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Case/Source Based MCQs of Money and Banking chapter class 12

• October 31, 2021
• MCQS , Money & Banking

Looking for Case study or Source-Based MCQs (Multiple Choice Questions) of Money and Banking chapter of Macroeconomics Class 12 CBSE, ISC and other state Board.

I have made a collection of important MCQs

Lets Practice.

Case/Source Based Multiple Choice Questions of Money and Banking Chapter Class 12

Following are the MCQs

1. Based on the passage below, answer the following questions.

The Reserve Bank of India (RBI) is India’s Central Bank, also known as the banker’s bank. The RBI controls the monetary and other banking policies of the Indian government. The Reserve Bank of India (RBI) was established on April 1, 1935, in accordance with the Reserve Bank of India Act, 1934. The role of RBI has undergone a significant change after the introduction of the new Economic Policy in 1991.

The Reserve Bank of India (RBI) is India’s central bank and regulatory body under the jurisdiction of the Ministry of Finance, the RBI is responsible for the issue and supply of the Indian rupee and the regulation of the Indian Banking system. It also manages the country’s main payment systems and works to promote its economic development.

On 8 November 2016, the government of India announced the demonetization of all ₹ 500 and ₹ 1000 banknotes of the Mahatma Gandhi Series on the recommendation of the Reserve Bank of India (RBI).

Answer the following Questions.

1. Why RBI is said to be a banker of the bank. Choose the correct option

a) Lender’s of last resort b) controller of credit c) Decide LRR d) None of the above.

Ans – a)

2. ‘RBI is responsible for issue and supply of Indian Rupee in the economy’. Identify the function of RBI and explain.

a) Central bank has the authority to issue currency in the economy. b) This develops the public faith in the system of note circulation. c) It allows the central bank to supervise and control the money supply. d) All of the above.

Ans – d)

3. Define Demonetisation.

a) it refers to selling the public sector to the private. b) It refers to the release of new coins. c) It refers to the process where currency notes of certain denominations are declared no longer as legal tender. d) None of the Above.

Ans – c)

4. How the role of RBI has changed after the 1991 New Economic Policy.

a) Its role changes from the regulator to facilitator b) Interest rates decision are left with financial institutions c) It only formulates the guidelines and decision-making rights are left with financial institutions d) All of the above.

The Monetary Policy Committee of the Reserve Bank of India kept interest rates on hold Thursday even as it vowed to keep policy sufficiently loose to help revive the coronavirus battered economy. Accepting a key demand of lenders and the corporate sector, the central bank cleared a one-time restructuring of loan accounts to bail out stressed borrowers, including personal, small, and medium loans.

The details of the loan restructuring scheme – expected to kick in after the moratorium on loan repayments ends. August 31 – will be worked out by a committee headed by former ICICI Bank Chairman KV Kamath. The RBI also continued to provide support on the liquidity front and opened a new targeted window for small lenders.

The central bank kept the repo rate unchanged at 4 percent and reduced the reverse repo rate to 3:35 percent.

Answer the following questions on the basis of the above Case.

Q.1 Suppose you are a member of the Monetary Policy Committee of the RBI. You have suggested the ___________ of the money supply be ensured to help revive the coronavirus battered economy.

a) restriction b) release c) doubling d) no change

Ans – b)

Q.2 “The Monetary Policy Committee of the RBI kept interest rates on hold—-“. Which of the following is highlighted above by the term ‘interest rates’?

a) Bank Rate and Repo Rate b) Bank Rate and Lending Rate c) Repo Rate and Reverse Repo Rate d) Bank Rate and Reverse Repo Rate

Q.3 What does the ‘Repo Rate’ mean?

a) Rate at which banks borrow from the RBI for short term b) Rate at which banks borrow from the RBI for long term c) Rate at which banks deposit excess funds with the RBI d) Rate at which banks lend funds to the public

Q.4 ‘Reduction in Repo Rate by RBI’ is likely to _ the demand for goods and services in the economy.

a) increase b) decrease c) double d) not effect

The key indicators of RBI Monetary Policy along with their current rates in the table given below:

On 9th October 2020, RBI has kept the Repo Rate unchanged at 4.00% and reduced reverse repo rate to 3.35%. In addition to that, the bank rate stands at 4.65%. This has been done to limit the damage to the economy caused by the Covid-19 and subsequent lockdowns.

Q.1 What does RBI Monetary Policy 2020 mean?

a) It is the policy formulated by the RBI in 2020 related to expenditure and taxation of the government. b) It is the policy formulated by the RBI in 2020 realted to money matters of the country. c) It is the policy formulated by the RBI in 2020 related to the government budget. d) It is the policy formulated by the RBI in 2020 realted to the distribution of credit among users as well as the rate of interest on borrowing and lending.

Ans – b), d)

Q.2 What does the ‘Bank Rate’ mean?

a) Rate at which banks borrow from the RBI for short term b) Rate at which banks borrow from the RBI for long term c) Rate at which banks deposit excess funds with the RBI d) Rate at which banks lend funds to the public.

Q.3 Which of the following is a quantitative credit control technique of RBI?

a) CRR b) SLR c) Repo Rate d) All of these

Q.4 Cut in Reverse Repo Rate is likely to _ the demand for goods and services in the economy during Covid – 19 lockdowns.

Case Study – 3

Keeping in view the continuing hardships faced by banks in terms of social distancing of staff and consequent strains on reporting requirements, the Reserve Bank of India has extended the relaxation of the minimum daily maintenance of the CRR of 80% for up to September 25, 2020. Currently, CRR is 3% and SLR is 18.50%.

“As announced in the Statement of Development and Regulatory Policies of March 27, 2020, the minimum daily maintenance of CRR was reduced from 90% of the prescribed CRR to 80% effective the fortnight beginning March 28, 2020 till June 26, 2020, that has now been extended up to September 25, 2020,” said the RBI.

Q.1 The full forms of CRR and SLR are:

a) Current Reserve Ratio and Statutory Legal Reserves b) Cash Reserve Ratio and Statutory Legal Reserves c) Current Required Ratio and Statutory Legal Reserves d) Cash Reserve Ratio and Statutory Liquidity Ratio

Q.2 What will be the value of money multiplier?

a) 33.33 b) 5.4 c) 4.65 d) None of these

Q.3 SLR implies:

a) Certain percentage of the total banks’s deposits has to be kept in the current account with RBI b) Certain percentage of net total demand and time deposits has to be kept by the bank with themselves. c) Certain percentage of net demand deposits has to be kept by the banks with RBI d) None of the above

Decrease in CRR will lead to __ .

a) fall in aggregate demand in the economy. b) rise in aggregate demand in the economy c) no change in aggregate demand in the economy d) fall in general price level in the economy

Case Study – 4

Due to 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. Previously, it was 4%. RBI governor Dr. Shaktikanta Das predicted a big global recession and said India will not be immune. It all depends on how India responds to the situation. Aggregate demand may weaken and ease core inflation.

Q.1 CRR stands for:

a) Cash Reserve Ratio b) Current Reserve Ratio c) Cash Required Rate d) Current Required Rate

Q.2 Cut in Repo Rate by RBI is likely to __ the aggregate demand in the Indian Economy.

“ reduced the CRR by 100 basis points. Previously, it was 4%.” Thus, CRR is reduced to ___ .

a) 5% b) 3% c) 96% d) 104%

Besides reduction in CRR and Repo Rate, What other measures can be taken by the Government of India through its budgetary policy to combat recession?

a) Decrease the bank rate b) Sell government securities in the open market c) Increase margin requirements on secured loans d) Decrease taxes and increase government expenditure

Anurag Pathak

Anurag Pathak is an academic teacher. He has been teaching Accountancy and Economics for CBSE students for the last 18 years. In his guidance, thousands of students have secured good marks in their board exams and legacy is still going on. You can subscribe his youtube channel and can download the Android & ios app for free lectures.

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Money and Banking Class 12 Notes PDF (Handwritten & Short Notes)

For some students, Money and Banking can be complex and difficult. To understand each and every topic in an easier way, students can look through the Money and Banking class 12 notes. After understanding the chapter Money and Banking, it is important for students to practise many questions from class 12 Economics notes so that level of understanding can be evaluated. 

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NCERT Solutions for Class 12 Macroeconomics Chapter 3 Case Study

NCERT Solutions for Class 12 Macroeconomics Chapter 3 Case Study Questions in English Medium prepared for academic session 2024-25. Students of class 12 economics can get here chapter 3 Money and Banking Case Study MCQ with Case based questions for practice in Case Studies during the exams.

Class 12 Macroeconomics Chapter 3 Case Studies Question Answers

• Class 12 Macroeconomics Chapter 3 Case Study
• Class 12 Macroeconomics Chapter 3 NCERT Solutions
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The call for cash tells us what makes humans preference a positive quantity of cash. Since cash is needed to behaviour transactions, the cost of transactions will decide the cash humans will need to maintain: the bigger is the quantum of transactions to be made, the bigger is the amount of cash demanded. Since the quantum of transactions to be made relies upon on earnings, it must be clean that an upward push in earnings will result in upward push in call for cash.

Also, whilst humans maintain their financial savings with inside the shape of cash in place of placing it in a financial institution which offers them hobby, how an awful lot cash humans maintain additionally relies upon on price of hobby. Specifically, whilst hobby prices pass up, humans end up much less inquisitive about preserving cash because preserving cash quantities to preserving much less of hobby-incomes deposits, and as a consequence much less hobby acquired. Therefore, at better hobby prices, cash demanded comes down.

• Question 1: Why can we want cash?
• Question 2: What takes place whilst hobby prices pass up?
• Question 3: Whether True or False. (a) The call for cash tells us what makes humans preference a positive quantity of cash. (b) Since cash is needed to behaviour transactions, the cost of transactions will decide the cash humans will need to maintain. (c) When hobby prices pass up, humans preserve their cash in coins. (d) At better hobby prices, call for of cash comes down. (e) Rise in earnings will result in lower in call for cash.
• Question 4: Fill with inside the blanks. (a) The large is the quantum of transactions to be made, the bigger is the ____________ demanded. (b) When humans maintain their financial savings with inside the shape of cash in place of placing it in a financial institution which offers them hobby, how an awful lot cash humans maintain additionally relies upon on ____________. (c) When hobby prices pass up, humans end up _____________ in preserving cash.
• Answer 1: We want cash to make or behaviour transactions.
• Answer 2: When hobby prices pass up, humans end up much less inquisitive about preserving cash because preserving cash quantities to preserving much less of hobby-incomes deposits, and as a consequence much less hobby acquired.
• Answer 3: (a) True, (b) True, (c)False, (d)True, (e) False
• Answer 4: (a) amount of cash, (b) hobby price, (c) much less fascinated.

In a present-day financial system, cash incorporates coins and financial institution deposits. Depending on what styles of financial institution deposits are being included, there are numerous measures of cash. These are created with the aid of using a machine comprising styles of establishments: important financial institution of the financial system and the economic banking machine. Central financial institution: Central Bank is a totally critical organization in a present-day financial system. Almost each country has one important financial institution. India was given its important financial institution in 1935. Its call is the ‘Reserve Bank of India’. Central financial institution has numerous critical functions. It troubles the Forex of the country. It controls cash deliver of the country via diverse methods, like financial institution price, open marketplace operations and versions in reserve ratios. It acts as a banker to the authorities. It is the custodian of the Forex reserves of the financial system. It additionally acts as a financial institution to the banking machine, that is mentioned in element later.

From the factor of view of cash deliver, we want to cognizance on its feature of issuing Forex. This issued with the aid of using the important financial institution may be held with the aid of using the general public or with the aid of using the economic banks, and is referred to as the ‘high-powered cash’ or ‘reserve cash’ or ‘financial base’ because it acts as a foundation for credit score creation. Commercial Banks: Commercial banks are the alternative sort of establishments which might be part of the cash-growing machine of the financial system. They take delivery of deposits from the general public and lend out a part of those budget to people who need to borrow. The hobby price paid with the aid of using the banks to depositors is decrease than the price charged from the borrowers. This distinction among those styles of hobby prices, referred to as the ‘spread’ is the earnings appropriated with the aid of using the financial institution.

• Question 1: Fill with inside the blanks: (a) In a present-day financial system, cash incorporates coins and _________. (b) India was given its important financial institution in 1935. Its call is the ________. (c) Reserve Bank troubles the _________ of the country. (d) The hobby price paid with the aid of using the banks to depositors is ____________ than the price charged from the borrowers. (e) This distinction among those styles of ________, referred to as the ‘spread’ is the earnings appropriated with the aid of using the financial institution.
• Question 2: State whether or not True of False. (a) Central Bank controls cash deliver of the country via diverse methods. (b) Central Bank acts as a banker to the authorities. (c) Commercial Banks take delivery of deposits from the general public and lend out a part of those budget to people who need to borrow. (d) The hobby price paid with the aid of using the banks to depositors is better than the price charged from the borrowers.
• Answer 1: (a) financial institution deposits, (b) Reserve Bank of India, (c) Forex, (d) decrease, (e) hobby prices.
• Answer 2: (a) True, (b) True, (c) True, (d) False.

Banks can lend truly due to the fact they do now no longer count on all of the depositors to withdraw what they have got deposited on the equal time. When the banks lend to any man or woman, a brand-new deposit is opened in that man or woman’s call. Thus, cash deliver will increase to vintage deposits plus new deposit (plus Forex.) Let us take an example. Assume that there may be most effective one financial institution with inside the country. Let us assemble a fictional stability sheet for this financial institution. Balance sheet is a file of belongings and liabilities of any organization. Conventionally, the belongings of the organization are recorded at the left-hand aspect and liabilities at the right-hand aspect. Accounting regulations say that each facet of the stability sheet have to be identical or general belongings have to be identical to the full liabilities. Assets are mattering an organization owns or what an organization can declare from others. In case of a financial institution, aside from buildings, furniture, etc., its belongings are loans given to public.

When the financial institution offers out mortgage of Rs one hundred to a man or woman, that is the financial institutions declare on that man or woman for Rs one hundred. Another asset that a financial institution has is reserves. Reserves are deposits which industrial banks maintain with the Central financial institution, Reserve Bank of India (RBI) and its coins. These reserves are saved in part as coins and in part with inside the shape of monetary instruments (bonds and treasury bills) issued with the aid of using the RBI. Reserves are much like deposits we maintain with banks. We maintain deposits and those deposits are our belongings, they may be withdrawn with the aid of using us. Similarly, industrial banks like State Bank of India (SBI) maintain their deposits with RBI and those are referred to as Reserves.

• Question 1: Fill with inside the blanks: (a) Balance sheet is a file of ___________ any organization. (b) In case of a financial institution, aside from buildings, furniture, etc., its belongings are ___________. (c) Another asset that a financial institution has is ______________ which industrial banks maintain with the Central financial institution, Reserve Bank of India (RBI) and its coins. (d) When the financial institution offers out mortgage of Rs one hundred to a man or woman, that is the financial institution’s ____________ on that man or woman for Rs one hundred.
• Question 2: What are reserves?
• Question 3: State whether or not True or False. (a) Assets are mattering an organization owns or what an organization can declare from others. (b) Accounting regulations say that each facet of the stability sheet has to be identical or general belongings have to be identical to the full liabilities. (c) Reserves aren’t much like deposits we maintain with banks. (d) Reserves are deposits which industrial banks maintain with the Central financial institution.
• Answer 1: (a) belongings and liabilities, (b) loans given to public, (c) reserves, (d)declare
• Answer 2: Reserves are much like deposits we maintain with banks. We maintain deposits and those deposits are our belongings, they may be withdrawn with the aid of using us. Similarly, industrial banks like State Bank of India (SBI) maintain their deposits with RBI and those are referred to as Reserves.
• Answer 3: (a) True, (b)True, (c)False, (d) True.

There are styles of open marketplace operations: outright and repo. Outright open marketplace operations are everlasting in nature: whilst the important financial institution buys those securities (as a consequence injecting cash into the machine), it’s miles with none promise to promote them later. Similarly, whilst the important financial institution sells those securities (as a consequence taking flight cash from the machine), it’s miles with none promise to shop for them later. As a result, the injection/absorption of the cash is of everlasting nature. However, there may be any other sort of operation wherein whilst the important financial institution buys the security, this settlement of buy additionally has specification approximately date and rate of resale of this security. This sort of settlement is referred to as a repurchase settlement or repo. The hobby price at which the cash is lent on this manner is referred to as the reporate. Similarly, in preference to outright sale of securities the important financial institution might also additionally promote the securities via a settlement which has a specification approximately the date and rate at which it’ll be repurchased. This sort of settlement is referred to as an opposite repurchase settlement or opposite repo.

The price at which the cash is withdrawn on this way is referred to as the opposite reporate. The Reserve Bank of India conducts repo and opposite repo operations at diverse maturities: overnight, 7-day, 14- day, etc. This sort of operations has now end up the primary device of financial coverage of the Reserve Bank of India. The RBI can impact cash deliver with the aid of using converting the price at which it offers loans to the economic banks. This price is referred to as the Bank Rate in India. By growing the financial institution price, loans taken with the aid of using industrial banks end up greater expensive; this reduces the reserves held with the aid of using the economic financial institution and subsequently decreases cash deliver. A fall with inside the financial institution price can boom the cash deliver.

• Question 1: What is repo?
• Question 2: Fill with inside the blanks: (a) A fall with inside the financial institution price can _______ the cash deliver. (b) The Reserve Bank of India conducts repo and _______ at diverse maturities: overnight, 7-day, 14- day, etc. (c) There are styles of open marketplace operations: ________ and _________. (d) Outright open marketplace operations are __________ in nature. (e) The hobby price at which the cash is lent on this manner is referred to as the _______. (f) The price at which the cash is withdrawn on this way is referred to as the ________. (g) The RBI can impact _________ with the aid of using converting the price at which it offers loans to the economic banks. (h) By growing the financial institution price, ________ taken with the aid of using industrial banks end up greater expensive; this reduces the reserves held with the aid of using the economic financial institution and subsequently ________ cash deliver.
• Answer 1: When the important financial institution buys the security, this settlement of buy additionally has specification approximately date and rate of resale of this security. This sort of settlement is referred to as a repurchase settlement or repo.
• Answer 2: (a) boom, (b) opposite repo, (c) outright, repo, (d) everlasting, (e) reporate, (f) opposite reporate; (g) cash deliver, (h) loans, decreases

Demonetisation turned into a brand-new initiative taken with the aid of using the Government of India in November 2016 to address the trouble of corruption, black cash, terrorism and move of faux forex with inside the financial system. Old notes of Rs 500, and Rs one thousand have been not felony gentle. New notes with inside the denomination of Rs 500 and Rs 2000 have been launched. The public have been suggested to deposit vintage notes of their financial institution account until 31 December 2016 with none assertion and as much as 31March 2017 with the RBI with assertion. Further to keep away from a whole breakdown and coins crunch, authorities had allowed change of Rs 4000 vintage forex the with the aid of using new forex in step with man or woman and in step with day. Further until 12 December 2016, vintage notes have been proper as felony gentle at petrol pumps, authority’s hospitals and for fee of presidency dues, like taxes, electricity bills, etc. This circulate acquired each appreciation and criticism. There have been lengthy queues out of doors banks and ATM booths. The scarcity of forex in move had a negative effect at the financial sports.

However, matters advanced with time and normalcy returned. This circulate has had tremendous effect additionally. It advanced tax compliance as a big wide variety of humans have been offered with inside the tax ambit. The financial savings of a character have been channelised into the formal monetary machine. As a result, banks have greater sources at their disposal which may be used to offer greater loans at decrease hobby prices. It is an illustration of State’s choice to place a slash on black cash, displaying that tax evasion will not be tolerated. Tax evasion will bring about monetary penalty and social condemnation. Tax compliance will enhance and corruption will lower. Demonetisation may also assist tax management in any other manner, with the aid of using moving transactions out of the coin’s financial system into the formal fee machine. Households and corporations have started to shift from coins to digital fee technologies.

