AHSEC| CLASS 11| FINANCE| SOLVED PAPER - 2018| H.S. 1ST YEAR
2018
FINANCE
Full Marks: 100
Time: 3 hours
The figures in the margin indicate full marks for the questions.
1. Answer as directed:
1×8=8
(a) Who is
authorized to issue notes in India?
Ans:- Reserve Bank of India (RBI).
(b) Write the
full form of ATM.
Ans:- Automated teller machine.
(c) Write the
name of the central bank of our country.
Ans:- Reserve Bank of India (RBI).
(d) State a
characteristic of inflation.
Ans:- Rapidly
rising prices that lead to a decline in the purchasing power of money.
(e) RRBs were
started in the year 1967/1975/1976.
(f) In which
year was the Cooperative Credit System introduced?
Ans:- March 25, 1904.
(g) The
Banking Regulation Act was passed in the year. (Fill in the blank)
Ans:- In 1949.
(h) What do
you mean by barter system?
Ans:- Barter
is an alternative method of trade where goods and services are directly
exchanged for each other without using money as an intermediary.
2. What is savings bank? 2
Ans:- It is a deposit account with a bank to manage
your savings, expenses and investments. A standard transaction at a bank goes
like this - A deposits money into the bank as extra cash/loan/salary, the bank
then gives the same amount to B as a loan at interest.
3. Name any two public sector banks in India. 2
Ans:- (i) Bank of Baroda.
(ii) Bank of
India.
4. Give the meaning of prosperity. 2
Ans:- Prosperity comes from the Latin word 'prosperous'
- to do well. It is not about financial wealth or how you stack up next to
someone else - it is what is unique and personal to you.
5. Who is a bank customer? 2
Ans:- A customer is a person who has an account with
a bank or has a relationship with a banker, even if he does not have an account
with the bank.
6. Write two functions of regional rural banks. 2
Ans:- RRB and its functions include: Giving loans to
artisans, farmers, laborers and MSMEs. Accepting savings and other forms of
deposits. Distribution and disbursement of pension and wages.
7. Explain the retail banking. 3.
Ans:- Retail banking, also known as consumer banking
or personal banking, is banking that provides financial services to individual
consumers rather than businesses. Retail banking is a way for individual
consumers to manage their money, access credit, and store their money securely.
8. Give the meaning of credit card. 3
Ans:- A credit card is a type of credit facility
provided by banks that allows customers to borrow money within a pre-approved
credit limit. It enables customers to conduct purchase transactions on goods
and services. Credit card limits are set by the credit card issuer based on
factors such as income and credit score, which also decide the credit limit.
9. Mention three different departments of the commercial
banks. 3
Ans:- (i) Risk Management Department.
(ii) Legal
Compliance and Compliance Control Division.
(iii) Money
Laundering and Terrorist Financing Reporting Section.
(iv) Internal
Legal Control and Audit Department.
(v) Human
Resource Department.
(vi) Department
of Treasury and Investments.
10. State briefly the difficulties of barter system. 3
Ans:- The system of exchanging goods without using
money is known as barter system. The problems associated with barter system are
inability to make deferred payments, lack of common measure of value,
difficulty in storage of goods, lack of double coincidence of wants.
The barter system
also has the problem of storing its money, while the monetary system has no
such storage problem.
11. Give the meaning of Banking Ombudsman. 3
Ans:- The Banking Ombudsman is a quasi-judicial
authority created in 2006, and the authority was created pursuant to a decision
made by the Government of India to enable redressal of complaints by customers
of banks relating to certain services provided by banks.
The Banking
Ombudsman Scheme was first introduced in India in 1995, and was revised in
2002. The present scheme came into effect from 1 January 2006, and replaced the
Banking Ombudsman Scheme 2002. At present the Banking Ombudsman Scheme 2006
(amended up to July 1, 2017) is in operation.
12. Narrate five differences between cooperative bank and
commercial bank. 5
Ans:- Five differences between co-operative bank and
commercial bank:
(i) Commercial
banks work from the point of view of commercialization while co-operative banks
work on the principle of co-operation. That is why State Cooperative Banks get
at least 2% cheaper loan from RBI.
