Money and Banking
What this domain tests
This domain covers the functions of money, money supply measures, the central bank, commercial banks, credit creation, and instruments such as CRR, SLR, repo rate, reverse repo, bank rate, and open market operations.
Core rules
- Money acts as a medium of exchange, measure of value, store of value, and standard of deferred payment.
- M1 = currency with the public + demand deposits + other deposits with the RBI. M3 = M1 + time deposits.
- The central bank issues currency, acts as banker to the government and banks, controls credit, and manages foreign exchange.
- Commercial banks create credit from deposits; the simple money multiplier is 1/CRR.
- CRR is the cash reserve ratio with the RBI; SLR is the liquid asset ratio held by banks.
- Repo is the rate at which the RBI lends short-term funds; reverse repo absorbs liquidity.
Worked example
A primary deposit is Rs 1,000 and CRR is 10%, with no excess reserves or leakages. Money multiplier = 1/0.10 = 10. Total deposits created = 1,000 x 10 = 10,000. Credit created = total deposits - initial deposit = 9,000. If CRR rises to 20%, the multiplier falls to 5 and total deposits fall to 5,000.
Traps that cost marks
Commercial banks create credit, not currency. CRR and SLR are not the same. Repo lending by the RBI injects liquidity; reverse repo absorbs it. The central bank does not deal directly with the public. Credit creation is limited by cash leakages, excess reserves, and weak borrowing demand.