• Question 1: Fill with inside the blanks: (a) Demonetisation acquired each appreciation and _______. (b) The scarcity of forex in move had an _________ effect at the financial sports. (c) Due to demonetisation, tax __________ will enhance and ________ will lower. (d) New forex notes with inside the denomination of ₹ ___________ and ₹ _________ have been launched.
• Question 2: Why did the authorities take the initiative of demonetisation?
• Question 3: What precautions have been taken to keep away from whole breakdown?
• Question 4: What have been the results and blessings of the demonetisation?
• Question 5: State whether or not True or False: (a) Demonetisation acquired each appreciation and criticism. (b) Government had allowed change of ₹4000 vintage forex the with the aid of using new forex in step with man or woman and in step with day. (c) There have been no queues out of doors banks and ATM booths. (d) New forex notes with inside the denomination of ₹500 and ₹1000 have been launched. (e) Till 12 December 2016, vintage forex notes have been proper as felony gentle at petrol pumps, authority’s hospitals and for fee of presidency dues, like taxes, electricity bills, etc. (f) It advanced tax compliance as a big wide variety of humans have been offered with inside the tax ambit.
• Answer 1: (a) criticism, (b) negative, (c) compliance, corruption, (d) 500, 2000.
• Answer 2: Demonetisation turned into a brand-new initiative taken with the aid of using the Government of India in November 2016 to address the trouble of corruption, black cash, terrorism and move of faux forex with inside the financial system.
• Answer 3: The public have been suggested to deposit vintage notes of their financial institution account until 31 December 2016 with none assertion and as much as 31March 2017 with the RBI with assertion. Further to keep away from a whole breakdown and coins crunch, notes authorities had allowed change of ₹4000 vintage forex the with the aid of using new forex in step with man or woman and in step with day. Further until 12 December 2016, vintage forex notes have been proper as felony gentle at petrol pumps, authority’s hospitals and for fee of presidency dues, like taxes, electricity bills, etc.
• Answer 4: This circulate acquired each appreciation and criticism. There have been lengthy queues out of doors banks and ATM booths. The scarcity of forex in move had a negative effect at the financial sports. However, matters advanced with time and normalcy returned. This circulate has had tremendous effect additionally. It advanced tax compliance as a big wide variety of humans have been offered with inside the tax ambit. The financial savings of a character have been channelised into the formal monetary machine. As a result, banks have greater sources at their disposal which may be used to offer greater loans at decrease hobby prices. It is an illustration of State’s choice to place a slash on black cash, displaying that tax evasion will not be tolerated.
• Answer 5: (a) True, (b)True, (c) False, (d) False, (e) True, (f) True.

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Money And Banking Chapter 2 Notes, QnA 2023

Money and banking, money  .

Money is a liquid asset used in the settlement of transactions. It is an economic unit that functions as a generally recognized medium of exchange for transactional purposes in an economy.

Function of money is based on the general acceptance of its value within a governmental economy and internationally through foreign exchange. 

Money is commonly referred to as currency. Each government has its own money system. 

It is a normally recognized medium of exchange that people and global economies intend to hold, and are willing to accept as payment for current or future transactions.

Supply of Money

The overall stock of money circulating in an economy or among the public is the money supply. This circulating money involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets.

Valuation and analysis of the money supply help the policy makers to frame the policy or to change the current policy of increasing or reducing the supply of money. The valuation of money is important as it ultimately affects the business cycle and thereby affects the economy.

The Reserve Bank of India publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4.

• M1 = CU + DD   M2 = M1 + Savings deposits with Post Office savings banks  
• M3 = M1 + Net time deposits of commercial banks  
• M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)  
• CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks

Money deposits of the public held by the banks are to be included in the money supply.

The interbank deposits, in which a commercial bank holds in other commercial banks, are not to be regarded as part of the money supply.

• M1 and M2 are known as narrow money. M3 and M4 are known as broad money.
• These gradations are in decreasing order of liquidity.
• M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.
• M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources.

Money Creation By The Commercial Banking System .

Commercial banks create money through credit against deposits through the bank multiplier. Here credit means granting loans and advances made by banks to the public. 

Credit creation by commercial banks refers to the multiplication of original bank deposits, 

As every loan creates a deposit.

Commercial Banks create deposits via lending. Banks don’t give loans in cash, instead they issue cheques against the name of the borrowers. 

Now the borrower is free to draw money by drawing cheques upon the banks. Borrowers deposit the cheque in another bank. However, the bank knows that the amount of money that the depositors withdraw soon returns to the bank.

Banks keep a certain minimum fraction of the deposits made by customers as reserves. Rest of the deposits they lend. This fraction is called the Legal Reserve Ratio (LRR) and is fixed by the central bank. 

Banks keep this fraction of deposits as Cash Reserves because all the depositors do not withdraw the entire amount in one go.

So, to meet the daily demand for withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as cash reserves. It means, if experience of the banks show that withdrawals are generally around 20% of the deposits, then it needs to keep only 20% of deposits as cash reserves (LRR).

Let’s take an example:

Suppose, initial deposits in banks is Rs 10000, now banks are required to keep only Rs 2000 (20%) as cash reserve and are free to lend Rs 8000.

Banks do not lend this money in cash. Rather, they open the accounts in the names of borrowers, who are free to withdraw the amount whenever they like.

Suppose borrowers withdraw the entire amount of 8000, it will come back into the banks in the form of deposit accounts of those who have received this payment. 

With these new deposits of 8000, banks keep 20% as cash reserves and lend the balance Rs 6400. Borrowers use this amount and deposits back. 

In this manner the deposits keep on increasing in each round by 80% of the last round deposits. Simultaneously, cash reserves also go on increasing, each time by 80% of the last cash reserve. 

This deposit creation comes to end when total cash reserves become equal to the initial deposit.

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Click Below To Learn Other Chapter Notes

• Unit 1: National Income and Related Aggregates
• Unit 3: Determination of Income and Employment  
• Unit 4: Government Budget and the Economy 
• Unit 5: Balance of Payments
• Unit 6: Development Experience (1947-90) and Economic Reforms since 1991
• Unit 7: Current challenges facing Indian Economy  
• Unit 8: Development Experience of India

Central Bank And Its Functions

A central bank of any country ( e.g. Reserve Bank of India) is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. 

Central bank’s goals are to stabilize the nation’s currency, keep unemployment low, and prevent inflation.

Most central banks are governed by a board consisting of its member banks. The central bank aligned with the nation’s long-term policy goals. At the same time, it is free from political influence in its day-to-day operations.

Functions of Central Bank

There are two kinds of functions of the Central bank.

Traditional Functions

Developmental Functions

The traditional functions of the central bank include the following:

• Bank of issue :

Possesses an exclusive right to issue notes in every country of the world. The issue of notes by one bank has led to uniformity in note circulation and balance in money supply.

• Government’s banker, agent :

Central bank performs banking functions for the government as commercial banks performs for the public by accepting the government deposits and granting loans to the government. As an agent, the central bank manages the public debt.

• Custodian of cash reserves :

Central bank takes care of the cash reserves of commercial banks. 

• Custodian of international currency :

Central bank maintains a minimum reserve of international currency to meet emergency requirements of foreign exchange and overcome adverse requirements of deficit in balance of payments.

• Bank of re discount :

Serve the cash requirements of individuals and businesses by Re discounting the bills of exchange through commercial banks. 

• Lender of last resort :

The central bank provides loans against treasury bills, government securities, and bills of exchange.

• Bank of settlement and transfer:

The central bank helps in settling mutual indebtedness between commercial banks. 

• Controller of Credit :

The central bank regulate the credit creation by commercial banks directly or indirectly.

Functions that are related to the promotion of banking system and economic development of the country. 

• Developing specialized financial institutions:

The central bank establishes institutions that serve credit requirements of the agriculture sector and other rural businesses.

• Influencing money market and capital market:

Central bank deals in short term credit and capital market deals in long term credit. The central bank maintains the country’s economic growth by controlling the activities of these markets.

• Collecting statistical data:

Gathers and analyzes data related to banking, currency, and foreign exchange position of a country. 

Bank of issue

The central bank is the bank of issue. It issues notes and coins to commercial banks.

In addition to issuing currency to the banks, the central bank also issues currency to the central Government of the country.

Currency which are manufactured by the Government, they are put into circulation through the central bank.

However, the central bank has its monetary liability, it is obliged to back the currency issued by its asset of equal value such as gold and bullions.

Government Bank

Government banks are also called Public Sector Banks (PSBs), where a majority stake  is held by the Ministry of Finance of the Government of India or Ministry of Finance of various State governments of India.

Currently there are 12 Public Sector Banks in India are existing.

Banker’s Bank

A bankers’ bank is a specific type of bank that exist for the purpose of servicing the charter banks that founded them. 

Their banking services are not open to the public. These institutions are designed to support community banks.

Bankers’ banks can help community banks to effectively compete with larger banking entities.

Control of Credit Through Bank Rate

There are two methods of Credit Control through Bank Rate.

• Quantitative or general methods, and
• Qualitative or selective methods.

Quantitative or General Methods

This methods is used by the central bank to influence the total volume of credit in the banking system.

It regulates the lending ability of the financial sector of the whole economy and do not discriminate among the various sectors of the economy. 

The quantitative methods of credit control are- 

• Open market operations
• Cash-reserve ratio.

Qualitative or Selective Methods

These methods are used by the central bank to regulate the flows of credit into particular directions of the economy. 

The qualitative methods affect the types of credit extended by the commercial banks. They affect the composition rather than the size of credit in the economy.

The qualitative methods of credit control are; 

• Marginal requirements
• Regulation of consumer credit
• Control through directives
• Credit rationing
• Moral suasion and publicity
• Direct action

Bank Rate Policy

The bank rate or the discount rate is the rate at which a central bank is prepared to discount the first class bills of exchange. 

The bank rate is different from the market interest rate. The bank rate is the rate discount of the central bank, while the market interest rate is the lending rate charged in the money market by the ordinary financial institutions.

An increase in the bank rate makes the credit costlier, reduces the volume of credit, discourages economic activity and brings down the price level in the economy.

A declining in the bank rate makes the credit cheaper, increases the volume of credit, encourages the businessmen to borrow and invest, and increases the levels of economic activity.

Bank rate policy aims at influencing:

• The cost and availability of credit to the commercial banks
• Interest rates and money supply in the economy
• The level of economic activity of the economy. 

Cash Reserve Ratio (CRR)

Cash reserve ratio is a certain percentage or share that all banks have to keep with the RBI as a deposit as reserves in the form of liquid cash.

This percentage is fixed by the RBI, which changes from time to time. Currently, the CRR is fixed at 3%. That means for every Rs 100 worth of deposits, the bank has to keep Rs 3 with the RBI.

CRR keep inflation under control. During high inflation in the economy, RBI raises the CRR to sanction loans. It squeezes the money flow in the economy, reducing investments and bringing down inflation.

Statutory Liquidity Ratio (SLR)

SLR is the minimum percentage of the aggregate deposits that commercial banks has to maintains in the form of liquid cash, gold or other securities. 

Basically it is the reserve requirement that banks are expected to keep before offering credit to customers. 

SLR is not reserved with the Reserve Bank of India (RBI), but with banks themselves. But the ratio is fixed by RBI. The SLR was prescribed by Section 24 (2A) of Banking Regulation Act, 1949.

CRR and SLR are the tools of the central bank’s monetary policy to control credit growth, flow of liquidity and inflation in the economy.

Repo Rate and Reverse

Repo rate refers to the rate at which commercial banks borrow money from Central bank (Reserve Bank of India) by selling their securities to maintain liquidity, in case of shortage of funds or due to some statutory measures. 

As you borrow money from the bank as a loan on interest, similarly, banks also borrow money from RBI during a cash crunch on which they are required to pay interest to the Central Bank. This interest rate is called the repo rate.

Repo stands for ‘Repurchasing Option’. It is an agreement in which banks provide eligible securities such as Treasury Bills to the RBI while availing overnight loans.

Components of a Repo Transaction

Control inflation – The Central bank increases or decreases the Repo rate depending on the inflation, to control the economy by keeping inflation in the limit.

Hedging & Leveraging – RBI aims to hedge and leverage by buying securities from the banks and provide cash to them 

Short-Term Borrowing – RBI lends money for a short period of time, maximum being an overnight post which the banks buy back their securities deposited at a predetermined price.

Collaterals   – RBI accepts collateral in the form of gold, bonds etc.

Cash Reserve (or) Liquidity – Banks borrow money from RBI to maintain liquidity as a precautionary measure.

Affect Of Repo Rate

Repo rate is a strong system of the Indian monetary policy that can regulate the country’s money supply, inflation levels, and liquidity. 

The levels of repo have a direct impact on the cost of borrowing for banks. If repo rate is  higher then borrowing will be a costly affair for businesses and industries, which in turn slows down investment and money supply in the market.

On the other hand lowers the repo rate, industries find it cheaper to borrow money. It also boost the overall supply of money in the economy.

Reverse Repo Rate  

RBI borrows money from banks when there is excess liquidity in the market is called Reverse Repo Rate. In return the banks benefit out of it by receiving interest for their holdings with the central bank.

When levels of inflation is high in the economy, the RBI increases the reverse repo. It encourages the banks to keep more funds with the RBI to earn higher returns on excess funds. Banks are left with lesser funds to extend loans.

Open Market Operations

Open Market operations are purchases and sales of government securities and sometimes commercial paper by the central bank for the purpose of regulating the money supply and credit conditions on a continuous basis.

Under this system, when the central bank wants to reduce the money supply in the market, it sells securities in the market.

Similarly, when the central bank wants to increase the money supply, it purchase securities from the market. This step is taken to reduce the rate of interest and also to help in the economic growth of the country. 

Margin Requirement

Margin Requirement means the amount of money that you are required to deposit for entering into a Trade and maintaining an Open Position.

It is the amount of equity, that an investor has in their brokerage account. A margin account is a account in which the broker lends the investor money to buy more securities than what they could otherwise buy with the balance in their account.

Frequently Asked Questions

Q1. What is Repo Rate?

Answer : Repo rate refers to the rate at which commercial banks borrow money from Central bank (Reserve Bank of India) by selling their securities to maintain liquidity, in case of shortage of funds or due to some statutory measures. 

Q2. How the Repo Rate affects economy?

Answer : The levels of repo have a direct impact on the cost of borrowing for banks. If repo rate is  higher then borrowing will be a costly affair for businesses and industries, which in turn slows down investment and money supply in the market.

Q3: What is money?

Answer: Money is a liquid asset used in the settlement of transactions. It is an economic unit that functions as a generally recognized medium of exchange for transactional purposes in an economy.

Money and Banking Unit 2 CBSE, class 12 Economics notes. This cbse Economics class 12 notes has a brief explanation of every topic that NCERT  syllabus has. You will also get ncert solutions, cbse class 12 Economics sample paper, cbse Economics class 12 previous year paper.

Final Words

From the above article you must have learnt about ncert cbse class 12 Economics notes of unit 2 Money and Banking. We hope that this crisp and latest Economics class 12 notes will definitely help you in your exam.

• CBSE Class 12 Macro Economics Chapter 3 – Money and Banking Class 12 Notes

Money and Banking Class 12 Revision Notes

In the money and banking class 12 notes, we will be discussing the meaning and various roles that Money plays. Thus, we will discuss the functions of Money. Then, we will discuss the various motives of holding money under the heading “Demand for Money”. Demand For Money is also known as liquidity preference. Hence, we will seek knowledge about The Transaction and Speculative Motives for holding money. Then, we will learn the legal definitions of Narrow and Broad Money. Also, we will study about the creation of money by the Banking System under the head “Supply For Money.”  Moreover, we will be studying the working of Commercial Banks. We will study the type of deposits. Also, we will come to know about the different types of lending by Commercial Banks.

Moreover, we will seek knowledge about the Instruments of Monetary Policy and the Reserve Bank of India (also called a lender of last resort). Here, we will learn about RBI (monetary authority of India). Also, about the instruments which RBI uses for conducting monetary policy. These include regulating money through Open Market Operations, Bank rate policy, Varying Reserve Requirements and others.

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Sub-topics under Money and Banking:

• Functions of Money and its Demand : In this Sub-topic, we will study the Functions of Money and Demand for Money also known as liquidity preference.
• Supply of Money : Here, we will learn the legal definitions of Narrow and Broad Money. Also, we will study money Creation by the Banking System Instruments of Monetary Policy and the RBI (lender of last resort).
• Instruments of Monetary Policy and the Reserve Bank of India : In this Sub-topic, we will learn about RBI (monetary authority of India). Also, about the instruments which RBI uses for conducting monetary policy.

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CBSE Class 12 Macro Economics Revision Notes

• CBSE Class 12 Macro Economics Chapter 4 – Income Determination Class 12 Notes
• CBSE Class 12 Macro Economics Chapter 6 – Open Economy Macroeconomics Class 12 Notes
• CBSE Class 12 Macro Economics Chapter 5 – Government Budget and the Economy Class 12 Notes 
• CBSE Class 12 Macro Economics Chapter 2 – National Income Accounting Class 12 Notes
• CBSE Class 12 Macro Economics Chapter 1 – Introduction to Macro Economics Class 12 Notes

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Commerce Aspirant » Economics Class 12 » Money and Banking Class 12 Notes Economics

Money and Banking Class 12 Notes Economics

Money and Banking class 12 Notes studies the various concepts about the money used in the Indian economy and the role of commercial and central banks in supply of money and credit creation.

Money is an important discovery of modern times. It is the basic requirement of all economies in today’s time.

Before money was invented, the world used to trade as per the barter system of exchange in which the commodity was exchanged for another commodity.

Money and Banking is an important concept as one cannot imagine his life without money. Banks also plays an important role as they are considered a better place to store money or take advances and loans.

Money and Banking Class 12 Notes Economics: Overview

What is money.

Money is anything which is generally used as a medium of exchange, measure of value, store of value and means of standard deferred payment.

It covers all types of money: coins, paper notes, cheques, digital money, plastic money etc…. It can be used to buy anything as it is legally accepted by everyone. It removes the problem of double coincidence of wants as anyone can buy anything he needs.

FUNCTIONS OF MONEY

The functions of money are broadly classified as:

• Primary Functions
• Secondary Functions

TYPES OF MONEY

• Legal Tender Money: Money which can be legally used to make payments for some obliged debt is known as legal tender money . It is of two types-
• Limited legal tender money : It is that form of legal money which is used to make payments for the debts up to a certain amount. For example; coins.
• Unlimited legal tender money : It is that form of legal money which can be used to make payment of debts up to any amount. There is no limit fixed. For example; paper/ currency notes.
• Full Bodied Money : It is that form of money in which face value is equal to intrinsic value of money. It means commodity value= money value. For example: gold and silver coins.
• Representative Full Bodied Money : It is that form of full bodied money in which intrinsic value is less than face value of money. It means commodity value< money value. For example: paper notes.
• Credit Money: It is that form of money whose intrinsic value is lower than its face value. It means that money value> commodity value. For example: credit cards, bank deposits etc….

MONETARY SYSTEM IN INDIA

• In India, monetary authority is ‘Reserve Bank of India’.
• Paper currency standard is followed in India.
• Coins are regarded as limited legal tender money.
• RBI has sole monopoly to issue currency in India.
• Ministry of Finance issues 1 rupee coins and notes in India.
• India follows Minimum Reserve System for issuing notes. It means that RBI has to keep a minimum of Rs. 200 crores as gold and foreign exchange with the World Bank for issuing coins and notes.

MONEY SUPPLY

Money supply refers to the total money held by public at a particular point of time in an economy.

It includes money only held by the “public” not the government or banking system. Money supply is a “Stock” concept.

There are 4 measures of money supply. As per money and banking class 12 we need to cover only M 1 measure of money supply.