(ii) Commercial
banks are formed by an act passed by the Parliament whereas co-operative banks
are formed by different states under different acts relating to cooperative
societies of different states.
(iii)
Co-operative banks have a three-tier setup in India i.e., State Co-operatives
at the top level, Central/District Co-operative Banks at the middle level and
Primary Co-operative Banks at the bottom level whereas there are no commercial
banks. There is no such tier system in India.
(iii) Every
commercial bank has the right to take loan directly from the Reserve Bank of
India while in co-operative banks only state co-operative banks can avail this
facility.
(v) Commercial
banks can set up their branches in any district/state of the country, whereas
co-operative banks, on the other hand, can operate in a limited area only. As
district co-operative banks can carry out banking activities only within the
limits of the respective district and primary co-operative banks can operate
only in the respective villages.
13. Discuss the general utility functions of a bank. 5
Ans:- utility functions of the bank:
(i) Issue of
letters of credit, travellers’ cheques, etc.
(ii) Safe
custody of valuables, important documents, and securities by providing safe
deposit vaults or lockers.
(iii) To
facilitate foreign exchange transactions to the customers
(iv)
Underwriting of shares and debentures
(v) dealing in
foreign exchange
(vi) Social
welfare program
(vii) Project
Report
(viii) Standing
Guarantee on behalf of its customers etc.
14. What are the main causes of inflation? 5
Ans:- The causes of inflation are:
Inflation is
caused by many factors, here are some:
(i) Money
Supply: Excess money (money) supply in the economy is one of the primary
causes of inflation. This happens when the supply/circulation of money in a
country outpaces the economic growth, therefore depreciating the value of the
currency. In the modern era, countries have shifted from traditional methods of
valuing money with the amount of gold they hold. Modern methods of valuing
money are determined by the amount of currency in circulation, which in turn is
determined by the public's perception of the value of that currency.
(ii)
National Debt: There are many factors that affect the national debt,
including the borrowing and spending of nations. In a situation where a
country's debt increases, the country concerned is left with two options: Taxes
can be increased internally. Additional money can be printed to pay off the
debt.
(iii)
Demand-Pull Effect: The demand-pull effect states that as wages rise in an
economy in a growing economy, people will have more money to spend on goods and
services. An increase in demand for goods and services will result in companies
increasing the prices that consumers will bear to balance supply and demand.
(iv)
Cost-push effect: This theory states that when companies face increased
costs on raw materials and wages to manufacture consumer goods, they pass on
the increased production costs to the final consumer in the form of increased
prices. By doing this, you will maintain your profitability.
(v)
Exchange Rates: An economy with exposure to foreign markets mostly
functions on the basis of the value of the dollar. In a trading global economy,
exchange rates are an important factor in determining the rate of inflation.
(vi)
Effects of Inflation: When there is inflation in the country, the
purchasing power of the people goes down because the prices of goods and
services are high. The value of the currency unit decreases which affects the
cost of living in the country. When the inflation rate is high, the cost of
living also increases, leading to a decline in economic growth.
However, a
healthy inflation rate (2-3%) is considered positive as it directly increases
wages and corporate profitability and maintains capital inflows into a growing
economy.
15. Explain the principles of note issue followed by the
RBI. 5
Ans:- For currency issuance, the RBI currently
follows the minimum reserve system. Minimum Reserve System (MRS) is followed
since 1956.
Under the
minimum reserve system, the RBI must maintain a minimum reserve of Rs 200 crore
consisting of gold coins and gold bullion and foreign currencies. Out of the
total Rs 200 crore, Rs. 115 crores should be in the form of gold coins or gold
bullion.
The purpose of
adopting this system was to expand the money supply to meet the growing
transaction needs in the economy.
In accordance
with these principles of note issue, notes are issued against gold reserves.
Paper currency is a suitable alternative to metallic currency. Paper money
should have one hundred percent of the gold reserves. If compared to paper
money there is a shortage of gold reserves.
