Money, Banking and Credit
Money is anything generally accepted as a medium of exchange and a measure of value. This domain tests the functions of money, the role of the Reserve Bank of India (RBI), money supply measures, credit creation by commercial banks, monetary policy tools and financial inclusion. Karnataka's cooperative banks, regional rural banks and self-help groups are useful local examples.
Core rules and concepts
- Functions of money: medium of exchange, unit of account, store of value and standard of deferred payment.
- RBI functions: issues currency, acts as banker to government and banks, lender of last resort, manages foreign exchange and conducts monetary policy.
- Money supply: M1 = currency with public + demand deposits + other deposits with RBI; M3 adds time deposits; M1 is narrow money.
- Credit creation: banks keep a fraction of deposits as reserves and lend the rest; total deposits = initial deposit × (1 ÷ reserve ratio).
- Policy tools: repo rate (RBI lends to banks), reverse repo (RBI borrows), CRR (cash reserve with RBI), SLR (liquid assets held by banks), bank rate and open market operations.
- Financial inclusion: Jan Dhan accounts, Kisan Credit Cards, SHGs, RRBs and cooperative banks extend formal credit.
Worked example
A customer deposits ₹1,000 in a bank. If the cash reserve ratio is 20%, the bank keeps ₹200 and lends ₹800. The money multiplier is 1 ÷ 0.20 = 5, so total deposits in the system can reach ₹1,000 × 5 = ₹5,000. Credit created = ₹5,000 - ₹1,000 = ₹4,000. If CRR rises to 25%, the multiplier falls to 4 and total deposits fall to ₹4,000; higher reserves reduce lending capacity.
Traps that cost marks
CRR is kept with the RBI; SLR is held by the bank itself, often in government securities. Repo is RBI lending to banks, not borrowing. Do not call every bank a commercial bank; the RBI is the central bank. Credit creation is limited by reserve requirements, cash leakage and borrower demand.