MEASURES OF MONEY SUPPLY

(i) M 1 : It is the first and basic measure of money supply. It includes currency held by the public, demand deposits of commercial banks and other deposits with the RBI. M 1 = Currency and coins with public+ Demand deposits with commercial banks+ Other deposits with RBI

(ii) M 2 : It is a broader concept of money supply as compared to M 1 . It also includes savings deposits with the post office saving bank. M 2 = M 1 + Savings deposit with Post office saving bank

(iii) M 3 : It also includes net time deposits in addition to M 1 measure of money supply. M 3 = M 1 + Net time deposits with banks

(iv) M 4 : It includes total deposits with post office savings bank in addition to M 3 measure of money supply. M 4 = M 3 + Total deposits with post office saving bank

• M 1 is the most liquid form of money supply while M 4 is the least liquid.
• M 1 and M 2 are considered the narrow concept of money supply while M 3 and M 4 are the broader concept of money supply.

HIGH POWERED MONEY

• High powered money is the money produced by RBI and the government.
• It includes currency held by the public and the cash reserves held by the banks.
• It is denoted by symbol (H).
• It is different from money because money consists of demand deposits while it includes cash reserves which act as a base for generating demand deposits.

There are mainly 2 types of banks, Commercial Banks and Central Banks. In money and banking class 12 we will study about the functions of both banks and the credit creation process of commercial banks.

COMMERCIAL BANKS

A commercial bank is a bank which accepts deposits and advance loans for the purpose of earning profits. For example: SBI, PNB, Canara Bank, Kotak Mahindra Bank etc….

CREDIT CREATION PROCESS

This is an important activity of commercial bank. Through this process, commercial banks create credit, which is created through excess reserves of the initial deposits.

There are two main assumptions

1. The entire banking system is one unit known as “BANK”. 2. All the receipts and payments in the economy is done through the Banks.

For the credit creation, commercial banks are legally required to keep a certain fraction of deposits with RBI and themselves. This fraction is called Legal Reserve Ratio (LRR).

The bank knows that all the customers will not come in one go to withdraw their money and that there is a constant flow of money with the bank. That’s why only a fraction of deposits are kept as reserve.

• Money creation is an important aspect of money and banking class 12. Let us take a hypothetical example to understand this concept.
• Let us assume that LRR= 10% and Initial deposits= Rs. 100.
• Now, the banks will keep 10% of Rs. 100 as reserve and give the rest Rs.90 as loan to the public in round 1.
• In round 2, banks will keep 10% of Rs. 90 as reserve and give Rs. 81 as loan to public.
• This process goes on and on till the reserves are exhausted. In this way, commercial banks create multiple credits with just the initial deposit.
• This gives rise to the concept of “Money Multiplier”.
• “Money Multiplier” or deposit multiplier measures the amount of deposits the commercial banks are able to create through the deposits of public kept with them as reserves. Money Multiplier = 1/LRR
• In this case, money multiplier is 1/10% = 10.

Total Deposits=  = 100*10= Rs. 1000

CENTRAL BANKS

Central bank is the ‘apex’ body that controls, regulates and operates the entire banking system in the country. In India, the central bank is RBI.

FUNCTIONS OF CENTRAL BANK

• Bank of issue: Central bank has the sole authority to issue currency notes and coins (except one rupee notes and coins). The central bank is obliged to keep the reserves in terms of gold equal to the amount of currency issued with the World Bank. It leads to uniformity in note circulation. It gives the power to Central Bank to enhance the money supply. It also helps in maintaining stability in value of money.
• Bankers to Government: The RBI acts as a banker, agent and a financial advisor to the central and state government. As a banker, it carries out all the banking business of the government. As an agent, it manages the public debt. As a financial advisor, it advices the government from time to time in financial and monetary matters.
• Banker’s Bank: Being the apex bank, central bank acts as a banker to all other banks. Other banks in the economy keep their reserves with the RBI. It has same relationship with other banks as the commercial banks have with the public. It obliges the commercial banks to keep CRR with them during the credit creation process.
• Custodian of Foreign Exchange: Central banks keep the reserves of foreign currency with themselves so that there is no excess increase or decrease in price of foreign currency. Central bank does this so that foreign reserves are available to the public.
• Lender of Last Resort: When commercial banks fail to meet the needs of the public, then RBI helps the commercial banks and the public by advancing loans to them and acts as a lender of last resort.
• Clearing House: Central bank has the reserves of commercial banks with themselves. All commercial banks have their accounts with the RBI. Therefore, RBI can make settlement of claims of various banks against each other by editing the entries in their accounts.
• Supervisor: Central bank regulates and controls the commercial banks. It exercises regular inspection and of banks and entries passed by them.

CONTROL OF CREDIT AND MONEY SUPPLY

There are TWO ways of controlling the credit creation in the market: Quantitative measure and Qualitative measures.

QUANTITATIVE MEASURES

• Repo Rate: It is the rate at which central bank gives money to commercial banks for short- term purpose without any collateral. An increase in repo rate reduces the capability of commercial banks to lend money and thus decreases money supply in the economy. A decrease in repo rate increases the money supply in the economy.
• Bank Rate: It is the rate at which central bank lends money to commercial banks for long- term purpose by keeping something as collateral. An increase in bank rate will decrease the lending capacity of commercial banks and thus reduces money supply in the economy. A decrease in bank rate increases the money supply in the economy.
• Reverse Repo Rate: It is the rate at which commercial banks keep their reserves with central bank in order to earn interest willfully. An increase in reverse repo rate induces commercial banks to keep reserves with central bank rather than giving to public. So, money supply decreases in the economy. A decrease in reverse repo rate increases the money supply in the economy.
• Legal Reserve Ratio (LRR): It is the amount of deposits which the commercial banks are obliged to keep with themselves and the central bank for credit creation process. There are two parts of LRR: CRR and SLR.
• Cash Reserve Ratio (CRR): It is the amount of deposits which the commercial banks are obliged to keep with the central bank for creating credit in the economy. An increase in CRR decreases money supply in economy and decrease in CRR increases money supply in the economy.
• Statutory Liquidity Ratio (SLR): It is the amount of deposits which the commercial banks are obliged to keep with themselves for the credit creation process. An increase in SLR decreases money supply in economy and decrease in SLR increases money supply in the economy.

QUALITATIVE MEASURES

• Open Market Operations: It refers to the sale and purchase of securities in the open market by the central bank to/from commercial banks or public. Purchase of securities by central bank increases the bank capacity to give credit as it receives money and thus it increases the money supply in the economy. Sale of securities by commercial banks soaks the excess money from the economy and thus reduces the money supply in the market.
• Margin Requirement: It refers to the difference between the amount of loan and the market value of the securities offered against the loan. An increase in margin reduces the borrowing capacity and reduces the money supply in the economy. A decrease in margin increases the borrowing capacity and increases the money supply in the economy.

DIFFERENCE BETWEEN COMMERCIAL BANK AND CENTRAL BANK

CBSE Economics Class 12 Notes Term I Syllabus

Part A: Introductory Macroeconomics

• Money and Banking Class 12 Notes
• Government Budget and the Economy Notes
• Balance of Payments Class 12 Notes
• Foreign Exchange Rate Notes

Part B: Indian Economic Development

Development Experience (1947-90) and Economic Reforms since 1991:- 12 Marks

• Indian Economy on the eve of Independence Notes
• Indian Economy (1950-90) Notes
• Economic Reforms since 1991 Notes

Current challenges facing Indian Economy – 10 Marks

• Poverty Class 12 Notes
• Human Capital Formation Class 12
• Rural Development Class 12 Notes
• Economics Class 12 Notes
• Business Studies Class 12 Notes
• Accountancy Class 12 Notes
• Economics Class 12 MCQs
• Business Studies Class 12 MCQs
• Accountancy Class 12 MCQs

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Class 11 Notes

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Class 12 MCQs

CBSE Class 12 Case Studies In Business Studies – Financial Management

FINANCIAL MANAGEMENT Financial Management: Definition Financial Management is concerned with optimal procurement as well as usage of finance.

Objective The prime objective of financial management is to maximise shareholder’s wealth by maximising the market price of a company’s shares.

Financial Decisions Involved in Financial Management

• Investment Decision
• Financing Decision
• Dividend Decision

Role of Financial Management

• To determine the capital requirements of business, both long-term and short-term.
• To determine the capital structure of the company and determine the sources from where required capital will be raised keeping in view the risk and return matrix.
• To decide about the allocation of funds into profitable avenues, keeping in view their safety as well.
• To decide about the appropriation of profits.
• To ensure efficient management of cash in order to ensure both liquidity and profitability.
• To exercise overall financial controls in order to promote safety, profitability and conservation of funds.

INVESTMENT DECISION

• It seeks to determine as to how the firm’s funds are invested in different assets
• It helps to evaluate new investment proposals and select the best option on the basis of associated risk and return.
• Investment decision can be long-term or short-term.
• A long-term investment decision is also called a Capital Budgeting decision.

Types of Investment Decision

• It refers to the amount of capital required to meet day- to-day running of business.
• It relates to decisions about cash, inventory and receivables.
• It affects both liquidity and profitability of business.
• It refers to the amount of capital required for investment in fixed assets or long term projects which will yield return and influence the earning capacity of business over a period of time.
• It affects the amount of assets, competitiveness and profitability of business.
• The expected cash flows from the proposed project should be carefully analysed.
• The expected rate of return should be carefully studied in terms of risk associated from the proposed project.
• Different types of ratio analysis should be done to evaluate the feasibility of the proposed project as compared to similar projects in the same industry.

FINANCING DECISION Financing Decision: Definition Financing decision relates to determining the amount of finance to be raised from different sources of finance.This decision determines the overall cost of capital and the financial risk of the enterprise. Types of Sources of Raising Finance

• Equity shares
• Preference shares
• Retained earnings
• Loan from bank or financial institutions
• Public deposit

Considerations Involved in the Issue of Debt

• Interest on borrowed funds has to be paid regardless of whether or not a business has made a profit. Likewise, borrowed funds have to be repaid ata fixed time.
• There is some amount of financial risk in debt financing.
• The cost of debt is less than equity as the degree of risk assumed by the investors is less and the amount of interest paid by the company is tax deductible.

Factors Affecting Financing Decision

• The source of finance which involves the least cost should be chosen.
• The risk involved in raising debt capital is higher than equity.
• The sources involving high flotation cost require special consideration.
• If the cash flow position of a business is good, it should opt for debt else equity.
• If the fixed operating cost ofa business is low, it should opt for debt else equity.
• The issue of equity capital dilutes the control of existing shareholders over business whereas financing through debt does not lead to any such effect
• If there is boom in capital market it is easy for the company to raise equity capital, else it may opt for debt.

Considerations Involved in the Issue of Equity

• Shareholders do not expect any commitment regarding the payment of returns or repayment of capital.
• The floatation cost on raising equity capital is high.
• The shareholders expect higher returns in return for assuming higher risks.

DIVIDEND DECISION Dividend Decision relates to disposal of profit by deciding the proportion of profit which is to be distributed among shareholders and the proportion of profit which is to be retained in the business for meeting the investment requirements.

Factors Affecting Dividend Decision

• If the earnings of the company are high, dividends are paid at a higher rate.
• If the earnings of a company are stable, it is likely to pay higher dividends.
• A company is more likely to maintain a stable dividend rate over a period of time,unless there is a significant change in its earnings.
• A company planning to pursue a growth opportunity is likely to pay lower dividends. The dividends are paid in cash, therefore if the cash flow of the company is good, it is likely to pay higher dividends.
• If the shareholders prefer regular income in form of dividends, the company is likely to maintain a dividend payout rate.
• If the tax rate is high, the company is likely to pay less dividend.
• If a company wants positive reactions at stock market, It Is likely to pay higher dividends.
• A large company can access funds easily from capital market as per its requirements, therefore, it is likely to retain lesser profits and is likely to pay higher dividends.
• The legal constraint should be considered at the time of dividend payment by a company.
• The contractual constraints may also affect the dividend payment by a company.

FINANCIAL PLANNING Financial Planning: Definition The process of estimating the funds requirement of a business and specifying the sources of funds is called financial planning. It basically involves preparation of a financial blueprint of an organisation’s future operations.

Twin Objectives of Financial Planning

• To ensure availability of funds as per the requirements of business.
• To see that the enterprise does not raise resources needlessly.

Importance of Financial Planning

• It ensures smooth running of a business enterprise by ensuring availability of funds at the right time.
• It helps in anticipating future requirements of funds and evading business shocks and surprises.
• It facilitates co-ordination among various departments of an enterprise, like marketing and production functions, through well-defined policies and procedures.
• It increases the efficiency of operations by curbing wastage of funds, duplication of efforts, and gaps in planning. .
• It helps to establish a link between the present and the future.
• It provides a continuous link between investment and financing decisions.
• It facilitates easy performance as evaluation standards are set in clear, specific and measurable terms.

CAPITAL STRUCTURE Capital Structure: Definition It refers to the mix between owners and borrowed funds.

Financial Risk: Definition It refers to a situation when a company is unable to meet its fixed financial charges like payment of interest on debt capital.

Trading on Equity: Definition It refers to the increase in the earnings per share by employing the sources of finance carrying fixed financial charges like debentures (interest is paid at a fixed rate) or preference shares (dividend is paid at fixed rate).

Financial Leverage: Definition The proportion of debt in the overall capital is called financial leverage. It is computed as D/E or D/D+E, where D is the Debt and E is the Equity.

FIXED CAPITAL Fixed Capital: Definition It refers to investment in long-term assets.

Importance of Management of Fixed Capital

• It affects the growth and profitability of busmess m future.
• It involves huge investment outlay in terms of investment in land, building, machinery etc.
• Its influences the overall level of business risk of the organisation.
• If these decisions are reversed they may lead to major losses.

WORKING CAPITAL Working Capital: Definition The funds needed to meet the day-today operations of the business is called working capital.

Factors Affecting the Choice of Capital Structure

13. Regulatory framework: The business will choose the option where it can easily fulfill the norms of the concerned regulator like a bank or SEBI. 14. Capital structure of other companies: The business must know what the industry norms are, whether they are following them or deviating from them and adequate justification must be there.

Factors Affecting the Working Capital Requirements of a Business Enterprise

LATEST CBSE QUESTIONS

Question 1. What is meant by ‘financial management’ ? (CBSE, Delhi 2017) Answer: Financial Management is concerned with optimal procurement as well as usage of finance.

Question 2. Somnath Ltd. is engaged in the business of export of garments. In the past, the performance of the company had been upto the expectations. In line with the latest technology, the company decided to upgrade its machinery. For this, the Finance Manager, Dalmia estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Dalmia therefore, began with the preparation of a sales forecast for the next four years. Fie also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds he is trying to find out alternative sources from outside. (CBSE, Delhi 2017) Identify the financial concept discussed in the above para. Also state the objectives to be achieved by the use of financial concept, so identified. Answer: Financial planning is the financial concept discussed in the above paragraph. The process of estimating the fund requirements of a business and specifying the sources of funds is called financial planning. It relates to the preparation of a financial blueprint of an organisation’s future operations. The objectives to be achieved by the use of financial concept are stated below:

• To ensure availability of funds whenever required which involves estimation of the funds required, the time at which these funds are to be made available and the sources of these funds.
• To see that the firm does not raise resources unnecessarily as excess funding is almost as bad as inadequate funding. Financial planning ensures that enough funds are available at right time.

Question 3. Explain briefly any four factors which affect the choice of capital structure of a company. (CBSE, Delhi 2017) Answer: The four factors which affect the choice of capital structure of a company are described below:

• Risk: Financial risk refers to a situation when a company is unable to meet its fixed financial charges. Financial risk of the company increases with the higher use of debt. This is because issue of debt involves fixed commitment in terms of payment of interest and repayment of capital.
• Flexibility: Too much dependence on debt reduces the firm’s ability to raise debt during unexpected situations. Therefore, it should maintain flexibility by not using debt to its full potential.
• Interest Coverage ratio (ICR): The interest coverage ratio refers to the number of times earnings before interest and taxes of a company covers the interest obligation. This may be calculated as follows: ICR = EBIT/Interest. If the ratio is higher, lower is the risk of company failing to meet its interest payment obligations hence debt may be issued or vice versa. But besides interest payment related repayment obligations should also be considered.
• Cash flow position: The issue of debt involves a fixed commitment in the form of payment of interest and repayment of capital. Therefore if the cash flow position of the company is weak it cannot meet the fixed obligations involved in issue of debt it is likely to issue equity or vice versa.

Question 4. Explain briefly any four factors that affect the working capital requirement of a company. (CBSE, Delhi 2017) Answer: The four factors that affect the working capital requirements of a company are explained below:

• Credit availed: In case the suppliers from whom the firm procures the raw material needed for production or finished goods follow a liberal credit policy, the business can be operated on minimum working capital or vice versa.
• Credit allowed: The credit terms may vary from firm to firm. However, if the level of competition is high or credit worthiness of its clients is good the firm is likely to follow a liberal credit policy and grant credit to its clients it results in higher amount of debtors, increasing the requirement of working capital or vice versa.
• Scale of operations: The amount of working capital required by a business varies directly in proportion to its scale of business. For organisations which operate on a higher scale of operation, the quantum of inventory, debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.
• Growth prospects: The business firms who wish to take advantage of a forthcoming business opportunity or plan to expand its operations will require higher amount of working capital so that is able to meet higher production and sales target whenever required or vice versa .

Question 5. Explain briefly any four factors that affect the fixed capital requirements of a company. (CBSE, Delhi 2017) Answer: The four factors that affect the fixed capital requirements of a company are explained below:

• Nature of business: The kind of activities a business is engaged in has an important bearing on its fixed capital requirements. On one hand a trading concern does not require to purchase plant and machinery etc. and needs lower investment in fixed assets. Whereas on the other hand a manufacturing organisation is likely to invest heavily in fixed assets like land, building, machinery and needs more fixed capital.
• Scale of operations: The amount of fixed capital required by a business varies directly in proportion to its scale of businessA larger organisation operating at a higher scale needs bigger plant, more space etc. and therefore, requires higher investment in fixed assets when compared with the small organisation.
• Diversification: If a business enterprise plans to diversify into new product lines, its requirement of fixed capital will increase as compared to an organisation which does not have any such plans.
• Growth prospects: If a business enterprise plans to expand its current business operations in the anticipation of higher demand, its requirement of fixed capital will be more as compared to an organisation which doesn’t plan to persue any such plans.

Question 6. What is meant by ‘Capital Structure’ ? (CBSE, OD 2017) Answer: Capital structure refers to the mix between owned funds and borrowed funds.

Question 7. Ramnath Ltd. is dealing in import of organic food items in bulk. The company sells the items in smaller quantities in attractive packages. Performance of the company has been up to the expectations in the past. Keeping up with the latest packaging technology, the company decided to upgrade its machinery. For this, the Finance Manager of the company, Mr. Vikrant Dhull, estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Therefore, Mr. Vikrant Dhull began with the preparation of a sales forecast for the next four years. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources. For the remaining funds he is trying to find out alternative sources. Identify the financial concept discussed in the above paragraph. Also, state any two points of importance of the financial concept, so identified. (CBSE, OD 2017) Answer:

• Financial planning is the financial concept discussed in the above paragraph. The process of estimating the fund requirements of a business and specifying the sources of funds is called financial planning. It relates to the preparation of a financial blueprint of an organisation’s future operations.
• It helps in anticipating future requirements of a funds and evading business shocks and surprises .

Question 8. When is financial leverage favourable? (CBSE, Sample Paper 2017) Answer: Financial leverage affects the profitability of a business and it is said to be favourable when return on investment ( ROI) is higher than cost of Debt.