16. What precaution should be taken by a bank while
opening account in the name of a minor?
5
Ans:- A person who has not attained or completed the
age of 18 years is known as a minor. A minor is not capable of making a valid
contract and a contract made by a minor is void. The bank can open a savings,
fixed or recurring deposit account in the name of a minor.
Following are
the main steps to open a bank account:
(a) Age for
opening an account: A banker should allow a minor to open a savings bank
account in his own name only if he is between 10-14 years of age and can read
and write in English, Hindi or any other language. other language. If the minor
has such a quality, the banker must open his account in the joint name of the
minor and his guardian.
(b)
Selection of Account Type: The first step is to select the type of account
to be opened. An account can be of many types like Current, Savings Fixed
Account. The account can be opened jointly or singly. A banker can open a
savings bank account in the name of a minor. The banker should not open a
current account in the name of a minor.
(c) Bank
and Branch Selection: The prospective account holder should now select the
bank.
(d)
Obtaining Account Opening Form: The account opening form is obtained from
the bank. It should be read carefully and filled with utmost care.
(e)
Obtaining references: One or two references are obtained by the prospective
account holder. People who give references sign the form and give their account
number. and name and address.
(f) Form
Submission: Now the form should be submitted along with the required
documents. These documents differ from account to account.
(g) Giving
Specimen Signature: Now, the account holder signs a card which is called
Specimen Signature Card. These signatures are matched with the check of the
account holder.
(h) Making
Initial Deposit: The applicant is allotted an account and is asked to make
an initial deposit in his account through a deposit slip.
(i) Account
is opened: The account is opened as soon as the initial deposit is made.
(j) Receipt
of Check Book / Fixed Deposit Certificate: Finally, a check book is issued
which contains the account number of the applicant. Money can be withdrawn with
the help of these cheques.
17. Discuss the primary function and secondary function
of commercial bank. 5
Ans:- The functions of commercial banks can be explained
by the following two categories:
(A) the primary
functions or services of commercial banks and
(B) Secondary
functions or services of commercial banks.
(A) Primary
Functions: The primary functions of commercial banks are:
(i)
Accepting Deposits: Deposits are an important source of funds for the bank.
They can be broadly classified into three categories.
(a) Savings
Deposits: These deposits are of small amount and are accepted by banks to
encourage persons with small means to save. Repeated withdrawals are not
allowed.
(b) Fixed
Deposit: Money is accepted in this account for a fixed period. say a year
or more. The money so deposited cannot be withdrawn before the expiry of the
fixed period. The rate of interest on this account is higher as compared to
other accounts. The longer the tenure, the higher the interest.
(c) Current
Account: The depositor can withdraw money from this current account
whenever he wants. Normally, the bank does not pay any interest on this account
as it has to keep cash ready at all times to meet the requirements of the
depositor. This account is generally opened by businessmen who may have to
withdraw money several times a day.
(ii) Money
Lending: A major part of the deposits received by the bank is lent out by
it. It is also the main source of income of the bank. However, lending money is
not without risk and therefore, a banker must exercise due diligence in the
process. The loan can be in any of the following forms.
(a) Loan: It
is a type of advance which is made with or without security. It is given for a
fixed period at an agreed rate of interest. The loan amount is usually
deposited in the account of the customer who can withdraw from there as per his
requirements. Loan can be secured or unsecured.
(b) Cash
Credit: It is an arrangement by which a banker allows his customer to
borrow money up to a specified limit on the security of goods.
(c)
Overdraft: It is an arrangement whereby a customer is permitted to
overdraft temporarily from his current account. This is without any protection.
(d)
Discounting Bills of Exchange: This is another type of loan granted by the
banks. If the holder of a bill of exchange needs money immediately, he can get
it discounted by the bank. After deducting his commission, the bank pays the
current value of the bill to the holder. When the bill of exchange matures, the
bank can secure its payment from the party who accepted the bill.
(B) Secondary
Functions/Services of Commercial Banks: This functions or services can be
classified into the following two categories:
(a) Agency
Service: In many cases commercial banks act as agents of their customers.
