supply may be referred as the total stock of money of various kinds at any particular point of time held by the public. Following are the main components of money supply
(a) Currency with public – Currency held public means coins and currency notes with the public outside the bank.
(b) Demand deposits with banks – Demand deposits are the deposits which can be withdrawn at any time by writing cheques.
Question. Explain the ‘medium of exchange’ function of money.
Ans: Money when used as a medium of exchange helps to eliminate the basic limitation of barter trade, that is, the lack of double coincidence of wants.
1. Individuals can exchange their goods and services for money and then can use this money to buy other goods and services according to their needs and convenience.
2. Thus, the process of exchange shall have two parts: a sale and a purchase.
3. The ease at which money is converted into other goods and services is called “liquidity of money”.
Question. Explain the working of money multiplier with the help of a numerical example.
Ans. Money multiplier refers to the process of creation of credit by the commercial banks, with the help of initial deposits made by the public and legal reserve ratio (LRR).
Money Multiplier = 1/𝐿𝑅𝑅 Suppose there is initial deposit of Rs.1000 crores and LRR is 10%, then
Money Multiplier = 1/10% = 10
Total deposits = Initial deposits X 1/𝐿𝑅𝑅
Credit Creation = 1000 X 10 = Rs.10000 Crore.
Question. Explain bankers bank function of Central Bank.
Ans. Central Bank act as banker to all other banks in the country just as commercial banks act as banker to general bank public. It performs following function –
(a) Making policies and regulation for commercial banks
(b) Maintaining cash reserve as deposit by the commercial banks
(c) Providing financial assistance to commercial banks during crisis
Question. Explain the role of repo rate in reducing money supply.
Ans. Repo rate is the rate of interest at which Central Bank lends money to commercial banks for short period. Raising repo rate makes borrowing by commercial banks costlier. So these banks are forced to raised their lending rates. Since borrowing becomes costly for people, they borrow less. Banks therefore create less credit.
Question. Discuss briefly the credit controller function of Central Bank.
Ans. The primary objective of credit control is to remove causes responsible for instability in price fluctuations which in turn are related to the supply of money. By controlling credit, the Central Bank can exercise an effective control over economic activity and mobilise it in the desired direction. Central Bank regulates the volume and use of credit by using quantitative and qualitative tools.
Question.What is a ‘legal tender’? What is ‘fiat money’?
(a) Legally, money is anything proclaimed by law as a medium of exchange.
(b) Paper notes and coins (together called currency) is money as a matter of law.
(c) Nobody can refuse its acceptance as medium of exchange.
Question. What role of RBI is known as ‘Lender of last Resort’?
Ans: 1. As banker to the banks, the central bank acts as the lender of the last resort.
2. In other words, 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 and advances.
3. The central bank assists such banks through discounting of approved securities and bills of exchange.
Question. What are the main functions of money? How does money overcome the shortcoming of a barter system?
Ans. Money has overcome the shortcoming of a barter system in the following manner:
(a) Medium of exchange – Under barter system, there is lack of double coincidence of wants. With money as a medium exchange individuals can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences. A buyer can buy goods through money and a seller can sell goods for money.
(b) Measure of value – Under barter system, there was no common measure of value. Money has also solved this difficulty. Money measures the value of economic goods. Money works as a common denominator into which the values of all goods and services are expressed. When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.
(c) Store of value – Under barter system it is very difficult to store wealth for future use. Most of the goods are perishable and their storage requires huge space and transportation cost. Wealth can be conveniently stored in the form of money. Money can be stored without loss in value. Money can easily be stored for future use.
(d) Standard of deferred payments – Under barter system, transactions on deferred payments are not possible. With money, the debtors make a promise that they will make payments on some future dates. Inthose situations money acts as a standard of deferred payments. It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.
Question. Explain briefly the working of money multiplier.
Ans: Yes, commercial bank acts as a ‘Creator of money’ in the economy. It can be explained with the help of Credit creation process:
1. Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply “banks’. Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing cheque. The one who receives payment deposits the same in his deposit account.
2. Suppose initially people deposit Rs 1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank.
3. Let us now explain the process, suppose the initial deposits in banks is Rs 1000 and the LRR is 10 percent. Further, suppose that banks keep only the minimum required, i.e., Rs 100 as cash reserve, banks are now free to lend the remainder Rs 900. Suppose they lend Rs 900. What banks do to open deposit accounts in the .names of the borrowers who are free to withdraw the amount whenever they like. Suppose they withdraw the whole of amount for making payments.
4. Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposit in banks by Rs 900. It is 90 per cent of the initial deposit. These deposits of Rs 900 have resulted on account of loans given by the banks. In this sense the banks are responsible for money creation. With this round increase in total deposits is now Rs 1900 (=1000 + 900).
5. When banks receive new deposit of Rs 900, they keep 10 per cent of it as cash reserves and use the remaining Rs 810 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise, but by a smaller amount of Rs 810. It is 90 per cent of the last deposit creation. The total deposits now increase to Rs 2710 (=1000 + 900 + 810). The process does not end and continues till total deposit creation comes to ? 10000, ten times the initial deposit as shown in the table below.
Question. Define the term Commercial bank.
Ans. A Commercial bank is a financial institution which performs the function of accepting deposits from the public & advancing loans. This banks act as the financial intermediary between the idle resources & the productive sources of resources.
Question. What are the different types of deposits held by the Commercial Banks?
Ans. a) Current account deposits or Chequeable deposits which are payable on cheques & the depositors can withdraw their deposits whenever they like. This account is generally maintained by the traders for day to day transactions. The banks pay no interest on this deposit.
b) Saving Account deposits are those deposits on which the bank pay interest which is less than the interest paid on the fixed deposits. The bank imposes some restrictions on their withdrawal. The purpose of this deposit is to encourage & mobilize the small savings.
c) Fixed or Time Deposits refers to the deposits which are accepted for the specified period & which are not payable on demand before the expiry of the period. The bank pay relatively high rate of interest on this deposit.
The variant of this deposit is Recurring Deposit whose purpose is to encourage regular savings by the people. This deposit is based upon the installment payment for a fixed period of time on which the interest is paid after maturity of the account.
1. It has the monopoly of issuing currency notes. It has the exclusive right to issue the currency notes in the country which leads to the uniformity of the currency throughout the nation. Moreover, this enables it to have a total control over the total money supply of the country which leads to the strengthening of the monetary policy during the crisis time.
2. It act as a banker of the govt. as it accepts the deposits of the govt. & makes payment on behalf of the it, gives financial advices, & advances the loans in the crisis times, remit the surplus funds of Govt., purchase & sell Govt. securities on its behalf.
3. It acts as a banker’s bank in the form of lender of last resort, facilitate clearing house facilities & remit the surplus funds, supervise the banking activities & regulates creditdeposits of the Banks. Since RBI is the guardian of all the banks, the banks can get the benefit of easy & early credit during their financial requirements. As a facilitator of clearing, the RBI makes early settlement of financial claims & debts of the banks. As a result, the banks don’t face any problem of cash liquidity, & thus they need not to remain depended on the bank credit or capital funds of the banks. As a regulator & supervisor, the banks are not in the position of any malpractice & the entire banking system remains transparent & accountable to public.
4. It acts as a custodian of gold reserves & the nation’s stock of foreign exchange reserve.
The purchase & sale of Gold & foreign exchange at the global level is done by RBI only. As a custodian, RBI is responsible for maintaining the stock of gold & forex reserves & the determination of their prices.
5. It acts as a controller of credit which is one of the most important functions. Since it is an apex institution, therefore can play an effective role to combat or correct the inflationary or deflationary pressures of an economy. The RBI controls credit by using Quantitative(General) & Qualitative(Selective) credit control methods. The tools under quantitative methods are Bank/Repo rate, Reserve repo rate, CRR & SLR, Open market operations. Under selective methods, RBI use Margin, credit quota & rationing, moral suasion & direct action etc.
6. It promote the economic growth & development of the country by erecting the financial institutions in the rural areas, providing direct loans to the farmers, framing the policies in favour of trade & industry, collect the economic information’s & publish through its various journals which further helps the govt. & other institutions to adopt the correct policies etc.