Question 9. “A business that doesn’t grow dies”, says Mr. Shah, the owner of Shah Marble Ltd. with glorious 36 months of its grand success having a capital base of RS.80 crores. Within a short span of time, the company could generate cash flow which not only covered fixed cash payment obligations but also create sufficient buffer. The company is on the growth path and a new breed of consumers is eager to buy the Italian marble sold by Shah Marble Ltd. To meet the increasing demand, Mr. Shah decided to expand his business by acquiring a mine. This required an investment of RS.120 crores. To seek advice in this matter, he called his financial advisor Mr. Seth who advised him about the judicious mix of equity (40%) and Debt (60%). Mr. Seth also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to equity shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with Mr. Seth, Mr. Shah decided to raise funds from a financial institution.

• Identify and explain the concept of Financial Management as advised by Mr. Seth in the above situation.
• State the four factors affecting the concept as identified in part (1) above which have been discussed between Mr. Shah and Mr. Seth. (CBSE,Sample Paper 2017)
• Capital structure is the concept of Financial Management as advised by Mr. Seth in the above situation. Capital structure refers to the mix between owners funds and borrowed funds.
• Cashflow position: The issue of debt capital involves a fixed burden on the company in the form of payment of interest and repayment of capital. Therefore if the cash flow position of a company is good it may issue debt else equity to raise the required amount of capital.
• Risk Consideration: Financial risk refers to a situation when a company is unable to meet its fixed financial charges. Financial risk of the company increases with the higher use of debt. This is because issue of debt involves fixed commitment in terms of payment of interest and repayment of capital.
• Tax rate: Considering the fact that amount of interest paid is a deductible expense, cost of debt is affected by the tax rate. If for example a firm is borrowing @ 10% and the tax rate is 30%, the after tax cost of debt is only 7%. Therefore, when the tax rate is higher it makes debt relatively cheaper and increases its attraction vis-a-vis equity.
• Control: The issue of debentures doesn’t affect the control of the equity shareholders over the business as the debenture holders do not have the right to participate in the management of the business.

Question 10. Shalini, after acquiring a degree in Hotel Management and Business Administration, took over her family food processing company of manufacturing pickles, jams and squashes. The business had been established by her great grandmother and was doing reasonably well. However, the fixed operating costs of the business were high and the cash flow position was weak. She wanted to undertake modernisation of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately ? 50 lakh would be required for undertaking the modernisation and expansion programme. He also informed her that the stock market was going through a bullish phase.

• Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernisation and expansion of her food processing business. Give one reason in support of your answer.
• Explain any two other factors, apart from those stated in the above situation, which Shalini should keep in mind while taking this decision. (CBSE, Sample Paper 2016)
• Shalini should not choose debt capital for financing the modernisation and expansion of her food processing business because the fixed operating cost of the company is high. It cannot take the additional burden of fixed commitments in terms of payment of interest and repayment of capital by issuing debt.

Question 11. Radhika and Vani who are young fashion designers, left their job vyith a famous fashion designer chain to set-up a company ‘Fashionate Pvt. Ltd.’ They decided to run a boutique during the day and coaching classes for the entrance examination of National Institute of Fashion Designing in the evening. For the coaching centre, they hired the first floor of a nearby building. Their major expense was the money spent on photocopying of notes for their students. They thought of buying a photocopier knowing fully that their scale of operations was not sufficient to make full use of photocopier. In the basement of the building of Fashionate Pvt. Ltd, Praveen and Ramesh were carrying on a printing and stationery business in the name of ‘Neo Prints Pvt. Ltd.’ Radhika approached Praveen with the proposal to buy a photocopier jointly which could be used by both of them without making separate investment. Praveen agreed to this. Identify the factor affecting the fixed capital requirements of Fashionate Pvt. Ltd. (CBSE, Delhi 2016) Answer: The factor affecting the fixed capital requirement of Fashionable Pvt. Ltd. is the level of collaboration. This kind of arrangement of using the resources jointly helps to reduce the fixed capital requirements of the business firms.

Question 12. Kay Ltd. is a company manufacturing textiles. It has a share capital of ? 60 lakhs. In the previous year, its earning per share was ? 0.50. For diversification, the company requires an additional capital of ? 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the year, the company earned a profit of ? 8 lakhs on the capital employed. It paid tax @ 40%.

• State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
• Also state any three factors that favour the issue of debentures by the company as part of its capital structure. (CBSE, OD 2016)

OR Vivo Ltd. is a company manufacturing textiles. It has a share capital of Rs. 60 lakhs. The earning per share in the previous year was Rs. 0.50. For diversification, the company requires an additional capital of Rs. 40 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year, the company earned a profit of Rs. 8 lakhs on the capital employed. It paid tax @ 40%.

• State whether the shareholders gained a lost, in respect of earning per share on diversification. Show your calculations clearly.
• Also, state any three factors that favour the issue of debentures by the company as part of its capital structure. (CBSE, Delhi 2016)

*0.50 x 6,00,000 = 3,00,000 Consequently EBT/EBIT in situation 1 = Rs. 5,00,000 Thus, on diversification, the earning per share fell down from Rs. 0.50 to Rs. 0.40.

• Tax deductibility: Debt is considered to be a relatively cheaper source of finance as the amount of interest paid on debt is treated as a tax deductible expense.
• Flotation cost: The money spent by the company on raising capital through debentures is less than that spent on equity.

Question 13. Rizul Bhattacharya, after leaving his job, wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing mobile-phones with some unique features. Rizul Bhattacharya felt that mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore, he convinced his son to start a furniture business. Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones. (CBSE, OD 2016) Answer: The factor affecting the fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones is technological upgradation.

Question 14. Tata International Ltd. earned a net profit of Rs. 50 crores. Ankit, the finance manager of Tata International Ltd. wants to decide how to appropriate these profits. Discuss any five factors which will help him in taking this decision. (CBSE, Sample Paper, 2015) Answer: The five factors which will help Ankit, in taking the dividend decision are described below:

• Earnings: Since the dividends are paid out of current and past earnings, there is a direct relationship between the amount of earnings of the company and the rate at which it declares dividend. If the earnings of the company are high, it may declare a higher dividend or vice-versa.
• Cash flow position: Since the dividends are paid in cash, if the cash flow position of the company is good it may declare higher dividend or vice-versa.
• Access to capital market: If the company enjoys an easy access to capital market because of its credit worthiness. It does not feel the need to depend entirely on retained earnings to meet its financial needs. Hence, it may declare higher dividend or vice-versa.
• Growth prospects: If the company has any forthcoming investment opportunities, it may like to retain profits to finance its expansion projects. This is because retained profits is considered to be the cheapest source of finance as it doesn’t involve any explicit costs. Hence, it may declare lower dividend or vice-versa.
• Preferences of the shareholders: The companies paying stable dividends are always preferred by small investors primarily if they want regular income in the form of ‘stable returns’ from their investments. Large shareholders may be willing to forgo their present dividend in pursuit of higher profits in future. Therefore, the preferences of the shareholders must be taken into consideration.

Question 15. ‘Abhishek Ltd’ is manufacturing cotton clothes. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of Rs. 50 lakhs from ICICI Bank and is bound by certain restrictions on the payment of dividend according to the terms of the loan agreement. The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion, identify and explain any four such factors. (CBSE, 2015) Answer: The five factors which Ankit has to consider before taking dividend decisions are:

• Growth Opportunities: Financial needs of a firm are directly related to the investment opportunities available to it. If a firm has abundant profitable investment opportunities, it will adopt a policy of distributing lower dividends. It would like to retain a large part of its earnings because it can reinvest them at a higher rate.
• Stability of Dividends: Investors always prefer a stable dividend policy. They expect to get a fixed amount as dividends which should increase gradually over the years.
• Legal Restrictions: A firm’s dividend policy has to be formulated within the legal provisions and restrictions of the Indian Companies Act.
• Restrictions in Loan Agreements: Lenders, mostly financial institutions, put certain restrictions on the payment of dividends to safeguard their interests.
• Liquidity: The cash position is a significant factor in determining the size of dividends. Higher the cash and overall liquidity position of a firm, higher will be its ability to pay dividends.

Question 16. Amit is running an ‘advertising agency’ and earning a lot by providing this service to big industries State whether the working capital requirement of the firm will be ‘less’ or ‘more’. Give reason in support of your anser. (CBSE, Sample Paper 2014-15) Answer: The working capital requirements of Amit will be relatively less as he is running an advertising agency, wherein there is no need to maintain inventory.

Question 17. Yogesh, a businessman, is engaged in the purchase and sale of ice-creams. Identify his working capital requirements by giving reasons to support your answer. Now, he is keen to start his own ice-cream factory. Explain any two factors that will affect his fixed capital requirements. (CBSE, OD 2012) Answer:

• The working capital requirements of Yogesh will be less as he is engaged in trading business.
• Level of collaboration: If Yogesh gets an opportunity to set up his factory in collaboration with another enterprise, his fixed capital requirements will reduce considerably else his fixed capital requirements will be more.
• Financial alternatives available: If Yogesh is able to get the place to start the factory and machinery on lease, his fixed capital requirements will reduce considerably. Whereas if he decides to purchase them, his fixed capital requirements will be more.

Question 18. Amar is doing his transport business in Delhi. His buses are generally used for tourists going to Jaipur and Agra. Identify the working capital requirements of Amar. Give reasons to support your answer. Further, Amar wants to expand and diversify his transport business. Explain any two factors that will affect his fixed capital requirements. (CBSE, OD, 2012) Answer:

• The working capital requirements of Amar will be relatively less as he is engaged in prtividing transport services wherein there is no need to maintain inventory.
• Diversification: If a business enterprise plans to diversify into new product lines, its requirement of fixed capital will increase.
• Growth prospects: If a business enterprise plans to expand its current business operations in the anticipation of higher demand, consequently, more fixed capital will be needed by it.

Question 19. Manish is engaged in the business of manufacturing garments. Generally, he used to sell his garments in Delhi. Identify the working capital requirements of Manish giving reason in support of your answer. Further, Manish wants to expand and diversify his garments business. Explain any two factors that will affect his fixed capital requirements. (CBSE, Delhi 2012) Answer:

• The working capital requirements of Manish will be relatively more as he is engaged in the business of manufacturing garments. This is because the length of production cycle is longer i.e. it takes time to convert raw material into finished goods.
• Scale of Operations: The amount of fixed capital required by a business enterprise is directly proportionate to its scale of operations. Therefore, if Manish plans to do business on a large scale, his fixed capital requirements will be more or vice versa.
• Technological Upgradation: If Manish plans to use machines of latest technology in manufacturing garments, his fixed capital requirements will be more as replacement of obsolete machines will require huge financial outlay.

Question 20. Harish is engaged in the warehousing business and his warehouses are generally used by businessmen to store fruits. Identify the working capital requirements of Harish giving reasons in support of your answer. Further, Harish wants to expand and diversify his warehousing business. Explain any two factors that will affect his fixed capital requirements. (CBSE, Delhi 2012) Answer:

• The working capital requirements of Harish will be relatively less as he is engaged in providing warehousing services wherein there is no need to maintain inventory.
• Scale of Operations: The amount of fixed capital required by a business enterprise is directly proportionate to its scale of operations. Therefore, if Harish plans to do business on a large scale his fixed capital requirements will be more or vice versa.

ADDITIONAL QUESTIONS

Question 1. Arun is a successful businessman in the paper industry. During his recent visit to his friend’s place in Mysore, he was fascinated by the exclusive variety of incense sticks available there. His friend tells him that Mysore region is known as a pioneer in the activity of Agarbathi manufacturing because it has a natural reserve of forest products especially Sandalwood to provide for the base material used in production. Moreover, the suppliers of other types of raw material needed for production follow a liberal credit policy and the time required to manufacture incense sticks is relatively less. Considering the various factors, Arun decides to venture into this line of business by setting up a manufacturing unit in Mysore. In context of the above case:

• Identify and explain the type of financial decision taken by Arun.
• Identify the three factors mentioned in the paragraph which are likely to affect the working capital requirements of his business.
• Investment decision has been taken by Arun. Investment decision seeks to determine as to how the firm’s funds are invested in different assets. It helps to evaluate new investment proposals and select the best option on the basis of associated risk and return. Investment decision can be long term or short-term. A long-term investment decision is also called a Capital Budgeting decision
• Availability of raw material: As there is easy availability of Sandalwood which is used as the base material for production, the working capital requirements of his business will be less as there is no need to stock the raw materials.
• Production cycle: The production cycle is shorter and less time is required to manu¬facture incense sticks. Thus, the working capital requirements of his business will be low.
• Credit availed: Due to the fact that the suppliers of other types of raw material needed for production follow a liberal credit policy, the business can be operated on minimum working capital.

Question 2. ‘Adwitiya’ is a company enjoying market leadership in the food brands segment. It’s portfolio includes three categories in the Foods business namely Snack Foods, Juices and Confectionery. Keeping in line with the growing demand for packaged food it now plans to introduce Ready- To-Eat Foods. Therefore, the company has planned to undertake investments of nearly Rs. 450 crores for its new line of business. As per the current financial report, the interest coverage ratio of the company and return on investment is higher. Moreover, the corporate tax rate is high. In context of the above case:

• As a financial manager of the company, which source of finance will you opt for debt or equity, to raise the required amount of capital? Explain by giving any two suitable reasons in support of. your answer.
• Why are the shareholder’s of the company like to gain from the issue of debt by the company?
• Interest coverage ratio: The interest coverage ratio of the company is high so it can easily meet its fixed commitment of payment of interest and repayment of capital.
• Tax rate: The tax rate is high which makes debt relatively cheaper as the amount of interest paid on debt is treated as a tax deductible expense.
• The shareholders of the company are likely to gain from the issue 6f debt by the company because the return on investment is higher. It helpS a company to take advantage of trading on equity to increase the earnings per share.

Question 3. Computer Tech Ltd.,is one of the leading information technology outsourcing services providers in India. The company provides business consultancy and outsourcing services to its clients. Over the past five years the company has been paying dividends at high rate to its shareholders. However, this year, although the earnings of the company are high, its liquidity position is not so good. Moreover, the company plans to undertake new ventures in order to expand its business. In context of the above case: .

• Give any three reasons because of which you think Computer Tech Ltd. has been paying dividends at high rate to its shareholders over the past five years.
• Comment upon the likely dividend policy of the company this year by stating any two reasons in support of your answer.
• Earnings: The earnings of the company have been high. Since the dividends are paid out of current and past earnings, there is a direct relationship between the amount of earnings of the company and the rate at which it declares dividend .
• Cashflow position: The cash flow position of the company must have been good as in order to pay high dividends, more cash is required.
• Access to capital market: Because of its credit worthiness, the company enjoyed an easy access to capital market. Therefore, it did not feel the need to depend entirely on retained earnings to meet its financial needs. Hence, it declared higher dividends in past.
• The cash flow position of the company is not good and dividends are paid in cash.
• The company may like to retain profits to finance its expansion projects. Retained profits do not involve any explicit cost and are considered to be the cheapest source of finance.

Question 4. Bhuvan inherited a very large area of agricultural land in Haryana after the death of his grandfather. He plans to sell this piece of land and use the money to set up a small scale paper factory to manufacture all kinds of stationary items from recycled paper. Being an amateur in business, he decides to consult his friend Subhash who works in a financial consultancy firm. Subhash helps him to prepare a blue print of his future business operations on the basis of sales forecast in next five years. Based on these estimates, he helps Bhuvan to assess the fixed and working capital requirements of business. In context of the above case:

• Identify the type of financial service that Subhash has offered to Bhuvan.
• Briefly state any four points highlighting the importance of the type of financial service identified in part (1).
• Financial planning is the type of financial service that Subhash has offered to Bhuvan.
• It helps in anticipating future requirements of a funds and evading business shocks and surprises.
• It facilitates co-ordination among various departments of an enterprise like marketing and production functions, through well-defined policies and procedures.
• It increases the efficiency of operations by curbing wastage of funds, duplication of efforts, and gaps in planning.

Question 5. ‘Madhur Milan’ is a popular online matrimonial portal. It seeks to provide personalized match making service. The company has 80 offices in India, and is now planning to open offices in Singapore, Dubai and Canada to cater to its customers beyond the country. The company has decided to opt for the sources of equity capital to raise the required amount of capital. In context of the above case:

• Identify and explain the type of risk which increases with the higher use of debt.
• Explain briefly any four factors because of which you think the company has decided to opt for equity capital.
• Financial risk of the company increases with the higher use of debt. This is because issue of debt involves fixed commitment in terms of payment of interest and repayment of capital. Financial risk refers to a situation when a company is unable to meet its fixed financial charges.
• Capital market conditions: The state of capital market is bullish, so people are likely to invest more in equity.
• Fixed operating cost: The fixed operating cost of company is high so it cannot take the further burden fixed commitment in terms of payment of interest and repayment of capital by issuing debt.
• Cashflow position: The cash flow position of the company is weak so it cannot meet the fixed obligations involved in issue of debt.
• Risk: The proportion of debt in its capital structure is already high so it cannot issue further debt, thereby endangering the solvency of the company.

Question 6. Wooden Peripheral Pvt. Ltd. is counted among the top furniture companies in Delhi. It is known for offering innovative designs and high quality furniture at affordable prices. The company deals in a wide product range of home and office furniture through its eight showrooms in Delhi. The company is now planning to open five new showrooms each in Mumbai and Bangalore. In Bangalore it intends to take the space for the showrooms on lease whereas for opening showrooms in Mumbai, it has collaborated with a popular home furnishing brand, ‘Creations.’

• Identify the factors mentioned in the paragraph which are likely to affect the fixed capital requirements of the business for opening new showrooms both in Bangalore and Mumbai separately,
• “With an increase in the investment in fixed assets, there is a commensurate increase in the working capital requirement.” Explain the statement with reference to the case above.
• The fixed capital requirements of Wooden Peripheral Pvt. Ltd. for opening new showrooms in Bangalore will be relatively less as its taking space on lease, so only rentals have to be paid. Similarly, its fixed capital requirement for opening showrooms in Mumbai will be reduced as its going to share the costs with another company through collaboration.
• It’s true that,” With an increase in the investment in fixed assets, there is a commen¬surate increase in the working capital requirement.” Like in the above case, Wooden Peripheral Pvt. Ltd. is planning to invest in new showrooms. Consequently, its requirement of working capital will increase as it will need more money to stock goods, pay electricity bills and salaries to staff. Also, it intends to take the space for the showrooms in Mumbai on lease so it will have to pay rentals.

Question 7. ‘Apparels’ is India’s second largest manufacturer of branded Lifestyle apparel. The company now plans to diversify into personal care segment by launching perfumes, hair care and skin are products. Moreover, it is planning to open ten exclusive retail outlets in various cities across the country in next two years. In context of the above case:

• Identify the two factors affecting the fixed capital needs of the company by quoting lines from the paragraph.
• Why is the management of fixed capital considered to be an important for a business?
• It affects the growth and profitability of business in future.
• It influences the overall level of business risk of the organisation.
• If these decisions are reversed, they may lead to major losses.

Question 8. After persuing a course in event management, Kajal and her brother Kamal promoted an event management company under the name Khushi Entertainment Private Limited. They strive together as dedicated and dynamic professionals managing different kinds of formal and informal events across all major cities in India and abroad. They design the event idea and co-ordinate the different aspects of the event to make it a grand success. As a policy, they take fifty percent of the payment as advance from the client before the start of an event and receive the balance charges after the successful completion of the event. In context of the above case:

• Comment upon the working capital needs of the company keeping in mind its nature of business.
• Identify the other factor mentioned in the paragraph which is likely to affect the working capital requirement of their business.
• The working capital requirements of Khushi Entertainment Private Limited will be relatively less as they are engaged in providing event management services, wherein there is no need to maintain inventory
• The other factor mentioned in the paragraph which is likely to affect the working capital requirement of their business is ‘Credit availed.’ Since as a policy, they take fifty percent of the payment as advance from the client before the start of an event, their requirement of working capital is reduced.