As agents they provide the following services.
(i) Collection
of drafts, bills, cheques, dividends etc. on behalf of customers.
(ii) Execution
of standing orders of customers viz. Payment of membership, rent, bills,
promissory notes, insurance premium etc.
(iii) To
undertake stock exchange transactions, i.e., buying and selling of securities
for clients.
(iv) to act as
correspondent or representative of customers, other banks, and financial
corporations.
(v) to act as
executor, trustee, or administrator of the client's estate.
(vi) Preparing
income tax returns, claiming tax refunds, and checking assessments on behalf of
clients.
(b) General
Utility or Miscellaneous Services: Modern banks provide various services to
their customers.
Important
utility services are:
(i) Safe custody
services for valuable documents, deeds, securities, jewellery, gold etc.
(ii)
Transactions in foreign currency.
(iii) Issue of
letters of credit, circular notes, travellers’ cheques, etc.
(iv) Acting as a
referee regarding the financial position, business reputation and reputation of
the customer.
(v) Underwriting
loans raised by Government, public bodies etc.
(vi) Advisory Services
to the Customer.
(vii) Issuance
of credit cards etc.
(viii) A.T.M.
Services.
Or
Write about
the capital of bank. 5
Ans:- Bank
capital is the difference between a bank's assets and its liabilities, and it
represents the bank's net worth, or its equity value, to investors. The asset
portion of a bank's capital includes cash, government securities, and
interest-earning loans (e.g., mortgages, debentures, and inter-bank loans). The
liabilities section of a bank's capital includes loan-loss reserves and any
loans outstanding on it. A bank's capital can be thought of as the margin for
which creditors are covered if the bank were to liquidate its assets.
Point:
(i) Bank capital
is the difference between a bank's assets and its liabilities, and represents
the bank's net worth or investors' equity value.
(ii) The Basel
I, Basel II, and Basel III standards provide definitions of regulatory bank
capital that are closely monitored by the market and banking regulators.
(iii) Bank
capital is divided into tiers with Tier 1 capital being the primary indicator
of a bank's health.
(iv) Creditors
are interested in knowing the bank capital of the bank as it is the amount by
which the bank will have to liquidate its assets.
18. Explain the function of Central Bank as bank of note
issue. 5
Ans:- The Central Bank has the sole authority to
issue currency in the country. In India, the RBI has the sole authority to
issue paper currency notes (except one-rupee notes and coins, which are issued
by the Ministry of Finance). This is because it brings uniformity in the
circulation of notes and gives the Central Bank direct control over the money
supply. It promotes efficiency in the financial system.
In order to
secure control over the quantity of currency and credit, the central bank is
given the sole monopoly to issue currency. These notes circulate as legal
currency throughout the country. It must keep reserves in the form of gold and
foreign securities as per statutory norms against the notes issued by it. It
may be noted that RBI issues all currency notes in India except the one rupee
note. Again, it is under the directions of the RBI that one-rupee notes and
smaller coins are issued by government mints. Remember, the central government
of a country is usually authorized to borrow money from the central bank.
Or
What are the
different types of account? Explain any two of them. 5
Ans:- The different
types of account:
(i) Fixed
Deposit account
(ii) Saving
Deposit accounts
(iii) Current
Deposit accounts
(iv) Recurring
Deposit account etc.
(i) Fixed
Deposit account: A fixed deposit is an account opened with a bank in which
the bank pays a guaranteed interest rate on the amount deposited in the fixed
deposit account for a specified period or tenure. By creating a Fixed Deposit,
you can earn higher returns on funds lying idle in your savings account.
(ii) Saving
Deposit accounts: It is a deposit account with a bank to manage your
savings, expenses and investments. A standard transaction at a bank goes like
this - A deposits money into the bank as extra cash/loan/salary, the bank then
gives the same amount to B as a loan at interest. The bank earns its money from
the interest on the loan given to B.
19. What do you mean by trade
cycle? Describe the different phases of trade cycle. 2+6=8
Ans:- In economics, the term ' trade cycle' refers to
fluctuations in overall economic activity, particularly in employment, output
and income. Business cycles are the ups and downs in economic activity.
