Money, Banking and Public Finance
This domain covers the monetary and fiscal machinery of the economy: what money does, how banks create credit, and how government raises and spends funds.
Core rules
- Functions of money: medium of exchange, measure of value, store of value, standard of deferred payment.
- RBI functions: note issue (one-rupee coins and notes are issued by the Government of India), banker to government, banker's bank, lender of last resort, credit control, custodian of foreign exchange.
- Credit creation: total deposits = initial deposit × 1/LRR; credit created = total deposits − initial deposit.
- Budget: revenue receipts (tax and non-tax) and capital receipts (borrowing, disinvestment); revenue expenditure and capital expenditure.
- Deficits: revenue deficit = revenue expenditure − revenue receipts; fiscal deficit = total expenditure − total receipts excluding borrowings.
- Taxes: direct (incidence stays with the payer) vs indirect (shiftable, e.g. GST); progressive, proportional, regressive.
Worked example
A bank receives a fresh deposit of ₹1,000 and the legal reserve ratio is 20%. Total deposits in the system = 1,000 × (1/0.20) = ₹5,000. Credit created = 5,000 − 1,000 = ₹4,000. With ₹1,000 of reserves locked at 20%, the system supports ₹5,000 of deposits.
Traps that cost marks
- Saying credit creation is unlimited - cash reserve, currency leakage and excess reserves limit it.
- Confusing revenue receipts (no liability created) with capital receipts (create liability or reduce assets).
- Mixing fiscal deficit with revenue deficit; fiscal deficit includes borrowing.
- Claiming every indirect tax is regressive regardless of rate structure.