Question 9. Storage Solution Ltd. is a large warehousing network company operating. through a chain of warehouses at 40 different locations across India. The company now intends to undertake computerisation of its owned ware houses as it seeks to provide better value added and cost effective solutions for scientific storage and preservation services to the market participants dealing in agricultural products including farmers, traders, etc. In context of the above case:

• How is the decision to undertake computerisation of owned warehouses likely to affect the fixed capital requirements of its business?
• Name any two sources that company may use to finance the implementation of this plan.
• The decision to undertake computerisation of owned warehouses will increase the fixed capital requirements of its business both in present and future as after sometime, the technology being used will become obsolete and need upgradation.
• The company may use retained earnings and take loans from financial institutions to implement this plan.

Question 10. Visions Ltd. is a renowned multiplex operator in India. Presently, it owns 234 screens in 45 properties at 20 locations in the country. Considering the fact that the there is a growing trend among the people to spend more of their disposable income on entertainment, two years back the company had decided to add more screens to its existing set up and increase facilities to enhance leisure, food chains etc. It had then floated an initial public offer of equity shares in order to raise the desired capital. The issue was fully subscribed and paid. Over the years, the sales and profits of the company have increased tremendously and it has been declaring higher dividend and the market price of its shares has increased manifolds. In context of the above case:

• Name the different kinds of financial decisions taken by the company by quoting lines from the paragraph.
• Do you think the financial management team of the company has been able to achieve its prime objective? Why or why not? Give a reason in support of your answer.
• Investment decision: “Two years back the company had decided to add more screens to its existing set up and increase facilities to enhance leisure, food chains etc.”
• Financing decision: “It had then floated an initial public offer of equity shares in order to raise the desired capital.”
• Dividend decision: “Over the years, the sales and profits of the company have increased tremendously and it has been declaring higher dividend.”
• Yes, the financial management team of the company has been able to achieve its prime objective i.e. wealth maximisation of the shareholders by maximising the market price of the shares of the company.

Question 11. After completing his education in travel and tourism, Arjun started Travel Angels Pvt. Ltd. along with his twin brother Bheem. Their company seeks to provide travel solutions to its clients like ticket booking for airways, railways and road ways, hotel booking, insurance etc. Although the business is doing well both of them have realised that they are not good in managing finance, and feel confused and frustrated sometimes due to financial crises that may suddenly arise. In order to avoid such situations in the future, they hire Nakul and Sehdev as financial managers, who have done a degree certification course in financial management. In context of the above

• Give the meaning of financial management.
• Outline the role of Nakul and Sehdev as the financial management team of the Travel Angels Pvt. Ltd. by giving any four suitable points.
• Financial Management is concerned with optimal procurement as well as usage of finance.
• To determine the capital requirements of business both long-term and short term.
• To exercise overall financial control in order to promote s’afety, profitability and conservation of funds.

Question 12. Wireworks Ltd. is a company manufacturing different kinds of wires. Despite fierce competition in the industry, it has been able to maintain stability in its earnings and as a policy, uses 30% of its profits to distribute dividends. The small investors are very happy with the company as it has been declaring high and stable dividend over past five years. In context of the above case:

• State any one reason because of which the company has been able to declare high dividend by quoting line from the paragraph.
• Why do you think small investors are happy with the company for declaring stable dividend?
• Stability in earnings: The company has been able to declare high dividend because its earnings are stable. “Despite fierce competition in the industry, it has been able to maintain stability in its earnings.”
• The small investors are happy with the company for declaring stable dividend as they enjoy a regular income on their investment.

Question 13. Manoj is a renowned businessman involved in export business of leather goods. As a responsible citizen, he chooses to use jute bags for packaging instead of plastic bags. Moreover, on the advice of his friends, he decides to use jute for manufacturing aesthetic handicrafts, keeping in view the growing demand for natural goods. In order to implement his plan, after conducting a feasibility study, he decides to set up a separate manufacturing unit for producing varied jute products. In context of the above case:

• Identify the type of investment decision taken by Manoj by deciding to set up a separate manufacturing unit for producing jute products.
• State any two factors that he is likely to consider while taking this decision
• Capital budgeting decision has been taken by Manoj.
• Cash inflows: The expected cash inflows from the proposed projects should be carefully analysed and the project indicating higher cash inflows should be selected.
• Rate of return: The expected rate of return should be carefully studied in terms of risk associated from the proposed project. If two projects are likely to offer the same rate of return, the project involving lesser risk should be selected.

Question 14. Khoobsurat Pvt. Ltd. is the largest hair salon chain in the Delhi, with over a franchise of 200 salons. The company is now planning to set up a manufacturing unit in Faribadad for production of various kinds of beauty products under its own brand name. In context of the above case:

• Comment upon the fixed capital needs of the company.
• How will the requirement of fixed capital of the company change when it implements its plan to set up a manufacturing unit?
• The fixed capital needs of the company are low as its salons have been promoted in the form of franchises.
• The requirement of fixed capital of the company will increase when it implements its plan to set up a manufacturing unit because it will have to make investments in buying land, building, machinery etc.

Question 15. Well-being Ltd. is a company engaged in production of organic foods. Presently, it sells its products through indirect channels of distribution. But, considering the sudden surge in the demand for organic products, the company is now inclined to start its online portal for direct marketing. The financial managers of the company are planning to use debt in order to take advantage of trading on equity. In order to finance its expansion plans, it is planning to ‘ raise a debt capital of Rs. 40 lakhs through a loan @ 10% from an industrial bank. The present capital base of the company comprises of Rs. 9 lakh equity shares of Rs. 10 each. The rate of tax is 30%. In the context of the above case:

• What are the two conditions necessary for taking advantage of trading on equity?
• Assuming the expected rate of return on investment to be same as it was for the current year i.e. 15% , do you think the financial managers will be able to meet their goal. Show your workings clearly.
• The rate of return on investment should be more than the rate of interest.
• The amount of interest paid should be tax deductible.

Yes, the financial managers will be able to meet their goal as the projected EPS, with the issue of debt, is higher than the present EPS.

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• CBSE Macro Economics Chapter 3 - Money and Banking Class 12 Notes
• Revision Notes

Revision Notes for CBSE Class 12 Macro Economics Chapter 3 - Free PDF Download

In this article, you will find a picturesque description of Class 12 Macroeconomics Chapter 3 Notes in a precise form. Macroeconomics Class 12 Chapter 3 Notes by Vedantu deals with one of the most important chapters of Macroeconomics namely Money and Banking. Class 12 Macroeconomics Money and Banking Notes PDF are to be followed thoroughly which will definitely guide you towards a compact preparation. If scoring high in the board exam and getting to know the chapter wholeheartedly are your targets, scroll down. You can also download the Class 12 Chapter 3 PDF to study and revise at your own pace.

Download CBSE Class 12 Macro Economics Revision Notes 2024-25 PDF

Also, check CBSE Class 12 Macro Economics revision notes for all chapters:

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Access Class 12 Macro Economics Chapter 3 - Money and Banking Notes

Money: Money is the most often used means of exchange. It is an economic unit that serves as a universally accepted means of exchange in a transactional economy. Money offers the benefit of lowering transaction costs, particularly the double coincidence of wants. There can be no exchange of commodities and thus no role for money in an economy consisting of only one person.

Barter Exchange: It is a trade in which one product or service is exchanged for another. It is the oldest form of commerce. Individuals and businesses exchange goods and services based on equivalent prices and good estimates. Individuals and businesses barter goods and services with one another based on similar pricing and quality assessments. Bartering, on a larger scale, can result in the most efficient use of resources by exchanging items in quantities that have equivalent values. Bartering can also assist economies in reaching equilibrium, which happens when supply and demand are equal.

Disadvantages of Barter Exchange:

1. A lack of a standardised means of measuring value.

2. There is a lack of desire for duplication.

3. A scarcity of common value measures.

4. Inadequate store of value.

5. Deferred payment standards are lacking.

6. Inability to divide.

Functions of Money: The functions of money are broadly classified as

1. Primary functions.

i. A mode of exchange.

ii. A common measure of value or a common unit of value.

2. Secondary functions: 

i. Value storage.

ii. Value transfer.

iii. Deferred payment standard.

Demand of Money: It is referred to as an individual's liquidity preference, which is the decision of holding money in liquid form, i.e., cash, in order to earn interest or as a precaution. Money demand is impacted by a number of factors such as inflation, income, interest rates, and future uncertainty. The two important motives for the demand of money: transaction, and speculative motives, are commonly used to describe how these elements affect money demand.

i. Transaction Motive: The drive to hold cash amounts is referred to as the transaction's motive. The fact that most transactions involve an exchange of money is the transaction motive for demanding money. Money will be demanded because it is necessary to have money available for transactions. The aggregate quantity of transactions in an economy tends to increase as income grows. As a result, as income or GDP rises, so does the demand for money in transactions.

ii. Speculative Motive: It refers to funds retained by investors in order to capitalise on potential investment opportunities in the economy. When retaining money is thought to be less hazardous than lending it or investing it in another asset, the speculative motive for demanding money emerges.

Aggregate Money Demand: In an economy, the entire demand for money is made up of transaction demand and speculative demand. The former is proportionate to real GDP and the price level, whereas the latter is inversely related to the market interest rate.

$\mathrm{M}^{\mathrm{d}}=\mathrm{M}_{\mathrm{T}}^{\mathrm{d}}+\mathrm{M}_{\mathrm{s}}^{\mathrm{d}}$

Where, $\mathrm{M}_{\mathrm{d}} =\text { Money Demand }$

$\mathrm{M}_{\mathrm{T}}^{\mathrm{d}} =\text { Transaction Demand }$

$\mathrm{M}_{\mathrm{S}}^{\mathrm{d}} =\text { Speculative Money Demand }$

Fiat money: It is the currency that a government declares to be legal tender but is not backed by a physical asset. The value of fiat money is calculated by the link between supply and demand rather than the worth of the commodity used to make the money.

Supply of Money: It refers to the total money held by the public at a particular point in time in an economy. The supply of money does not include the cash balances held by the national and state governments, as well as the stock of money held by the country's banking system, because these are not in active circulation in the country.

Measures of Money Supply: 

i. $\mathrm{M}_{1}$: It is the first and basic measure of the money supply. It includes currency held by the public, demand deposits of commercial banks, and other deposits with the Reserve Bank of India (RBI).

$\mathrm{M}_{1} = \text { Currency and coins with public( C) + Demand deposits of the public with the banks(DD) } +\text { Other deposits (OD) }$

ii. $\mathrm{M}_{2}$:  It is also known as narrow money along with M1. It includes Savings deposits with Post Office saving banks.

$\mathrm{M}_{2}=\mathrm{M}_{1}+\text { Savings deposits with Post Office saving banks }$

iii. $\mathrm{M}_{3}$:  It also includes time deposits with a commercial bank and is known as broad money.

$\mathrm{M}_{3}=\mathrm{M}_{1}+\text { Net time deposits with commercial banks }$

iv. $\mathrm{M}_{4}$:  It includes the total deposits excluding National Saving Certificates and is also known as broad money along with M 3 .

$\left.\mathrm{M}_{4}=\mathrm{M}_{3}+\text { Total post office deposits excluding National Saving Certificates( } \mathrm{NSC}\right)$

Banking Systems:

1. Commercial Bank: A commercial bank is a type of financial organisation that handles all transactions involving the deposit and withdrawal of money for the public, as well as the provision of loans for investment purposes and other similar activities. These banks are profit-making enterprises that conduct business only for the purpose of making a profit. State Bank of India, Canara Bank are some examples. 

2. Central Bank: In the banking system, the central bank is recognised as the highest financial institution. It is seen as an essential component of a country's economic and financial system. The central bank is an independent authority in charge of supervising, regulating, and stabilising the country's monetary and banking structures.

Money Creation by Banks: If the value of any of its constituents, such as CU, DD, or Time Deposits, changes, the money supply will alter. The public's preference for maintaining cash balances as opposed to bank deposits has an impact on the money supply. The following major ratios summarise these influences on the money supply.

1. The Currency Deposit Ratio: The currency deposit ratio (cdr) depicts the amount of currency held by individuals as a percentage of total deposits. For instance, cdr rises over the holiday season as people convert deposits to cash balances in order to cover extra expenses.

cdr = CU/DD

2. The Reserve Deposit Ratio: Banks keep a portion of the money customers keep in their bank accounts as reserve money and lend the rest to various investment initiatives. Reserve money is made up of two components: vault cash in banks and commercial bank deposits with the RBI. Banks use this reserve to meet account holders’ need for cash. The reserve deposit ratio (rdr) is the percentage of total deposits that commercial banks retain as reserves. 

Measures to bring forth a healthy Reserve deposit ratio:

I. Qualitative Measures

1. Cash Reserve Ratio (CRR): It is a portion of a bank's total deposits that the Reserve Bank of India requires to be kept with the latter as liquid cash reserves. When computing the base rate, one of the reference rates is the cash reserve ratio. The base rate is the lowest lending rate at which a bank is not permitted to lend money. The Reserve Bank of India sets the base rate.The rate is fixed, ensuring openness in the credit market when it comes to borrowing and lending.

2. Statutory Liquidity Ratio (SLR): It is essentially the reserve requirement that banks must maintain before extending credit to customers. Aside from the Cash Reserve Ratio (CRR), banks are required to keep a certain percentage of their net demand and time liabilities in liquid assets such as cash, gold, and unencumbered securities. Among other things, the statutory liquidity rate applies to dated securities issued under the market borrowing programme, treasury bills, and market stabilisation schemes (MSS). Banks must report their SLR maintenance to the RBI every other Friday, and penalties must be paid if SLR is not maintained as required.

3. Bank Rate: A bank rate is the interest rate charged by a nation’s central bank to its domestic banks in order for them to borrow money. The interest rates charged by central banks are meant to stabilise the economy. The lending rates of commercial banks are affected by bank rates. Higher bank rates will result in higher bank lending rates. The central bank might raise the bank rate in order to reduce liquidity, and vice versa.

4. High Powered Money: It is the money created by the RBI and the government, in which the public holds the currency, and the banks hold the cash reserves. It differs from money for that money consists of demand deposits, whereas cash reserves serve as a foundation for creating demand deposits. High-powered money is the sum of commercial bank reserves and currency, which denotes the notes and coins held by the general public. The increase of bank deposits and the creation of a money supply are both based on high-powered money.

II. Qualitative Measures

1. Open Market Operation: It refers to the central bank's selling and purchase of securities on the open market to and from commercial banks or the general public. The open market operation is one of the quantitative techniques used by the Reserve Bank of India to smooth out liquidity conditions throughout the year and reduce the impact on interest and inflation rates. Changes in the Cash Reserve Ratio (CRR), bank rate, or open market operations are all examples of quantitative measures used to limit the size of the money supply.

2. Bank Rate Policy: The term "bank rate policy" refers to the central bank's manipulation of the discount rate in order to influence the economy's credit condition. The bank rate policy is based on the idea that changes in the bank rate are usually followed by comparable changes in the money market rate, making credit more expensive or less expensive and impacting demand and supply.

3. Sterilisation by RBI: Sterilising is the RBI's market-based technique for neutralising a portion or all of the monetary impact of foreign inflows. Sterilising is the RBI's market-based technique for neutralising a portion or all of the monetary impact of foreign inflows. The sterilising procedure is used to alter the value of one local currency compared to another and is launched in the foreign exchange market. Sterilization in the traditional sense entails central banks buying and selling on open markets.

Class 12 Economics Chapter Money and Banking Notes: Overview

What is Money?

In the first half of Chapter 3 Macroeconomics Class 12 Notes, money is rightfully defined. Anything which is accepted as a medium of exchange and simultaneously acts as a measure, store of value and standard of deferred payment is termed as ‘money’.

What are the Functions of Money?

The functions of money are classified into three categories namely primary functions, secondary functions and contingent functions.

Primary Functions:

Medium of Exchange.

A general gauge of value or unit of value.

Secondary Functions:

Benchmark of deferred payment.

Store of value.

Transfer of value.

Contingent Functions:

Basis of credit.

Profit statement to the producers.

Ultimate satisfaction to the consumers.

Foundation of the price mechanism.

Source of distribution of income.

What is Barter Exchange and What are the Difficulties Involved in the Barter Exchange?

In the Macroeconomics class 12 Chapter 3 Notes, ‘barter exchange’ is defined as the direct exchange of commodities for commodities without using money as the medium of exchange.

Problems in the Barter Exchange:

An inadequate common measure of value.

Insufficient amount of double coincidence of wants.

Absence of benchmark of deferred payments.

Commodities cannot be divisible.

Exchange of services cannot be possible in the Barter Exchange.

Supply of Money

In the Class 12 Macroeconomics Chapter 3 Notes, ‘supply of money’ refers to the aggregate stock of money (currency notes, coins and demand deposit of banks) in the distribution or are held by the public at a certain point of time.

The cash balance held by Central or State Govt and stock of money acquired by the banking system of a country is not included in the Supply of Money. Hence,

Measures of Money Supply = Currency possessed by public + Net Demand Deposits possessed by commercial banks.

M1 = C + DD + OD

Where, 

C stands for currencies and coins possessed by the public.

DD stands for Demand Deposits in the name of the public with the banks.

OD stands for other deposits.

M2 = M1 + POSB deposits.

M3 = M1 + Time Deposits of Commercial Banks.

M4 = M3 + Total POSB Deposits excluding the deposit on National Savings Certificates.

What do You Mean by a Bank and Banking System?

As per Class 12 Economics Chapter Money And Banking Notes, the financial institution in which deposits are accepted from the public and loan facilities for investment are provided is termed as Commercial Bank. The main aim of the services provided by commercial banks is to earn profits.

What are the Functions of Commercial Banks?

Functions of commercial banks are classified into two categories namely primary functions and secondary functions.

Recognizing deposits.

Giving loans.

Discounting boll of exchange.

a) Agency Functions:

Fund transfer.

Fund collection.

Buying and selling of shares and securities on behalf of the customers.

Playing the role of executor and trustee of a will.

Playing the role of correspondent and representative of the customer and offer letter of credit to the customers.

b) General Utility Functions:

Buying and selling of foreign exchange.

Issuance of cheques of travellers.

Secured custody of costly commodities in lockers.

Endorsing of securities.

What is Central Bank and What are its Roles?

The apex institution of the financial system of a particular country is known as the Central Bank.

Roles of Central Bank:

Bank of issue.

Banker of the Government.

Bank and Supervisor of the Bankers.

Credit controlling authority.

Lender of ultimate resort.

Foreign exchange reserves are secured in the Central Bank.

Conclusion 

Class 12 CBSE Macro Economics Chapter 3 notes on Money and Banking are a valuable resource for students. They provide a clear and concise understanding of key concepts related to money, banking, and the financial system. These notes can be a great aid in preparing for exams and gaining a solid foundation in macroeconomics. With free PDF downloads available, they offer accessibility to all students. Studying and mastering this chapter is essential, as it helps us comprehend the intricate world of finance and its impact on our daily lives. So, make the most of these notes and excel in your studies!

FAQs on CBSE Macro Economics Chapter 3 - Money and Banking Class 12 Notes

1. What is the Cash Reserve Ratio (CRR)?

In Class 12 Economics Chapter Money And Banking Notes, Cash Reserve Ratio (CRR) refers to the minimum ratio of deposit legally needed to be kept as cash by banks.

2. What is Flat Money?

Flat Money refers to the currency that a government has considered to be a legal tender.

3. Why Should You Refer to Class 12 Macroeconomics Chapter 3 Notes by Vedantu?

The reasons for choosing Class 12 Chapter 3 Notes by Vedantu include:

Money and Banking class 12 Notes are available in PDF format on the official website of Vedantu which can be easily accessed.

Macroeconomics Class 12 Chapter 3 is one of the most high-scoring chapters in Economics. Class 12 Economics Chapter 3 Notes are prepared in such a way which will assist the students to grab the maximum of it.

Chapter 3 Macroeconomics Class 12 Notes consists of several mock tests and question answers which will definitely help you understand the chapter to score good marks in the exam.

Macroeconomics Class 12 Chapter 3 Notes are entirely free of cost and are prepared by the experienced professors of Vedantu.