According to
Harberler, "The business cycle may be defined in a general sense as the
alternation of periods of prosperity and depression, of good and bad business.
A trade
cycle is generally divided into four phases viz.
(a)
Prosperity: Economic activities are expanding from a revival phase to an
upward trend. So, the revival of upward trend in the economy is the starting
point of prosperity. This stage is characterized in the following way.
(i) High level of
production and trade.
(ii) High level
of effective demand.
(iii) Higher
level of employment and income
(iv) Rising
structure of interest rate.
(v) A large
expansion of bank credit.
(vi) High
marginal efficiency of capital.
(vii) A price
inflation
(viii) Overall
business optimism.
(ix) The tendency
of an economy to operate almost at full capacity along the production
possibilities frontier.
(b)
Recession: When prosperity ends, recession begins. It is related to a
turning point rather than a phase. During prosperity, investment, production,
employment, reaches the maximum extent. Cut-throat competition arises on raw
material, labour, capital etc. As a result, the cost of production increases
and the profit margin decreases. Since the goods are available in the market,
there is no possibility of selling the goods in the market. The confidence of
businessmen wavers. Everyone feels pessimistic about the future profitability
of investments. Therefore, there will be a drastic reduction in investment and
production of capital goods industries will fall.
(c) Depression:
It starts from the stage of recession. Business activity in the country is well
below normal in this phase. It is characterized by a sharp reduction in output,
mass unemployment, low employment, falling prices, falling profits, low wages,
contraction of credit, high rates of business failures, and an atmosphere of
all-round despair and hopelessness. The decline in production or output is
accompanied by a decrease in the amount of employment. The prices of
manufactured goods fall. level. The producers must bear huge financial losses.
Many of these firms have had to close due to accumulated losses.
(d)
Recovery or Revival: It refers to the increase in business activity after
reaching the lowest point of depression. During this phase, initially, there is
a slight recovery in economic activities. Entrepreneurs begin to realize that
the economic situation is not as bad as it was in the earlier stages. This
leads to further improvement in business activity. Industrial production grows
slowly and gradually. The amount of employment also increases continuously.
There has been a slow, but steady rise in prices with a marginal increase in
profits. Wages also rise, though they do not rise in the same proportion as
prices. Attracted by rising profits, new investments are made in capital goods
industries. Banks extend credit. Merchandise also starts increasing gradually.
The pessimism and gloom of the operating period has been replaced by an
atmosphere of all-round cautious hope.
Or
Discuss the
evolution, origin, and growth of banking in India. 8
Ans:- Modern
joint stock commercial banking in India dates back to the early 19th century.
The early commercial banks were known as agency houses and were started by
employees of the East India Company. Bank offices were largely confined to the
port cities of Bombay, Calcutta and Madras (now Mumbai, Kolkata, and Chennai).
Agency houses were primarily trading establishments and combined banking and
trading functions. Many banks were established mainly by the English Agency
Houses based on unlimited liability.
Alexander and
Company established the first joint stock, The Bank of Hindustan, in Calcutta
in 1770. It was finished in 1832. Banks set up by agency houses failed due to
mismanagement and speculation. Hence to revive the situation, the East India
Company established the Bank of Bengal in 1809, the Bank of Bombay in 1840 and
the Bank of Madras in 1843. These banks were known as Presidency Banks. In
1860, an act was passed allowing the establishment of banks on a limited
liability basis. The creation of joint stock banks was very slow from 1865
until the end of the 19th century. Some banks like the Allahabad Bank were
started during the last quarter of the 19th century. The Avadh Commercial Bank
and the flotation were followed by a banking crisis during 1913–17.
In 1920, the
"Imperial Bank of India Act" was passed to amalgamate the three
Presidency banks. The Imperial Bank of India was established in 1921 by merging
three Presidency banks. The bank was empowered to hold government funds and
manage the public debt.
