Money and Banking
What this domain tests
Money and Banking tests the functions and supply of money, credit creation by commercial banks, and the RBI’s monetary policy tools.
Core rules
- Functions of money: medium of exchange, unit of account, store of value, and standard of deferred payment. Money removes barter’s double coincidence of wants.
- Money supply aggregates: M1 = currency with the public + demand deposits + other deposits with RBI (most liquid); M2 = M1 + savings deposits with post office savings banks; M3 = M1 + net time deposits with banks (broad money); M4 = M3 + total post office deposits.
- Commercial banks create credit through deposits and lending. The process is limited by the cash reserve ratio, excess reserves, currency leakage, and demand for loans.
- Central bank functions: currency issue, banker to government and banks, lender of last resort, custodian of reserves, and credit control.
- Quantitative tools: repo/reverse repo, bank rate, CRR, SLR, open market operations. Qualitative tools: margin requirements, moral suasion, selective credit controls.
Worked example
A bank receives a new deposit of ₹1,000. The reserve ratio is 20%. Excess reserve = 800. If all banks lend fully, total deposit creation = 1,000 / 0.20 = ₹5,000; credit created = ₹4,000. The money multiplier is 1/0.20 = 5. Reasoning: each round keeps 20% idle and lends 80%; the geometric series sums to the initial deposit times the multiplier.
Traps
Calling M3 the most liquid aggregate (M1 is); treating CRR as a tax; confusing repo (RBI lends) with reverse repo (RBI absorbs liquidity); assuming credit creation is unlimited; and mixing the bank rate with market interest rates.