4. What is the Statutory Liquidity Ratio?

Statutory liquidity ratio or SLR is the minimum percentage of the total deposit that banks have to keep with themselves in the form of liquid cash, securities, or gold. The rate of SLR is fixed by the Reserve Bank of India (RBI). This reserve is kept by the bank themselves and not with the RBI. The banks must keep this reserved before giving out credits to the borrowers. For further explanation and examples of NCERT related to Statutory liquidity ratio, you can visit the page NCERT notes for Class 12 Macroeconomics .

5. What are the functions of the central bank in India?

The central bank of India is an important organ of government that takes some of the most crucial financial decisions to improve the conditions of financial institutions and support the country's economy.  Some of the most prominent functions of the central bank of India are as follows;  bank of issue and regulator of currency, banker, agent, and financial advisor to the government, management and custodian of Foreign Exchange Reserve, clearinghouse, lender of last resort, protection of depositor’s interest. 

6. Is Class 12  Macroeconomics chapter 3 difficult to study?

Chapter 3 of macroeconomics is important from the examination point of view. But the chapter is not difficult as compared to other chapters in the book. The chapter is mostly theory-based with few numerical. Chapter 3, Money and Banking talks about the role of money and systems of banking. It also talks about the roles, functions of the central bank and how money transactions take place in banks. You can visit NCERT notes for Class 12 Macroeconomics and download the notes PDF free of cost.

7. How are NCERT solutions helpful for studying Class 12 Macroeconomics Chapter 3?

NCERT solutions from Vedantu include all the study material that is required by the students to prepare for examinations. These NCERT solutions are available on the website as well as the vedantu app. You can find extra questions for practice, important topics, NCERT solutions to exercises related to Chapter 3- Money And Banking. It also explains the transaction of money under the banking system with the help of diagrams and flowcharts. You can also go through revision notes that are available in NCERT solutions for a quick review of the chapter before exams.

8. What is the weightage of Class 12 Macroeconomics Chapter 3?

The net weightage of chapter 3, Money and Banking is 8 marks. Although the chapter carries fewer marks, there is a 5 marker question and 3 one marker questions from this chapter. If you are well versed with the chapter these 8 marks are very easy to secure in the board examination. The chapter is not at all lengthy and you can learn and revise it pretty quickly if the chapter piques your interest. 

REVISION NOTES FOR CLASS 12 MICRO ECONOMICS

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• Updated on  
• Feb 12, 2021

The Central Board of Secondary Examination [CBSE] carries out periodic changes frequently in the structure of syllabus and question pattern across different commerce subjects . With more and more questions being added which aim to evaluate concept-application, analysis and interpretation, the prevalent practice of theoretical learning is being done away with. The inclusion of Business Studies class 12 case studies is a step in this direction. Further, the vast nature of syllabus in the subject makes this way testing much more practical in place of merely listing and rewriting. Here, we present a full-fledged guide on how to tackle these case studies questions in a way that can get you better scores.

This Blog Includes:

Overview & structure, what is a case study, business studies class 12 case studies: examples, how to solve case studies in business studies class 12.

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Business studies broadly encompass ‘Principles and Functions of Management’ which deal with management, its nature, elements, theories and application as well as ‘Business Finance and Marketing’ which concerns financial markets , marketing management and consumer protection. Before taking a look at the Business Studies Class 12, take a look at the pattern of the paper is as follows:

Note: Case studies are not separate sections or parts. They can be asked as all across the above-mentioned sections.

In particular, case studies are based on real-life scenarios which concern business-related situations. This involves, for instance, cases wherein a person starts a business concern, problems faced in its management, a unique set of circumstances encountered and a host of other different situations. The students are required to correlate concepts in management and solve questions based on their understanding of such concepts. Identification of a particular aspect of Business Management is also a highly used testing criterion.

Here are a few examples of case study questions you can expect to see in the Class 12 Business Studies paper based on official CBSE Question Paper 2020:

Umang Gupta is the Managing Director of Denver Ltd. The company had established a good name for itself and had been doing well. It was known for the timely completion of orders. The Production Manager, Ms Kanta was efficiently handling the processing of the order and had a team of fourteen motivated employees working under her. Everything was going on well. Unfortunately, she met with an accident. Umang knew that in the absence of Ms Kanta, the company may not be able to meet the deadlines. He also knew that not meeting the deadlines may lead to customer dissatisfaction with the risk of loss of business and goodwill. So, he had a meeting with his employees in which accurate the speedy processing of orders was planned. Everybody agreed to work as a team because the behaviour of Umang Gupta was positive towards the employees of the organisation. Hence everyone put in extra time and efforts and the targets were met on time. Not only this, Umang visited Ms Kanta and advised her to take sufficient rest. 1. Identify the leadership style of Umang Gupta and draw a diagram depicting the style. 2. State any two values highlighted by the behaviour of Umang Gupta. (CBSE, Delhi 2017)

Indian Youth Organisation (IYO) organised a visit of its members to an old age home to inculcate the habit of social work among them. The visit revealed that the living conditions of the inmates of the old age home were not hygienic. So, the IYO members decided to clean the premises. During their cleanliness drive, they realised that the old age home also required pest control. But some of the inmates of old age home were reluctant about it because they believed that the pest control might create health problems for them. IYO, therefore, decided to provide ethical, safe and odourless pest control. They showed to the inmates of old age home a pamphlet of the proposed pest control product which promised easy, inexpensive and long-lasting pest control. The inmates happily agreed and the pest control was carried out. It worked for a fortnight but to their dismay, the effect started wearing off. IYO contacted the pest control company which kept on postponing their visit. After waiting for a month, IYO filed a cased in the consumer court. The consumer court was satisfied with the genuineness of the complaint and issued necessary directions to the pest control company. 1. State the six directions that might have been issued by the court. 2. Also, identify any two values that are being communicated by IYO to society. (CBSE, Delhi 2017)

ABC Ltd is a consumer appliance company established in 1992. With its effort of quality maintenance, it has established a competent name in the market for its products. In its efforts of specialisation, it has set up different departments of finance, sales, manufacturing, technical services and maintenance services. As the spaces of operation have risen along with soaring consumer demand, ABD Ltd came to resolution to alter its current principle of management in order to meet varying requirements of the environment.  Write the specific general principle of management the company intends to modify to meet the changing requirements.

Gold Land Pvt. Ltd. is a wheat-producing company. Daily 5000 bags of wheat weighing 10 kg each are produced here. In comparison to the previous year, this ere has been less number of bags produced on a per-day basis. The number is around 4500 which is less than the target of 5000 set by the company. The company however has been able to reduce the costs involved in comparison to last year’s spending on the production and packaging of each bag. The quality of bags has also been up to the mark. Identify the concept of management ignored here.

A floor manager of a mall is a very good manager as he utilizes all the functions of management to minimize the cost of maintenance of his area. He directs all the staff members under him to follow the targets and advises them to put their efforts in the direction of the achievement of these targets. Under his guidance, the employees admit that they learn a lot and are able to meet their targets. This has led to an increase in their salaries. Identify the importance of management highlighted above.

A bank named ‘Dhan Sangraha Karta’ allows the Kapoor family to deposit their money time and again in it. It gives a definite return to this family which is in the form of interest. To get this interest the money stored in the household of Kapoor family gets entry into this bank. Nearby there is a stock exchange, Mr Rajan Kapoor, who is the head of the family, goes there and buys securities. He says that in this way more return in earned by him on his saved money though the risk is also there. 1. Identify the process in the above case performed by the bank and the stock exchange. 2. What are the roles of the bank and the stock exchange with respect to each other? 3. Name a condition for the bank to perform its role in this process. 4. Name a condition for the stock market to perform its role in this process.

To make the sports day of the school successful the Headmaster of the school divided all the activities into task groups each dealing with a specific area like holding of the event, the arrangement of medals, refreshments etc. Each group was placed under the overall supervision of a senior teacher. The physical education teacher was made responsible for holding different events, the home science teacher for refreshments and the Maths teacher for medals. Identify the function of management performed by the Headmaster in doing so.

Exploring Class 12 notes? Don’t Forget to Check Out Our Exclusive Guide on CBSE Accountancy Class 12 !

RTVB Technologies Ltd. entered the gaming market via its launch of a comprehensive gaming brand name that focused on gaming consoles, games and other accessories. This was done after careful consideration of changing consumer needs and market trends. While its products are expensive, they are of high quality as well as eco-friendly. Their efforts were to differentiate their product from the existing items available in the market and devoted significant efforts, time and money in the creation of the brand name as without this they can only focus on awareness for generic products and can never be sure of sale of products. After some time, their efforts led to a positive growth in demand of products and parallelly as the customers liking also grew, the higher price was no longer a buyer. Over time, the company’s gaming brand became regarded as a status symbol owing to its impressive quality and consumers by using them felt a sense of pride. I. What is RTVB Ltd.’s marketing management philosophy? II. In the above case, describe the benefits of branding to the marketeers.

Note: You can access more Business Studies Class 12 Case Studies here .

Since they aim to analyze the student’s understanding of business studies and management studies, the case studies in Class 12 can be intricate and complex ones to comprehend. But there are many ways to easily solve them and grasp the concepts covered under Business Studies. We have enlisted some of the best tips and tricks you can utilise to crack the case studies in Business Studies Class 12:

Read NCERT Books for Business Studies thoroughly and go through all the topics covered in each chapter. NCERT books can be your best buddy in exploring the nuances of business and management as they describe the essential topics in a simpler and uncomplicated manner. Once you have read all the chapters given in NCERT as well as the case studies under each chapter then move towards studying with reference books.

While solving case studies for Business Studies Class 12, understand the question carefully and highlight all the key aspects mentioned that seem important. This can vary from the changes brought forward by a business firm to a decision that led to something important or the beliefs and philosophies an enterprise started with. Highlight all the key pointers and then start drafting the answers.

If the question asks an analysis of a certain aspect of a decision or management, it’s better to write down all the key pointers elucidating the pros and cons of the issue you are asked to analyse . Once you have the pointers, you can write down the answer easily.

Don’t write lengthy answers and try to make them concise and insightful . Adhere to the word limit provided and draft a comprehensive answer accordingly.

Some questions might explicitly mention the topic from the syllabus for Business Studies Class 12 such as “analyse the step taken by ______ Manager as per the Functions of Management”. You can use this as a hint to answer the question as per the concepts covered under the Functions of Management in the syllabus. Look out for such hints in the question on case studies as they can help you draft an impressive and high-scoring answer.

While preparing for the class 12 examinations, one can make use of the following resources:

• Case Studies Mentor in Business Studies Class- XII by Alka Dhawan
• Case Studies in Business Studies by Tapan Pathak for CBSE Class 12 by Tapan Pathak
• Business Studies with Case Studies for Class-XI by Sandeep Garg
• Business Studies for Class 12 – Question-Answer Bank by MeriPustak
• CBSE Class 12 Business Studies-Case Studies by Shiv Das
• Oswaal CBSE Question Bank Class 12 Business Studies Book by Oswaal Books
• Business Studies for Class 12 by RK Singla
• All In One Business Studies CBSE class 12 2019-20 (Old Edition) by Arihant Experts
• ABD’s Business Studies – Mastering Case Studies – (Class XII) (2019-2020) by Neeru Sethi

It requires a solid grasp over business and management concepts to tackle Business Studies Class 12 Case Studies. If you are planning to pursue a degree in Business after class 12, take assistance of our team of experts at Leverage Edu and we’ll help you find a suitable course and university thus gearing you up for a successful future ahead.

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Money and Banking: Class 12 Notes Everything You Need to Know

If you're a student of Class 12, you may be looking for simplified and comprehensive Notes on Class 12 Macroeconomics Chapter 3 Money and Banking that can help you to understand complex concepts and theories. These detailed notes cover all the important topics, from the functions of money to the role of central banks in the modern economy. Whether you're studying for an exam or just trying to deepen your understanding, these notes are a valuable resource.

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The Ultimate Guide to Money and Banking Class 12 Economics Notes

Barter exchange.

Meaning : Economic exchanges without the mediation of money are referred to as barter exchanges.

Disadvantages of Barter Exchange

• Lack of double coincidence of wants : A common problem with the barter system is the lack of double coincidence of wants which means that if one wants to exchange some good with another person then the latter must also be willing to exchange his/her good with the former. For example, let a person wants cloth and he has a stock of wheat with him to exchange for it. In such a case the person can exchange wheat for cloth with another person who has cloth and who also wants wheat.
• Search cost is high.
• Lack of division of goods.
• The problem of storage.
• Loss of value.

Definition: Money is anything that is generally accepted as a means of exchange, a measure and store of value, and which also acts as a standard of deferred payments.

Functions of Money

• Medium of Exchange : Money acts as a medium of exchange for all goods and services. The use of money has greatly facilitated the process of exchange by dividing it into two parts i.e. sale and purchase.
• Unit of Account : The value of all goods and services can be expressed in monetary units. When we say that the value of a certain wristwatch is ₹ 500 we mean that the wristwatch can be exchanged for 500 units of money, where a unit of money is rupee in this case.
• Store of Value : Money is not perishable and its storage costs are also considerably lower. It is also acceptable to anyone at any point of time. Thus money can act as a store of value for individuals. Wealth can be stored in the form of money for future use.
• Standard of Deferred Payments : Deferred payments are payments to be made at some future date. Money serves as a standard of such deferred payments. This function has facilitated borrowing and lending. The function has also led to the creation of financial institutions.

Demand for Money

Meaning: The demand for money tells us what makes people desire a certain amount of money. It is a stock concept.

Demand for money depends on :

i. Quantum of transactions: Since money is required to conduct transactions, the value of transactions will determine the money people will want to keep. Since the quantum of transactions to be made depends on income, it should be clear that a rise in income will lead to a rise in demand for money.

ii. Interest rates: When interest rates go up, people become less interested in holding money since holding money amounts to holding less of interest-earning deposits, and thus less interest received. Therefore, at higher interest rates, money demand comes down.

Supply of Money

Meaning: The total stock of money in circulation among the public at a particular point of time is called money supply.

• The money supply is a stock concept.
• In a modern economy, the money supply comprises cash (currency notes and coins) and bank deposits .
• In India currency notes are issued by the Reserve Bank of India (RBI), except coins and ₹ 1 note.
• Coins and ₹ 1 notes are issued by the Government of India (Ministry of Finance).
• ₹ 1 note bears the signature of the Finance Secretary of India.
• Demand Deposit: The balance in savings, or current account deposits, held by the public in commercial banks is also considered money since cheques drawn on these accounts are used to settle transactions. Such deposits are called demand deposits as they are payable by the bank on demand from the account holder.
• Time Deposit: Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits.
• Every currency note bears on its face a promise from the Governor of RBI that if someone produces the note to RBI, or any other commercial bank, RBI will be responsible for giving the person purchasing power equal to the value printed on the note. The same is also true of coins. Currency notes and coins are therefore called fiat money . They do not have intrinsic value like gold or silver coin. They are also called legal tenders as they cannot be refused by any citizen of the country for settlement of any kind of transaction.
• Cheques drawn on savings or current accounts, however, can be refused by anyone as a mode of payment. Hence, demand deposits are not legal tenders.

Depending on what types of bank deposits are included, there are many measures of money.

Measures of Money Supply:

RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are defined as follows:

• M1 = CU + DD
• M2 = M1 + Savings deposits with Post Office savings banks
• M3 = M1 + Net time deposits of commercial banks
• M4 = M3 + Total deposits with Post Office savings organizations (excluding National Savings Certificates)

Here, CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks. The word ‘net’ implies that only deposits of the public held by the banks are to be included in the money supply. The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of the money supply.

• M1 and M2 are known as narrow money.
• M3 and M4 are known as broad money.
• These measures are in decreasing order of liquidity. M1 is the most liquid and easiest for transactions whereas M4 is the least liquid of all.

High-Powered Money : The currency (notes + coins) is created by the central bank (Reserve Bank of India in India) and is called the High-Powered Money /Reserve money/Monetary base.

Bank Money: Demand deposits are created by commercial banks and are called Bank money.

Commercial Banks

Meaning: The commercial bank is a financial institution that is primarily concerned with accepting deposits from the public and lending to the public besides others.

• These banks operate both under the public as well private sectors.
• Some public sector banks include the State Bank of India, Punjab National Bank, and Bank of India among others.
• The private sector commercial banks may include the banks namely HDFC Bank, ICICI Bank, and Axis Bank among others.

Credit Creation by Commercial Banks/The Process of Money Creation:

Basic Terms :

• Cash Reserve Ratio (CRR) : Percentage of deposits which a bank must keep as cash reserves with the Central bank (RBI). It is also known as the ‘Required Reserve Ratio’ or the ‘Reserve Ratio’. [ It is kept with the Central Bank (RBI) ]
• Statutory Liquidity Ratio (SLR) : The bank is also required statutorily to maintain a certain proportion of its total deposits as liquid assets in the form of cash, gold, and certain government-approved securities. This is known as Statutory Liquidity Ratio (SLR). [ It is kept with the bank itself ]
• Legal Reserve Ratio (LRR) : The CRR and SLR together form the LRR which is determined by the central bank of a country (R.B.I. in the case of India)

Why are the banks required to keep only a fraction of deposits as cash reserves? What will banks do if the demand for cash withdrawn is more than cash reserves at some point of time?

There are two reasons:

• First, the banking experience has revealed that not all depositors approach the banks for withdrawal of money at the same time, and also that normally they withdraw a fraction of deposits.
• Secondly, there is a constant flow of new deposits for withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as cash reserve.

Assumptions :

• Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply ‘’banks’.
• Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing a cheque. The one who receives payment deposits the same in his deposit account.

Let us now explain the process. Suppose the initial deposit in banks is ₹ 100 and the LRR is 20% (Note: 20% = 20 / 100 = 0.2). Further, suppose that banks keep only the minimum required i.e. ₹ 20 as cash reserve. Banks are now free to lend the remainder ₹ 80. Suppose they lend ₹ 80. What banks do is to open deposit accounts in the names of the borrowers who are free to withdraw the amount whenever they like. Suppose they withdraw the whole of amount for making payments.

Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposits in banks by ₹ 80. It is 80% of the initial deposit. These deposits of ₹ 80 have resulted on account of loans given by the banks. In this sense, the banks are responsible for money creation. With this round increase in total deposits is now ₹ 180 (=100+80).

When banks receive a new deposit of ₹ 80, they keep 20% of it as cash reserves and use the remaining ₹ 64 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise but by a smaller amount of ₹ 64. The Total deposits now increase to ₹ 244 (=100+80+64).

The deposit creation continues in the above manner. The deposit creation comes to an end when total cash reserves become equal to the initial deposit. The total deposit creation comes to ₹ 500, five times the initial deposit as shown in the table below:

Money Multiplier: It tells us how many times the total deposits would be of the initial deposit.

In our above illustration, the LRR is 0.2,

∴ Money multiplier = 1 / 0.2 = 5

Total Money created = Initial Deposit / LRR = 100 / 0.2 = ₹ 500

Central Bank

The Central Bank is the apex institution of a country’s monetary system. Almost every country has one central bank. India got its central bank in 1935. Its name is the ‘Reserve Bank of India’.

Functions of Central Banks

1. Bank of Issue : The Central Bank is the sole authority for the issue of currency in the country. It promotes efficiency in the financial system. Firstly, this leads to uniformity in the issue of currency. Secondly, it gives the Central Bank direct control over the money supply.

2. Banker to the Government :

The Central Bank acts as a banker to the government - both Central as well as State governments. It carries out all the banking business of the government, and the government keeps its cash balances in a current account with the Central Bank.

As the banker to the government, the Central Bank accepts receipts and makes payments for the government, and carries out exchange, remittance, and other banking operations. The Central Bank also provides short-term credit to the government, so that the government can meet any shortfalls in receipts over disbursements. The government borrows money by selling treasury bills to the Central Bank. The government carries on short-term borrowings by selling ad-hoc treasury bills to the Central Bank.