The Second
World War brought a radical change in the Indian banking system. Heavy wartime
expenditure resulted in an increase in bank deposits. The banking scenario in
India completely changed after independence. The entire system registered rapid
progress. The change became possible with the passing of the Banking Regulation
Act 1949. It is considered a major milestone in the history of commercial
banking in India. This act was passed with the aim of strengthening and
regulating the banking system in India. The State Bank of India was established
in 1955 by nationalizing the Imperial Bank of India. In 1959, the State Bank of
India and its Associates Act was passed and accordingly the public sector banks
were expanded. Fourteen (14) major Indian commercial banks were nationalized in
1969 and six more banks were nationalized in 1980. National Bank for
Agriculture and Rural Development (NABARD) was established in 1982 for the
development of agriculture sector.
Another
development of banking institutions in India is the establishment of various
industrial development banks to facilitate industrial development and balanced
economic growth. Such institutions are IDBI, IFCI, LIC, ICICI, IDBI, SFC etc.
Exim Bank was
established in 1982 with the objective of financing and promoting India's
foreign trade.
20. What is inflation? Discuss its effects on production
and distribution. 2+6=8
Ans:- Inflation means a substantial and rapid
increase in the general price level that causes a decline in the purchasing
power of money.
According to
Crowther, inflation is a "state in which the value of money is falling,
that is, prices are rising."
Effects of
Inflation: Inflation has its own effects and this can be discussed under
two sub-headings.
(i) Effect on
production
(ii) Effect on
distribution
(i) Effect on production:
Output is highly affected by inflation. Mild inflation acts as a stimulant to
the economy. An increase in the money supply in an economy where resources are
not yet fully employed, resulting in a gradual increase in the price level. In
such an economy the cost of production does not rise in proportion to the
prices. Higher increase in prices results in higher profit margin. It creates
optimism in business. This induces more investment. Productive activities start
increasing. The factors of production are the process of over-planning. The
income of the agent of production increases. Investment and employment remain
for some time. The economy can reach the point of full employment. If the money
supply increases past the point of full employment, causing more investment
pressure, prices tend to rise faster. This leads to hyperinflation. Excessive
inflation is disastrous for the economy. This will adversely affect the
productive system and create unemployment.
(ii) Effects
on Distribution: A long period of persistent inflation results in
redistribution of income and wealth. Inflation does not affect all sections of
the society equally. Some gain during inflation, while others lose. These
'gains' and 'losses' result in redistribution of income and wealth within the
society. The effects of inflation on different sections of the society can be
discussed as follows -
(a)
Farmers: Generally, farmers benefit during inflation. The prices of
agricultural products rise, but the cost of production was comparatively lower
than before. It provides additional benefits to the farmers. Also, farmers can
get more profit by repaying their loans borrowed earlier when purchasing power
is high, on the other hand small farmers suffer during inflation.
(b)
Entrepreneurs and business community: The business community and
entrepreneurs gain during inflation because the prices are low when they buy
raw materials and by the time they reach the market as finished products for
sale, they are high. sell at higher prices and hence make higher profits.
(c)
Investors of equity holders: Holders of equity shares, stocks etc. get the
benefit of inflation. The rate of return on equity varies with profit. During
inflation business houses make abnormal profits. A part of the additional
profit is received by the equity holders. That is why they get benefited.
(d) Wage
and salary earners: Wage and salary earners generally lose out during
inflation. Although their wages and salaries tend to rise in the face of rising
prices, wages and salaries generally do not rise in the same proportion as
prices or their cost of living.
(e)
Government: Government belongs to flexible income group. Due to
inflationary increase in prices, its revenue collection also increases.
However, its cost also increases. His monetary expenditure may increase but the
actual expenditure may not. It is believed that the increase in prices can
increase the revenue but it fails to restore the pre-inflationary expenditure.
Repayment of public debt provides benefits to the government.
(f) Debtors
and Creditors: Debtors stand to gain during inflation because they borrowed
when the purchasing power of money was high and now pay back the loan when the
purchasing power of money is low. Creditors, on the other hand, suffer losses
as they may get back less than what they lent in case of goods and services.
