Achievers Batch-12th

orksheet No. 05
MONEY AND BANKING

Key Word
High powered money Money injected by the monetary authority in the economy. It consists mainly
of currency.
Bank money Demand deposits created by the commercial banks.
Fiat money Money with no intrinsic value.
Legal tender Money issued by the monetary authority or the government which cannot
be refused by anyone
Narrow money Currency notes, coins and demand deposits held by the public in commercial
banks.
Broad money Narrow money + Time deposits held by commercial banks and post office
savings organisation.

1. If the Reserve Ratio is 25% and the primary deposits are `500 crore, what is the value of
deposit multiplier and total lending by the banking system? Given the same amount of
initial deposits, if the RBI increased the Reserve Ratio to 40%, what would happen in the
economy? Explain.
Sol. Deposit multiplier (or Money multiplier) = 1/Reserve ratio = 1/0.25 = 4
Total deposit creation (or money creation) = Primary Deposits × 1/Reserve ratio = `500 crore
× 4 = `2,000 crore
Total credit (loan) creation = Total lending by the banking system = `2,000 crore – `500 crore =
*1,500 crore
Now, if the RBI increases the Reserve Ratio to 40%, total deposit creation = 500 crore x 1/0.40 =
`500 crore × 2.5 = `1,250 crore
Total lending by the banking system = `1,250 crore – `500 crore = ₹750 crore
Thus, the banking system would now be able to lend ₹750 crore only because it would have to
call back some loans to meet the increased reserve requirements. Hence, money supply in the
economy would fall.
2. If the total deposits created by commercial banks is `400 crore and Legal Reserve Ratio
(LRR) is 12.5%, then calculate the amount of initial deposits with the banks.
Sol. Legal Reserve Ratio (LRR) = 12.5% = 0.125. Therefore, Money Multiplier = 1/LRR = 1/0.125 = 8
Total deposit creation = Initial deposits × 1/LRR
400 = Initial deposits × 8
Initial deposits = 400/8 = 50
Thus, the amount of initial deposits with the banks = `50 crore
3. Calculate the reserve deposit ratio if the primary deposits of `200 crore lead to a creation of
total deposits of `2,000 crore.
Sol. Total deposits creation = Primary deposits × 1/Reserve Deposit Ratio
2,000 = 200 × 1/Reserve Deposit Ratio
1/Reserve Deposit Ratio = 2,000/200

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 1/Reserve Deposit Ratio = 10
Reserve Deposit Ratio = 1/10 = 0.1 or 10%
4. "As per announcement made by the Governor of Reserve Bank of India (RBI) on May 4,
2022, it has been decided to increase the Cash Reserve Ratio (CRR) by 50 basis points from
4% to 4.5%." Analyse the impact of this step of RBI on total credit creation in the economy.
Sol. The total amount of credit creation in an economy depends upon the amount of initial deposits
and cash reserve ratio (CRR). An increase in the CRR by RBI may lead to lesser availability of
deposits with commercial banks. This may curtail the lending capacity of commercial banks.
Thus, adversely affecting the total credit creation in the economy.
5. Read the following information carefully and answer the questions that follow:
"The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), recently
increased the Repo Rate by 50 basis points. The Rate stands today at 5.40%, whereas Reverse
Repo Rate was left unchanged at 3.35%."
(i) Identify the two monetary policy measures and their nature mentioned in the above
text.
(ii) Elaborate the likely economic rationale behind the increase in Repo Rate by the
Monetary Policy Committee.
Sol. (i) The two monetary policy measures (Repo rate and Reverse repo rate) mentioned are of
quantitative nature.
(ii) An increase in the repo rate will force the commercial banks to increase the lending
rates, which may make borrowing costlier to the general public. It may discourage
general public from borrowing funds. As a result, Aggregate Demand in the economy
may decrease, thereby controlling the inflationary pressures in the economy.

