Money and Banking
What this domain tests
This domain tests the functions of money, measures of money supply, the role of the central bank, credit creation by commercial banks, and tools such as CRR, SLR and repo rate.
Core rules
- Functions of money: medium of exchange, unit of account, store of value and standard of deferred payment.
- Money supply: M1 = currency with the public + demand deposits + other deposits with the RBI. M2 adds savings deposits with post-office savings banks; M3 adds net time deposits; M4 adds total post-office deposits.
- Central bank: issues currency, acts as banker to government and banks, controls credit and manages foreign exchange.
- Credit creation: banks create deposits from initial deposits. The money multiplier is 1 ÷ LRR, where LRR is the reserve ratio.
- Tools: CRR, SLR, repo and reverse repo, open market operations and bank rate.
Worked example
A primary deposit of ₹1,000 enters the banking system and the legal reserve ratio is 20%. The multiplier is 1 ÷ 0.20 = 5. Total deposits can become ₹5,000, so total credit creation is ₹5,000 − ₹1,000 = ₹4,000.
Traps that cost marks
Do not treat currency alone as the full money supply. Demand deposits are money. CRR is the share of deposits kept with the RBI; SLR is held with the bank itself or approved securities. A higher reserve ratio lowers the multiplier. The central bank does not create deposits for profit like a commercial bank.