(g) Fixed
Income Group: The fixed income group loses to inflation. Pensioners, fixed
interest investment holders get fixed income. Fixed income allows them to buy
fewer goods during inflation. It discourages savings and capital formation.
Or
Explain the
technique of creating credit by a commercial bank. 8
Ans:- In
very simple words, credit creation differentiates a bank from other financial
banks. Credit creation is an extension of deposits. Also, banks can raise their
demand deposits as multiples of their cash reserves as demand deposits serve as
a major medium of exchange.
Demand
deposits are a very important component of the money supply. Expansion of
demand deposits means expansion of money supply. The entire banking structure
is based on credit. Credit means receiving purchasing power now and a promise
to pay at some point in the future. And bank credit means bank loans as well as
advances. A bank maintains a certain part of its deposits as minimum reserves
to meet the demands of its depositors and the rest is lending to earn income.
The credit is given to the browser's account. Each bank creates an equivalent
deposit in the bank. Hence credit creation means expansion of bank deposits.
Two Crucial
Aspects of Credit Creation
(i)
Liquidity: Banks are bound to pay cash to their depositors when they
exercise their right to call for cash against their depositors.
(ii)
Profitability: Banks are always in search of profit. They are profit-driven
enterprises. That is why a bank should provide loans in a way that helps it
earn more interest than it pays on its deposits.
A bank's credit
process assumes that only a small number of customers will actually need cash
at any given time. Also, on the other hand, banks assume that all their
customers will not demand cash against their deposits at the same time.
Learn the
basic concepts of credit building
(i) Bank as a
Business Institution: It must be recognized that bank is a business institution
which always tries to maximize profit through loans and advances received from
deposits.
(ii) Bank
Deposits: Bank deposits are the basis of credit creation. There are two types
of bank deposits:
(a) Primary
Deposit: A bank accepts cash from customers and opens a deposit in their
name. This is called primary deposit and does not mean credit creation.
These deposits
are simply converted from fiat currency to deposit money. These deposits form
the basis of credit creation.
(b) Secondary
or Derivative Deposits: A bank grants loans and advances. Instead of giving
cash to the borrower, the bank opens a deposit account in his name. This is
called a secondary or derivative deposit.
Every loan
creates a deposit and the creation of a derivative deposit means the creation
of credit.
Process of Credit
Creation by Commercial Banks:
A central bank
is the primary source of the money supply in a nation's economy through the
circulation of currency. It ensures the availability of currency to meet the
transaction needs of an economy. It also facilitates various economic
activities such as production, distribution, and consumption. For this purpose,
the central bank needs to rely on the reserves of commercial banks which are
the secondary source of money supply in the economy.
The most
important objective of a commercial bank is the creation of credit. This is the
reason why the money given by commercial banks is called credit money. All
commercial banks create credit by advancing loans and purchasing securities.
They lend money to individuals as well as businesses out of deposits accepted
from the public.
Commercial
banks are not allowed to use the entire number of public deposits for lending
purposes. They are accepted to keep a certain amount as reserve with the
central bank. This is to meet the cash requirements of the depositors.
Commercial
banks can lend the remaining part of public deposits after keeping the
requisite amount of reserve.
Factors
Affecting Credit Creation by Commercial Banks:
The factors
affecting the creation of credit are as follows:
(i) Banks The
ability of banks to create credit which is a matter of availability of cash
deposits with banks. Furthermore, the ability to create credit depends on the
factors that determine their cash deposit ratio.
(ii) Willingness
of banks to create credit.
(iii) Demand for
credit in the market.
Advantages and
Limitations of Credit Creation by Commercial Banks
On the
profitable side, depositors can access a wide range of products offered by
intermediaries that can be easily converted into cash. Investing in company
shares (Mutual Funds) can also be done in a very easy way.
On the
downside, there are several limitations, these are as follows:
(i) Shortage
of securities.