As the government’s banker, the Central Bank also has the responsibility of managing the public debt. This means that the Central Bank has to manage all new issues of government loans.

The Central Bank also advises the government on banking and financial matters.

3. Bankers’ Bank

As the banker to banks, the Central Bank holds a part of the cash reserves of banks, lends them short-term funds, and provides them with centralized clearing and remittance facilities. The banks are required to deposit a stipulated ratio of their net total liabilities (the CRR) with the Central Bank. The purpose of this stipulation is to use these reserves as an instrument of monetary and credit control. In addition to this, the bank holds excess reserves with the Central Bank to meet any clearing drains due to settlement with other banks or net withdrawals by their account holders. The pool of funds with the Central Bank serves as a source from which it can make advances to banks temporarily in need of funds, acting in its capacity as a lender of last resort.

The Central Bank supervises, regulates, and controls the commercial banks. The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation(merging of banks), and liquidation (the winding up of banks). The control is exercised by periodic inspection of banks and the returns filed by them.

4. Controller of Credit

The Central Bank controls the money supply and credit in the best interests of the economy. The bank does this by taking recourse to various instruments. These are:

• Bank Rate Policy: The bank rate is the rate at which the central bank lends funds to banks. The effect of a change in the bank rate is to change the cost of securing funds from the central bank. An increase in the bank rate increases the costs of borrowing from the central bank. This will reduce the ability of banks to create credit. A rise in the bank rate will then cause the banks to increase the rates at which they lend. This will then discourage businessmen and others from taking loans, thus reducing the volume of credit. A decrease in the bank rate will have the opposite effect.
• Open Market Operations : OMO is the buying and selling of government securities by the Central Bank from/to the public and banks. It does not matter whether the securities are bought or sold to the public or banks because ultimately the amounts will be deposited in or transferred from some bank. The sale of government securities to banks will have the effect of reducing their reserves. When the bank gives the Central Bank a cheque for the securities, the Central Bank collects the amounts by reducing the bank’s reserves by a particular amount. This directly reduces the bank’s ability to give credit and therefore decreases the money supply in the economy. When the Central Bank buys securities from the banks it gives the banks a cheque drawn on itself in payment for the securities. When the cheque clears, the Central Bank increases the reserves of the bank by a particular amount. This directly increases the bank’s ability to give credit and thus increases the money supply.
• Cash Reserve Ratio: Banks are obliged to maintain reserves with the Central Bank. The banks are required to deposit with the Central Bank a percentage of their net demand and time deposits. This minimum percentage is fixed by the Central Bank and is called Cash Reserve Ratio. Varying the CRR is a tool of monetary and credit control. An increase in the CRR has the effect of reducing the bank’s excess funds and thus curtails its ability to give credit.
• Statutory Liquidity Ratio : Banks are also required to maintain a specified percentage of their net total demand and time deposits in the form of designated liquid assets with themselves. This specific percentage is called Statutory Liquidity Ratio (SLR).
• Margin Requirements: A margin is the difference between the amount of the loan and the market value of the security offered by the borrower against the loan. If the margin imposed by the Central Bank is 40%, then the bank is allowed to give a loan only up to 60% of the value of the security. By altering the margin requirements, the Central Bank can alter the amount of loans made against securities by the banks.
• Repo Rate: When commercial banks are in need of funds for a short period, they can borrow from the Central Bank. The rate of interest charged by the Central Bank on such lending is called Repo Rate. Raising Repo Rate makes such borrowings by commercial banks costly. As such when Repo Rate is raised, banks are also forced to raise their lending rates. This has a negative effect on demand for borrowings from commercial banks. Lowering Repo Rate has the opposite effect.
• Reverse Repo Rate: When the commercial banks have surplus funds they can deposit the same with the central bank and earn interest. The rate of interest paid by the Central Bank on such deposits is called Reverse Repo Rate . When this rate is raised, it encourages commercial banks to park their funds with the central bank. This has a negative effect on the lending capability of commercial banks. Lowering Reverse Repo Rate has the opposite effect which raises demand for borrowings from commercial banks.

Demonetization

Demonetization was a new initiative taken by the Government of India in November 2016 to tackle the problem of corruption, black money, terrorism, and the circulation of fake currency in the economy.

Old currency notes of ₹ 500, and ₹ 1000 were no longer legal tender. New currency notes in the denomination of ₹ 500 and ₹ 2000 were launched.

Negative Impacts

• There were long queues outside banks and ATM booths.
• The shortage of currency in circulation had an adverse impact on the economic activities.

Positive Impacts

• It improved tax compliance as a large number of people were bought in the tax ambit.
• The savings of an individual were channelized into the formal financial system. As a result, banks have more resources at their disposal which can be used to provide more loans at lower interest rates.
• It is a demonstration of the State’s decision to put a curb on black money, showing that tax evasion will no longer be tolerated.
• Households and firms have begun to shift from cash to electronic payment technologies.

Hope you liked these notes on Class 12 Economics Money and Banking. Please share this with your friends and do comment if you have any doubts/suggestions to share.

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Chapter 2: MONEY & BANKING

• CBSE Class 12
• Macroeconomics
• Chapter 2: MONEY & BANKING Notes

BARTER EXCHANGE

• MacroEconomics & Indian Economy Book Class-12
• Publication
• PathSet Publications

INTRODUCTION:

This chapter is a detailed version of barter system and its difficulties, how money has overcome its drawbacks, money supply and its measures.

BARTER SYSTEM & ITS DIFFICULTIES

Barter system  

Definition: Barter system refers to exchange of goods for goods. An economy, where there is a direct barter of goods and services, is called a barter economy.

For example,  wheat may be exchanged for cloth; house for horses, etc., or a teacher may be paid wheat or rice as a payment for his/her services.

Such exchange exists in the C-C Economy (commodity-to-commodity exchange economy).

Note: In C-C Economy C stands for commodity. C-C economy is the one in which commodities are exchanged for commodities. C-C exchange refers to barter system of exchange. Hence, C-C Economy is an economy dominated by barter system of exchange

Limitations of Barter Exchange:

Lack of double coincidence of wants:

• Barter is possible only if goods produced by two persons are needed by each other, thus it is double coincidence of wants.
• Double coincidence of wants means that goods in possession of two different persons must be useful and needed by each other. It is the basis of barter system, however it is rare for this to happen.
• It is difficult to find such a person every time. In barter system, exchange becomes quite limited.

Lack of store of value:

• It is very difficult to store wealth for future use.
• Most of the goods like wheat, rice, cattle etc. are likely to deteriorate with the passage of time or involve heavy cost of storage.
• Further, the transfer of goods from one place to another place involves huge transport cost.
• Transfer of immovable commodities (such as house, farm, land, etc.) becomes almost impossible.

Absence of common measure of value:

Different commodities are of different values. The value of a good or service means the amount of other goods and services it can be exchanged for in the market. There is no common measure of value under barter system.

In this situation, it is difficult to decide in what proportions are the two goods to be exchanged.

Lack of standard of deferred payment:

• In a barter economy, future payments would have to be stated in terms of specific goods or services. This leads to following problems:
• There could be disagreement regarding the quality of the goods or services to be repaid.
• There would be disagreement regarding which specific commodities would be used for repayment.

Money has overcome the drawbacks   of barter system in the following ways :

Barter system makes the exchange process very difficult and highly inefficient.

(a) Medium of exchange

• Under barter system, there is lack of double coincidence of wants.
• With money as a medium exchange individuals can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences.
• A buyer can buy goods through money and a seller can sell goods for money.

(b) Measure of Value

• Under barter system, there was no common measure of value. Money has also solved this difficulty.
• As Geoffrey Crowther puts it, “Money acts as a standard measure of value to which all other things can be compared.” Money measures the value of economic goods.
• Money works as a common denominator into which the values of all goods and services are expressed.
• When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.

(c) Store of value

• Under barter system, it is very difficult to store wealth for future use.
• Most of the goods are perishable and their storage requires huge space and transportation cost.
• Wealth can be conveniently stored in the form of money.
• Money can be stored without loss in value.
• Money can easily be stored for future use.

(d) Standard of deferred payments

• Under barter system, transactions on deferred payments are not possible.
• With money, the debtors make a promise that they will make payments on some future dates. In these situations, money acts as a standard of deferred payments.
• It has become possible because money has general acceptability, its value is stable, and it is durable and homogeneous.

Definition: Money is something which is generally acceptable as a medium of exchange and can be converted into other assets without losing its time and value

Characteristics or Features of Money:

• Durability:  Money must be durable and not likely to deteriorate rapidly with frequent handling. Currency notes and coins are being used repeatedly and shall continue to do so for many years.
• Medium of exchange:  Money is the thing that acts as a medium of exchange for the sale and purchase of goods and services.
• Weight:  Money must be light in weight. Paper money is better than metal coins because it is light in weight.
• Measure of value:  It not only serves as medium of exchange but also acts as a measure of value. The value of all the goods and services is expressed in terms of money.

Important points about money:

• Legal definition of money:  Legally, money is anything proclaimed by law as a medium of exchange. Paper notes and coins (together called currency) is money as a matter of law.
• FIAT Money:  It is defined as a money which is under the ‘FIAT’ (order/authority) of the government to act as a money.
• Functional definition of money:  Functional definition of money refers to money as anything that performs four basic functions. (Medium of exchange, standard unit of value, standard of deferred payments, store of value)
• Narrow definition of money:  Functional definition of money is a narrow definition of money. It includes only notes, coins and demand deposits as money.
• Broad definition of money:  A broad definition of money also includes time deposits/ term deposits with the banks or post offices as a component of money.

MONEY SUPPLY

Money Supply & Measures of Money Supply

Money supply:  

Definition: The volume of money held by the public at a point of time, in an economy, is referred to as the money supply. Money supply is a stock concept.

Measures of money supply:  

On the recommendation of the second working group on money supply, the RBI presented four measures of money supply in its 1977 issues of RBI Bulletin, namely M 1 , M 2 , M 3  and M 4 .

Measures of M 1  include:

Currency notes and coins with the public (excluding cash in hand of all commercial banks) [C]

Demand deposits of all commercial and co-operative banks excluding inter-bank deposits. (DD)

Where demand deposits are those deposits which can be withdrawn by the depositor at any time by means of cheque. No interest is paid on such deposits.

• (c) Other deposits with RBI [O.D] M 1  = C + DD + OD Where, Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi¬government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc.

Measures of M 2 :

• M 1  [C + DD + OD]
• Post office saving deposits

Measures of M 3 :

• Time deposits of all commercial and co-operative banks. Where, Time deposits are the deposits that cannot be withdrawn before the expiry of the stipulated time for which deposits are made. Fixed deposit is an example of time deposit.

Measures of M 4

• Total deposits with the post office saving organization (excluding national savings certificates).
• High-powered money: High-powered money is money produced by the RBI and the government. It consists of two things: (a) currency held by the public and (b) Cash reserves with the banks.
• Barter system:  Barter system of exchange is a system in which goods are exchanged for goods.
• Double coincidence of wants:  It means that goods in possession of two different persons must be useful and needed by each other.
• Money:  Money is something which is generally acceptable as a medium of exchange and can be converted into other assets without loosing its time and value.
• Money Supply:  The stock of money held by the public at a point of time, in an economy, is referred to as the money supply. Money supply is a stock concept.
• High-powered money:  It is money produced by the RBI and the government. It consists of two things: (i) currency held by the public and (ii) Cash reserves with the banks.
• Demand deposits:  These are the deposits that can be withdrawn by the depositor at any time by means of cheque. No interest is paid on such deposits.
• Time deposits:  These are the deposits that cannot be withdrawn before the expiry of the stipulated time for which deposits are made. Fixed deposit is an example of time deposit.
• Other deposit measures of M 1 :  Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi-government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc

(c) Other deposits with RBI [O.D]

M 1  = C + DD + OD Where, Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi¬government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc.

Measures of M 4 :

• High-powered money: High-powered money is money produced by the RBI and the government. It consists of two things: (a) currency held by the public and (b) Cash reserves with the banks
• Other deposit measures of M 1 :  Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi-government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc ​​​​​​​

FUNCTIONS OF MONEY

Functions of Money:

We can conclude these four functions under the following two categories:

1 - Primary function

2 - Secondary function

Primary function or Main function:  

The primary function includes the most important functions of money, which it must perform in an economic system irrespective of time and place. The following two functions are included under this category.

(i) Medium of exchange

• Money when used as a medium of exchange helps to eliminate the basic limitation of barter trade, that is, the lack of double coincidence of wants.
• Individuals can exchange their goods and services for money and then can use this money to buy other goods and services according to their needs and convenience.
• Thus, the process of exchange shall have two parts: a sale and a purchase.
• The ease at which money is converted into other goods and services is called “liquidity of money”.

(ii) Measure of value /unit of account

• Another important function of money is that it serves as a common measure of value or a unit of account.
• Under barter economy, there was no common measure of value in which the values of different goods could be measured and compared with each other. Money has also solved this difficulty.

Secondary Functions:

(i) Standard of deferred payments

• Credit has become the life and blood of a modern capitalist economy.
• In millions of transactions, instant payments are not made.
• The debtors make a promise that they will make payments on some future date. In those situations, money acts as a standard of deferred payments.
• It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.

(ii) Store of value

• Wealth can be conveniently stored in the form of money. Money can be stored without loss in value.
• Savings are secured and can be used whenever there is a need.
• In this way, money acts as a bridge between the present and the future.
• Money means goods and services. Thus, money serves as a store of value.
• It is also known as asset function of money.

EVOLUTION OF MONEY

Money has evolved through different stages according to the time, place and circumstances. It developed through the following stages:

DEMAND FOR MONEY

There are three main motives, for which money is wanted by the people: 

Transaction Motive:

It refers to demand for money for conducting day-to-day transactions. This motive can be looked at from the perspective of consumers, who want income to meet their household expenditure (income motive) and from the perspective of businesspersons, who require money to carry on their business activities (business motive). The transaction motive relates to demand for money to meet the current transactions of individuals and business units. 

Precautionary Motive:  It refers to the desire of people to hold cash balances for unforeseen contingencies. People wish to hold some money to provide for the risk of unforeseen events like sickness, accident, etc. The amount of money held under this motive, depends on the nature of individual and on the conditions in which he lives. The demand of money for precautionary balances is also closely related to the level of income. Higher the level of income, more will be the cash balances 

Speculative Motive:  It refers to desire of the holder to keep cash balance as an alternative to financial assets like bonds. Under speculative motive, it is presumed that people can hold their wealth either in the form of bonds or in the form of cash balances. The decisions regarding holding of bonds or cash balances depend upon the expectations about changes in the rate of interest or capital value of assets (bonds) in future. The interest rate varies inversely with the market value of securities (bonds), i.e. when interest rate rises, market value of bonds falls. Hence, demand for money for speculative motive becomes less at high interest rates and becomes large at low interest rates.  

COMMERCIAL BANK

A commercial bank is a kind of financial institution that carries all the operations related to deposit and withdrawal of money for the general public, providing loans for investment, and other such activities. These banks are profit-making institutions and do business only to make a profit.

The two primary characteristics of a commercial bank are lending and borrowing. The bank receives the deposits and gives money to various projects to earn interest (profit). The rate of interest that a bank offers to the depositors is known as the borrowing rate, while the rate at which a bank lends money is known as the lending rate.

Function of Commercial Bank:

The functions of commercial banks are classified into two main divisions.

(a) Primary functions 

Accepts deposit:   The bank takes deposits in the form of saving, current, and fixed deposits. The surplus balances collected from the firm and individuals are lent to the temporary requirements of the commercial transactions.

Provides loan and advances:   Another critical function of this bank is to offer loans and advances to the  enterpreneurs and business people and collect interest. For every bank, it is the primary source of making profits. In this process, a bank retains a small number of deposits as a reserve and offers (lends) the remaining amount to the borrowers in demand loans, overdraft, cash credit, short-run loans, and more such banks.

Credit cash:  When a customer is provided with credit or loan, they are not provided with liquid cash. First, a bank account is opened for the customer and then the money is transferred to the account. This process allows the bank to create money.

(b) Secondary functions 

Discounting bills of exchange:  It is a written agreement acknowledging the amount of money to be paid against the goods purchased at a given point of time in the future. The amount can also be cleared before the quoted time through a discounting method of a commercial bank.

Overdraft facility:  It is an advance given to a customer by keeping the current account to overdraw up to the given limit.

Purchasing and selling of the securities:  The bank offers you with the facility of selling and buying the securities.

Locker facilities:   A bank provides locker facilities to the customers to keep their valuables or documents safely. The banks charge a minimum of an annual fee for this service.

Paying and gathering the credit:  It uses different instruments like a promissory note, cheques, and bill of exchange.

CREDIT CREATION

Money Creation / Credit Creation

Let us assume:

The entire commercial banking system is one unit. Let us call this one unit simply “banks’.

All receipts and payments in the economy are routed through the banks. One who makes payment does it by writing cheque. The one who receives payment deposits the same in his deposit account.

Suppose initially people deposit Rs.1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank. It has two components. A part of the LRR is to be kept with the Central bank and this part ratio is called the Cash Reserve Ratio (CRR). The other part is kept by the banks with themselves and is called the Statutory Liquidity Ratio.

Let us now explain the process, suppose the initial deposits in banks is Rs.1000 and the LRR is 10 percent. Further, suppose that banks keep only the minimum required, i.e., Rs.100 as cash reserve, banks are now free to lend the remainder Rs.900. Suppose they lend Rs.900. What banks do to open deposit accounts in the names of the borrowers who are free to withdraw the amount whenever they like.

Let us now suppose they withdraw the whole of amount for making payments.

Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposit in banks by 900. It is 90 per cent of the initial deposit. These deposits of Rs.900 have resulted on account of loans given by the banks. In this sense the banks are responsible for money creation. With this round, increased in total deposits are now Rs.1900 (1000 + 900).

When banks receive new deposit of Rs.900, they keep 10% of it as cash reserves and use the remaining Rs.810 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise, but by a smaller amount of Rs.810. It is 90 per cent of the last deposit creation. The total deposits now increase to Rs.2710 (=1000 + 900 + 810). The process does not end here.

The deposit creation continues in the above manner. The deposits go on increasing round after round but Deposit Creation by Commercial Banks increases each time by only 90 per cent of the last round deposits. At the same time, cash reserves go on increasing, each time 90 per cent of the last cash reserve. The deposit creation comes to end when the total cash reserves become equal to the initial deposit. The total deposit creation comes to Rs.10000, ten times the initial deposit as shown in the table.

  Deposit Creation By Commercial Banks

It can also be explained with the help of the following formula:

Money Multiplier = 1/LRR = 1/0.1 = 10

The total money creation thus,

Money creation = Initial deposit*1/LRR = 10,000

Note that lower the LRR, higher the money multiplier and more the money creation. If the LRR = 5% = 0.5, the money multiplier = 2(1/0.05). If the LRR = 20%, the money multiplier is

Banks are required to keep only a fraction of deposits as cash reserves because of the following two reasons:

First, the banking experience has revealed that not all depositors approach the banks for withdrawal of money at the same time and also that normally they withdraw a fraction of deposits.

Secondly, there is a constant flow of new deposits into the banks. Therefore to meet the daily demand for withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as a cash reserve.

When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.

CENTRAL BANK

Definition: The central bank is an apex body that controls, operates, regulates and directs the entire banking and monetary structure of the country.

It is known as apex as it occupies the top most position in the monetary and banking system of the country. India’s central bank is the Reserve Bank of India.

Functions of Central Bank:

1. Currency Authority:

• The central bank has the sole monopoly to issue currency notes. Commercial banks cannot issue currency notes. Currency notes issued by the central bank are the legal tender money.
• Legal tender money is one, which every individual is bound to accept by law in exchange for goods and services and in the discharge of debts.
• Central bank has an issue department, which is solely responsible for the issue of notes.

However, the monopoly of central bank to issue the currency notes may be partial in certain countries.