HOME ASSIGNMENT
1. "As per announcement made by the Governor of Reserve Bank of India (RBI) on May 4,
2022, it has been decided to increase the Cash Reserve Ratio (CRR) by 50 basis points from
4% to 4.5%.". Analyse the impact of this step of RBI on toral credit creation in the economy.
2. Read the following News Report and answer the questions that follow:
During Covid-19, the Reserve Bank of India (RBI), cut Repo Rate to 4.4 % the lowest in at least
15 years. Also, it reduced the CRR by 100 basis points. It all depends on how India responds to
the situation. Aggregate demand may weaken and ease core inflation.
(i) What is the likely effect of cut in Repo Rate by RBI on the money supply in the Indian
economy?
(ii) "reduced the CRR by 100 basis points. Previously, it was 4%." Thus, CRR is reduced to
________.
(iii) Besides reduction in CRR and Repo Rate, what other measure can be taken by the
Government of India through its budgetary policy to combat recession? State any one.
3. Read the following text carefully:
"After setting up a working group to study the possibility of a Central Bank Digital Currency
(CBDC) in India in 2020, the RBI revealed a concept note on digital rupee (e-Rupee) on 7th
October, 2022." "The e-Rupee will provide an additional option to the currency available forms
of money. It is substantially not different from bank notes, but being digital it is likely to be
easier, faster and cheaper." RBI said that it broadly defines CBDC as the legal tender issued by a
central bank in a digital form. It is akin to paper currency in a different form.

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 (a) Identify and discuss the function of central bank indicated above text.
(b) State any two advantages of digital rupee.
4. Read the following case and answer the questions that follow:
Once there was a goldsmith named Lala in a village. In this village, people used gold and other
precious metals in order to buy goods and services. In other words, these metals were acting
as money. People in the village started keeping their gold with Lala for safe keeping, In return
for keeping their gold. Lala issued paper receipts to people of the village and charged a small
fee from them. Slowly over time, the paper receipts issued by Lala began to circulate as money.
This means that instead of giving gold for purchasing wheat, someone would pay for wheat
or shoes or any other commodity by giving the paper receipts issued by Lala. Thus, the paper
receipes started acting as money since everyone in the village accepted these as a medium of
exchange. Now, let us suppose that Lala had 100 Kgs of gold, deposited by different people and
he had issued receipes corresponding to 100 kgs of gold. At this time Ramu comes to Lala and
asks for a loan of 25 kgs of gold. Can Lala give the loan? The 100 kgs of gold with him already
has claimants. However, Lala could decide that everyone with gold deposits will not come to
withdraw their deposits at the same time and so he may as well give the loan to Ramu and charge
him for it. If Lala gives the loan of 25 kgs of gold, Ramu could aho pay Ali with these 25 kgs of
gold and Ali could keep the 25 kgs of gold with Lala in return for a paper receipt. In effect, the
paper receipts, acting as money, would have risen to 125 kgs now. It seems that Lala has created
money out of thin air!
(a) The modern banking system works precisely the way Lala behaves in the above case.
Explain the process of deposit and loan (credit) creation by banks assuming that primary
deposits with banks are 500 crore and Legal Reserve Deposit Ratio is 20%.
(b) How much is the total lending (or credit creation) by the commercial banking system?
(c) Enumerate the functions of commercial banking system which are the basis for deposit
and loan (credit) creation
5. Read the following text carefully. Answer the given questions on the basis of the same and
common understanding:
On 30th September 2022, the Reserve Bank of India (RBI) raised Repo Rate for the fourth time
in a row. The Monetary Policy Committee (MPC) decided to raise the policy rate by 50 basis
points. (1 basis point 1/100th of a percent). After this announcement, the new repo rate stands
at 5.9%, while the reverse repo rate continues to stand at 3.35%. Commercial banks borrow
money from the Central Bank, when there is a shortage of funds. With the surge in the repo rate,
borrowings by general public will become costlier. This is because, as RBI hikes its repo rate, it
becomes costly for the banks to borrow short term funds from the Central Bank. As a result, the
banks hike the rates at which customers borrow money from them to compensate for the hike
in the repo rate. This happens because banks offer loans to retail consumers at an interest rate
which is generally, directly proportional to the repo rate. The increase of 0.50 percent in repo
rate will lead to a higher interest rate on loans for borrowers, implying that the Equated Monthly
Instalments (EMIs) for repaying the existing loans will also increase.
(a) Identify and explain the two monetary policy measures and their nature mentioned in the
above text.
(b) Outline the recent change made by the Monetary Policy Committee of Reserve Bank of
India in the repo rate.
(c) "Increase in repo rate is an important tool used by Monetary Policy Committee to combat
the situation of inflation in the Economy." Justify the given statement.

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