(ii) Business
environment
(iii) Cash
crunch
(iv) Habits of
the people
(v) leak
21. What is credit control? Explain the objectives of
credit control. 2+6=8
Ans:- Credit control is an act performed by the
Central Bank (Reserve Bank of India) to control credit, i.e. the demand and
supply or liquidity of money in the economy. With this function, the central
bank controls the loans given by commercial banks to their customers. It aims
to achieve economic growth while maintaining stability as well as managing
inflationary and deflationary pressures.
This includes
limiting the amount of credit created by commercial banks, regulating credit
volumes, directing credit to productive uses, and implementing measures that
strengthen the banks' structure.
Objectives of
Credit Control
The basic
objectives of credit control are:
(i) To achieve
stability in the internal price level.
(ii) To
achieve stability in foreign exchange rates, which maintains the external value
of the currency.
(iii)
Maintaining stability in the money market through liquidity control measures.
(iv) To
promote overall economic growth and development by maximizing income, employment,
and output.
(v) Promotion
of national interest.
Or
What do you mean
by internal organization of a bank? Mention six important departments of a
bank. 8
Ans:- The
structure of a commercial bank may be like that of a regular organization,
depending on the size of the bank. There is usually a CEO, executive directors,
operations managers, internal auditors, and standard bank staff. All these
persons or positions will not be at the same banking location.
There are
six important departments of a bank:
(i) Risk
Management Department.
(ii) Legal
Compliance and Compliance Control Division.
(iii) Money
Laundering and Terrorist Financing Reporting Section.
(iv) Internal
Legal Control and Audit Department.
(v) Human
Resource Department.
(vi)
Department of Treasury and Investments.
22. Write short notes on the following: 4+4=8
(a) E-banking
Ans:- The
growth and development of commercial banks go hand in hand with the line of
development in commerce. The growth of electronic commerce has forced the
banking sector to move towards e-banking using the services of information and
communication technology. E commerce refers to the ability to conduct business
electronically, including the business of banking. Business including banking
is going to be concerned with the transmission of knowledge and information on
finance and risk management. Under the influence of modern information
technology, banking will become more informative, quick and borderless. Banks must
adopt the use and application of information technology for their survival. Thus
e-banking is knowledge based and under the influence of electronic revolution
it has become more of a science than an art. It is characterized by the powers
of information execution, speed, choice, convenience, and frugality. Banking is
basically internet bank.
(b) Scheduled
and non-scheduled banks.
Ans:- Scheduled
banks are those banks which are included under the Second Schedule to the
Reserve Bank of India (RBI) Act, 1934. On the other hand, non-scheduled banks
are those banks which are not included in this schedule.
Scheduled
Banks:
(i) any bank
which is listed in the Second Schedule to the Reserve Bank of India Act, 1934
is deemed to be a scheduled bank.
(ii) The
Schedule includes those banks which fulfill the various parameters, criteria
under section 42 of this Act.
(iii) The list
includes State Bank of India and its subsidiaries (such as State Bank of Travancore),
all nationalized banks (Bank of Baroda, Bank of India etc.), Regional Rural
Banks (RRBs), foreign banks (HSBC Holdings plc, Citibank n) and some
co-operative banks.
(iv) These also
include private sector banks classified as both old (Karur Vysya Bank) and new
(HDFC Bank Ltd.).
(v) To qualify
as a scheduled bank, the paid-up capital and aggregated funds of the bank
should not be less than Rs.5 lakh.
(vi) Scheduled
banks are eligible to borrow from the Reserve Bank of India at the bank rate,
and are granted membership of clearing houses.
Non-Scheduled
Banks:
(i)
Non-scheduled banks are those not listed in the Second Schedule to the RBI Act,
1934.
(ii) They do not
conform to all the norms under section 42 but comply with the specific guidelines
laid down by RBI.
(iii) Banks with
reserve capital of less than Rs 5 lakh qualify as non-scheduled banks.
(iv) Unlike
scheduled banks, they are not entitled to borrow from RBI for general banking
purposes, except in emergency or unusual circumstances.
(v) The
Bangalore City Co-operative Bank Ltd. Bangalore, Baroda City Co-op. Bank Ltd.
are some examples.
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