Q. Define credit multiplier.
Ans. Credit multiplier refers to the ratio between change in demand deposit and change in case reserves of the commercial banks with the RBI. Credit multiplier = Change in demand deposit of the Commercial banks/ change in cash reserves of the commercial banks with the RBI
Q. How improvement in banking habits of the people pushes up credit availability from the commercial bank?
Ans. When banking habits of the people improve, they star holding less money as cash-in-hand. Instead more and more money is deposited with the commercial bank. Accordingly, cash reserves of the commercial bank start rising. Higher cash reserve of the bank enable them to deposits more funds with the RBI as CRR – deposits. If CRR remains constant higher CRR- deposits with the RBI gives the commercial bank the legal authority to create more credit by way of loans/credit. Accordingly, availability of credit from the commercial bank is increased.
Question. Define the term Central Bank & explain its functions.
A Central Bank is an apex institution which directs, control, regulates & supervises the monetary system of a country. Central bank is the monetary authority which leads all banking & non – banking institutions. The name of the Central bank in India is Reserve Bank of India (RBI) which is established in 1935.The RBI occupies the highest position in the money & capital market.
Question. Define the terms LRR, CRR, SLR, Repo & Reverse Repo rate, Credit Multiplier. Legal
Ans. Reserve Ratio: It refers to the minimum portion of total net demand & time deposits of Commercial Banks which have to be maintained with Central Bank & themselves as cash liquid assets. There are two legal reserves viz. CRR & SLR.
Cash Liquidity Ratio: It refers to that minimum portion of total net deposits of Commercial Banks which have to be maintained with Central Bank. During inflation or deflation, the CRR is regulated by RBI to control inflation or deflation. During inflation, CRR is increased to restrict the credit by making it dearer, while it is reduced during deflation to expand the money supply in the economy by making it cheaper.
Statutory Liquidity Ratio: It refers to that portion of total deposits which have to be maintained by the Banks themselves in the form of liquid cash assets against the securities of Govt. & RBI.
Repo rate ie Repurchase rate of interest refers to the interest paid by the Commercial Banks to RBI against the loans & advances taken by them from RBI to meet the short term needs. By changing Repo rate, RBI can regulate the money supply. It is different to Bank Rate in a way that Bank rate is charged against the loans taken by commercial banks for long term needs.
Reverse Repo Rate refers to the interest received by the Commercial Banks from the Central banks against the parking of funds by the commercial banks. By increasing RRR, the RBI can encourage the Commercial Banks to park more funds so as to restrict the money supply in the economy. By reducing RRR, the RBI discourages the parking of funds which helps to induce more credit in the economy to resolve the issue of deflation.
Credit Multiplier refers to the amount by which the initial deposit multiplies into a larger amount of final deposits. It is equal to 1/LRR. Thus, credit multiplier is inverse to LRR.
Q. What do you mean by double coincidence of wants?
Ans. Double coincidence of wants means that goods in possession of two different individual are needed by each other at the same time.
Q. Why has the government in India failed to combat inflation even when a series of monetary measures are available in the textbook of macroeconomics?
Ans. Monetary measures of combating/ controlling inflation focus largely on moderating/ lowering the demand for goods and services by making the availability of credit costlier and difficult. It does not address supply side of the problem. While the fact of the matter is that in India inflation has often been triggered by the low market supplies. Unless supplies are boosted (particularly the supply of farm output) we shall continue to wrestle with inflation without training it.
Q. How in your opinion, credit creation by the commercial banks accelerates the pace of economic growth? Write two observations.
Ans. Following observations may be noted in this regard: Observation 1: Credit creation accelerates the process of growth by expanding the availability of credit for purpose of investment. Observation 2: Credit creation contribute to the process of growth by expanding size of the market (or aggregate demand), as the availability of credit for the purchase of consumer durables increases.
Q. How can ‘Jan-Dhan Yojana’ used as an instrument to increase supply of money by the commercial banks?
Ans. A large section of the population in India does not have their bank accounts. ‘Jan- Dhan Yojana’ prompts people to open their bank accounts. When more and more accounts are open then some of the cash balances with the people (or idle cash lying with the people) are bound to reach the banking system as cash deposits or primary deposits. This increase enables commercial banks to increase their cash reserves with the central banks. If /\ CR (additional cash reserves with RBI)= Rs10,000 and if CRR=4% then the additional demand deposit the bank can create = 1/4% * 10,000 = Rs 2,50,000. This is how ‘Jan-Dhan Yojana’ may be used as an instrument to increase the supply of money by the commercial banks.