For example, in India, the government issues one-rupee notes and all types of coins and all other notes are issued by the Reserve Bank of India.

2. Banker to the Government:

• Central bank everywhere in the world acts as banker, fiscal agent and adviser to their respective government.

(I) As Banker :

As a banker to the government, the central bank performs same functions as performed by the commercial banks to their customers.

• It receives deposits from the government and collects cheques and drafts deposited in the government account.
• It provides cash to the government as resumed for payment of salaries and wages to their staff and other cash disbursements.
• It makes payments on behalf of the government.
• It also advances short-term loans to the government.
• It supplies foreign exchange to the government for repaying external debt or making other payments.

(ii) As Fiscal Agent:

• As a fiscal agent, it manages the public debt.
• It collects taxes and other payments on behalf of the government.
• It represents the government in the international financial institutions (such as World Bank, International Monetary Fund, etc.) and conferences.

(iii) As Adviser:

• The central bank also acts as the financial adviser to the government.
• It gives advice to the government on all financial and economic matters such as deficit financing, devaluation of currency, trade policy, foreign exchange policy, etc.

3. Banker’s Bank and Supervisor:

(a) Banker’s Bank:  Central bank acts as the banker to the banks in three ways:

• Custodian of the cash reserves of the commercial banks;
• As the lender of the last resort; and
• As clearing agent.

(i)  As a custodian of the cash reserves of the commercial banks, the central bank maintains the cash reserves of the commercial banks. Every commercial bank has to keep a certain percent of its cash reserves with the central bank by law.

(ii) As Lender of the Last Resort,

• As banker to the banks, the central bank acts as the lender of the last resort.
• In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances.
• The central bank assists such banks through discounting of approved securities and bills of exchange.

(iii) As Clearing Agent,

• Since it is the custodian of the cash reserves of the commercial banks, the central bank can act as the clearinghouse for these banks.
• Since all banks have their accounts with the central bank, the central bank can easily settle the claims of various banks against each other simply by book entries of transfers from and to their accounts.
• This method of settling accounts is called the Clearing House Function of the central bank.

(b) Supervisor

• The Central Bank supervises, regulates and controls the commercial banks.
• The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation (merging of banks) and liquidation (the winding of banks).
• The control is exercised by periodic inspection of banks and the returns filed by them.

4. Controller of Money Supply and Credit:  

Principal instruments of Monetary Policy or credit controls of the Central Bank of a country are broadly classified as:

• Quantitative Instruments or General Tools
• Qualitative Instruments or Selective Tools.

(a) Quantitative Instruments or General Tools of Monetary Policy: These are the instruments of monetary policy that affect overall supply of money/credit in the economy. These instruments do not direct or restrict the flow of credit to some specific sectors of the economy.

(i) Bank Rate (Discount Rate)

• Bank rate is the rate of interest at which central bank lends to commercial banks without any collateral (security for purpose of loan). The thing, which has to be remembered, is that central bank lends to commercial banks and not to public.

In a situation of excess demand leading to inflation,

• Central bank raises bank rate that discourages commercial banks in borrowing from central bank, as it will increase the cost of borrowing of commercial bank.
• It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans, which discourages investment.
• Again high rate of interest induces households to increase their savings by restricting expenditure on consumption.

Thus, expenditure on investment and consumption is reduced, which will control the excess demand.

In a situation of deficient demand leading to deflation,

• Central bank decreases bank rate that encourages commercial banks in borrowing from the central bank as it will decrease the cost of borrowing of commercial bank.
• Decrease in bank rate makes commercial bank to decrease their lending rates, which encourages borrowers from taking loans, which encourages investment.
• Again low rate of interest induces households to decrease their savings by increasing expenditure on consumption.

Thus, expenditure on investment and consumption increase, which will control the deficient demand.

(ii) Repo Rate

• Repo rate is the rate at which commercial bank borrow money from the central
• bank for short period by selling their financial securities to the central bank.
• These securities are pledged as a security for the loans.
• It is called Repurchase rate as this involves commercial bank selling securities
• to RBI to borrow the money with an agreement to repurchase them at a later
• date and at a predetermined price.

Therefore, keeping securities and borrowing is repo rate.

• Central bank raises repo rate that discourages commercial banks in borrowing from central bank as it will increase the cost of borrowing of commercial bank.
• Central bank decreases Repo rate that encourages commercial banks in borrowing from central bank, as it will decrease the cost of borrowing of commercial bank.
• Decrease in Repo rate makes commercial bank to decrease their lending rates, which encourages borrowers from taking loans, which encourages investment.

(iii) Reverse Repo Rate

• It is the rate at which the Central Bank (RBI) borrows money from commercial bank.
• In a situation of excess demand leading to inflation, Reverse repo rate is increased, it encourages the commercial bank to park their funds with the central bank to earn higher return on idle cash. It decreases the lending capability of commercial banks, which controls excess demand.
• In a situation of deficient demand leading to deflation, Reverse repo rate is decreased; it discourages the commercial bank to park their funds with the central bank. It increases the lending capability of commercial banks, which controls deficient demand.

(iv) Open Market Operations (OMO)

• It consists of buying and selling of government securities and bonds in the open market by Central Bank.
• In a situation of excess demand leading to inflation, central bank sells government securities and bonds to commercial bank. With the sale of these securities, the power of commercial bank of giving loans decreases, which will control excess demand.
• In a situation of deficient demand leading to deflation, central bank purchases.
• Government securities and bonds from commercial bank. With the purchase of these securities, the power of commercial bank of giving loans increases, which will control deficient demand.

(v) Varying Reserve Requirements

• Banks are obliged to maintain reserves with the central bank, which is known as legal reserve ratio. It has two components. One is the Cash Reserve Ratio or CRR and the other is the SLR or Statutory Liquidity Ratio.
• Cash Reserve Ratio: It refers to the minimum percentage of a bank’s total deposits, which it is required to keep with the central bank. Commercial banks have to keep with the central bank a certain percentage of their deposits in the form of cash reserves as a matter of law.

For example, if the minimum reserve ratio is 10% and total deposits of a certain bank is Rs. 100 crore, it will have to keep Rs. 10 crore with the Central Bank.

• In a situation of excess demand leading to inflation, Cash Reserve Ratio (CRR) is raised to 20 per cent, the bank will have to keep Rs.20 crore with the Central Bank, which will reduce the cash resources of commercial bank and reducing credit availability in the economy, which will control excess demand.
• In a situation of deficient demand leading to deflation, cash reserve ratio (CRR) falls to 5% the bank will have to keep Rs. 5 crore with the central bank, which will increase the cash resources of commercial bank and increasing credit availability in the economy, which will control deficient demand.

(vi) The Statutory Liquidity Ratio (SLR)

• It refers to minimum percentage of net total demand and time liabilities, which commercial banks are required to maintain with themselves.
• In a situation of excess demand leading to inflation, the central bank increases statutory liquidity ratio (SLR), which will reduce the cash resources of commercial bank and reducing credit availability in the economy.
• In a situation of deficient demand leading to deflation, the central bank decreases statutory liquidity ratio (SLR), which will increase the cash resources of commercial bank and increases credit availability in the economy.

It may consist of:

(1) Excess reserves

(2) Unencumbered (are not acting as security for loans from the Central Bank) government and other approved securities (securities whose repayment is guaranteed by the government); and

(3) Current account balances with other banks.

(b) Qualitative Instruments or Selective Tools of Monetary Policy: These instruments are used to regulate the direction of credit. They are as under:

Imposing margin requirement on secured loans

• Business and traders get credit from commercial bank against the security of their goods. Bank never gives credit equal to the full value of the security. It always pays less value than the security.
• So, the difference between the value of security and value of loan is called
• marginal requirement.
• In a situation of excess demand leading to inflation, central bank raises marginal requirements. This discourages borrowing because it makes people gets less credit against their securities.
• In a situation of deficient demand leading to deflation, central bank decreases marginal requirements. This encourages borrowing because it makes people get more credit against their securities.

Moral Suasion

• Moral suasion implies persuasion, request, informal suggestion, advice and appeal by the central banks to commercial banks to cooperate with general monetary policy of the central bank.
• In a situation of excess demand leading to inflation, it appeals for credit contraction.
• In a situation of deficient demand leading to deflation, it appeals for credit expansion.

Selective Credit Controls (SCCs)

• In this method, the central bank can give directions to the commercial banks not to give credit for certain purposes or to give more credit for particular purposes or to the priority sectors.
• In a situation of excess demand leading to inflation, the central bank introduces rationing of credit in order to prevent excessive flow of credit, particularly for speculative activities. It helps to wipe off the excess demand.
• In a situation of deficient demand leading to deflation, the central bank withdraws rationing of credit and make efforts to encourage credit.

5. Custodian of Foreign Exchange Reserves:

• The central bank also acts as the custodian of the country's stock of gold and reserves of foreign exchange. This function enables the central bank to exercise a reasonable control on foreign exchange. According to regulations of foreign exchange, all foreign exchange transactions must be routed through RBI. Centralization of foreign exchange transactions with the Reserve Bank serves two objectives:
• It helps the bank in stabilizing the external value of the currency;
• It helps in pursuing a coordinated policy towards the balance of payments situation of the country.

CENTRAL BANK v/s COMMERCIAL BANK

DIFFERENCE BETWEEN CENTRAL BANK AND COMMERCIAL BANK:

IMPORTANT TERMS FROM THE CHAPTER

• Commercial Bank:  Commercial bank is a financial institution, which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit.
• Legal Reserve Ratio:  It is the minimum ratio of deposits legally required to be kept by the commercial banks with themselves (Statutory Liquidity Ratio) and with the central bank, (Cash reserve Ratio).
• Money Multiplier or Credit Multiplier:  When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.
• Central Bank:  The central bank is the apex institution of a country’s monetary system. The design and the control of the country’s monetary policy is its main responsibility.
• Quantitative Instruments or General Tools of Monetary Policy:  These are the instruments of monetary policy that affect overall supply of money/credit in the economy.
• Qualitative Instruments or Selective Tools of Monetary Policy:  The instruments which are used to regulate the direction of credit is known as Qualitative Instruments.
• Bank rate:  It is the rate of interest at which central bank lends to commercial banks without any collateral (security for purpose of loan).
• Repo rate:  It is the rate at which commercial bank borrow money from the central bank for short period by selling their financial securities to the central bank.
• Reverse Repo rate:  It is the rate at which the central bank (RBI) borrows money from commercial bank.
• Open Market Operation:  It consists of buying and selling of government securities and bonds in the open market by central bank.
• Cash Reserve Ratio:  It refers to the minimum percentage of a bank’s total deposits, which it is required to keep with the central bank.
• Statutory Liquidity Ratio:  It refers to minimum percentage of net total demand and time liabilities, which commercial banks are required to maintain with themselves.
• Marginal requirement:  Business and traders get credit from commercial bank against the security of their goods. Bank never gives credit equal to the full value of the security. It always pays less value than the security. Therefore, the difference between the value of security and value of loan is called marginal requirement.
• Moral suasion:  It implies persuasion, request, informal suggestion, advice and appeal by the central banks to commercial banks to cooperate with general monetary policy of the central bank.
• Selective Credit Controls (SCCs ):  In this method, the central bank can give directions to the commercial banks not to give credit purposes or to give more credit for particular purposes or to the priority sectors.

Related Chapter Name

Chapter 1: national income.

• CIRCULAR FLOW OF INCOME - GENERAL
• REAL & CASH FLOW
• CIRCULAR FLOW OF INCOME - TWO SECTOR ECONOMY MODEL
• DOMESTIC TERRITORY, RESIDENTSHIP, CITIZENSHIP
• FINAL GOODS & INTERMEDIATE GOODS
• FACTOR INCOME & TRANSFER INCOME
• CONSUMPTION GOODS & CAPITAL GOODS
• NATIONAL INCOME AGGREGATES
• THREE GOLDEN RULES
• VALUE ADDED METHOD
• INCOME METHOD
• EXPENDITURE METHOD
• TREATMENT OF DIFFERENT ITEMS IN NATIONAL INCOME
• GDP DEFLATOR

Chapter 3: DETERMINATION OF INCOME & EMPLOYMENT

• AGGREGATE DEMAND
• AGGREGATE SUPPLY
• CONSUMPTION FUNCTION
• TYPES OF PROPENSITIES TO CONSUME
• SAVING FUNCTION & NUMERICALS
• TYPES OF PROPENSITIES TO SAVE
• DERIVATION OF SAVINGS CURVE FROM CONSUMPTION CURVE
• DERIVATION OF CONSUMPTION CURVE FROM SAVINGS CURVE
• INVESTMENT FUNCTION
• SAVINGS & INVESTMENT
• FULL EMPLOYMENT
• UNEMPLOYMENT
• EQUILIBRIUM LEVEL
• INVESTMENT MULTIPLIER
• EXCESS DEMAND
• DEFICIENT DEMAND
• MEASURES TO CONTROL AD - MONETARY POLICY & FISCAL POLICY

Chapter 4: GOVERNMENT BUDGET

• GOVERNMENT BUDGET
• BUDGET RECEIPTS
• BUDGET EXPENDITURE
• MEASUREMENT OF GOVERNMENT DEFICIT

Chapter 5: FOREIGN EXCHANGE RATE

• MARKET FORCES
• TYPES OF FOREIGN EXCHANGE RATE
• CHANGES IN FOREX
• FUNCTIONS OF FOREIGN EXCHANGE MARKET
• KINDS OF FOREIGN EXCHANGE MARKETS

Chapter 6: BALANCE OF PAYMENTS

• TYPES OF BOP
• STRUCTURE OF BOP
• BALANCE OF BOP
• AUTONOMOUS & ACCOMODATING ITEMS

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• CBSE Revision Notes
• Macroeconomics Chapter 3: Money And Banking

Revision Notes For Class 12 Economics Macroeconomics Chapter 3 Money And Banking

Money And Banking is a chapter that briefly explains about the monetary system. This chapter comprises of various concepts barter system, barter economy, difficulties of barter system, money, functions of money – primary function, secondary function of money, contingent functions , fiat money, fiduciary money, money supplier, high powered money, banking, commercial bank, central bank, functions of commercial bank, functions of central banks (RBI), cash reserve ratio (CRR), statutory reserve ratio (SLR).

Frequently asked Questions on CBSE Class 12 Microeconomics Notes Chapter 3: Money and Banking

Wha is ‘fiduciary money’.

Fiduciary money refers to money backed up by trust between the payer and payee.

What are the types ‘commercial bank’?

1. Public sector banks.2. Private sector banks.3. Foreign banks.

What are the functions of RBI?

1. Issue of Bank Notes.2. Banker to the Government.3. Custodian of the Cash Reserves of Commercial Banks.4. Custodian of country’s forex reserves.5. Lender of last resort.6. Controller of credit.

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CBSE 12th Standard Economics Subject Case Study Questions with Solutions

By QB365 on 20 May, 2021

QB365 Provides the updated CASE Study Questions for Class 12 , and also provide the detail solution for each and every case study questions . Case study questions are latest updated question pattern from NCERT, QB365 will helps to get  more marks in Exams 

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Class 12 Economics Case Study Questions

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In this article, we will discuss how to download CBSE class 12 Economics Case Study Questions from the myCBSEguide App and our Student Dashboard for free. For the students appearing for class 12 board exams from the commerce/ humanities stream, Economics is a very lucrative and important subject. It is a very high-scoring subject that aids the students to increase their percentile and excel in academics.

The exam is divided into 2 parts:

• Macro Economics
• Indian Economics Development

12 Economics Case Study Questions

CBSE introduced case-based questions for class 12 in the year 2021-22 to enhance critical thinking in students. CBSE introduced a few changes in the question paper pattern to enhance and develop analytical and reasoning skills among students. Sanyam Bharadwaj, controller of examinations, CBSE quoted that the case-based questions would be based on real-life situations encountered by students.

The purpose was to drift from rote learning to competency and situation-based learning. He emphasized the fact that it was the need of the hour to move away from the old system and formulate new policies to enhance the critical reasoning skills of students. Introducing case study questions was a step toward achieving the goals of the National Education Policy (NEP) 2020.

What is a Case Study Question?

As part of these questions, the students would be provided with a comprehensive passage, based on which analytical questions will have to be solved by them. The students will have to read the given passage thoroughly before attempting the questions. In The current examination cycle (2021-22), case-based questions have a weightage of around 20%.

Types of Case Study Questions in Economics

CBSE plans to increase the weightage of such questions in the following years, so as to enhance the intellectual and analytical abilities of the students. Case-based questions are predominantly of 3 types namely:

• Inferential

Local questions

Local questions can be easily solved as the answers are there in the given passage itself.

Global Questions

For Global questions, the students will have to read the passage in depth, analyze it and then solve it.

Inferential questions

Inferential questions are the ones that would require the student to have complete knowledge of the topic and could be answered by application of the concepts. The answers to such questions are tricky and not visible in the given passage, though the passage would highlight the concept on which the questions would be asked by CBSE.

HOTS Questions in Class 12 Economics

Personally, the concept of case-based questions is not new since CBSE has always included questions based on Higher Order Thinking Skills (HOTs). Though now we will have an increased percentage of such questions in the question paper.

Advantages of Case-based Questions

Class 12 Economics has two books and CBSE can ask Case study questions from any of them. Students must prepare themselves for both the books. They must practice class 12 Economics case-based questions as much as possible.

Case study questions:

• Enhance the intellectual and analytical abilities of the students.
• Provide a complete and deeper understanding of the subject.
• Inculcate intellectual reasoning and scientific temperamental in students.
• Help students retain knowledge for a longer time.
• Would definitely help to discard the concept of memorizing insanely and cramming without a factual understanding of the content.
• The questions would help to terminate the existing system of education in India that promotes rote learning.

Sample case study questions (Economics) class 12

Here are some case study questions for CBSE class 12 Economics. If you wish to get more case study questions and other related study material, download the myCBSEguide App now. You can also access it through our Student Dashboard.

Case Study 1

Keeping in view the continuing hardships faced by banks in terms of social distancing of staff and consequent strains on reporting requirements, the Reserve Bank of India has extended the relaxation of the minimum daily maintenance of the CRR of 80% for up to September 25, 2020. Currently, CRR is 3% and SLR is 18.50%.

“As announced in the Statement of Development and Regulatory Policies of March 27, 2020, the minimum daily maintenance of CRR was reduced from 90% of the prescribed CRR to 80% effective the fortnight beginning March 28, 2020 till June 26, 2020, that has now been extended up to September 25, 2020,” said the RBI.

Q.1 The full forms of CRR and SLR are:

• Current Reserve Ratio and Statutory Legal Reserves
• Cash Reserve Ratio and Statutory Legal Reserves
• Current Required Ratio and Statutory Legal Reserves
• Cash Reserve Ratio and Statutory Liquidity Ratio (ans)

Q.2 What will be the value of the money multiplier?

• None of these

Q.3 SLR implies:

• a) Certain percentage of the total banks’ deposits has to be kept in the current account with RBI
• b) Certain percentage of net total demand and time deposits have to be kept by the bank themselves (ans)
• c) Certain percentage of net demand deposits has to be kept by the banks with RBI
• d) None of the above

Q.4 Decrease in CRR will lead to __.

• a) fall in aggregate demand in the economy
• b) rise in aggregate demand in the economy (ans)
• c) no change in aggregate demand in the economy
• d) fall in the general price level in the economy

Case Study 2

An important lesson that the COVID-19 pandemic has taught the policymakers in India is to provide greater impetus to sectors that make better allocation of resources and reduce income inequalities. COVID-19 has also taught a lesson that in crisis the population returns to rely on the farm sector. India has a large arable land, but the farm sector has its own structural problems. However, directly or indirectly, 50 percent of the households still depend on the farm sector. Greater support to MSMEs, higher public expenditure on health and education and making the labour force a formal employee in the economy are some of the milestones that the nation has to achieve.

One of the imminent reforms to be done in the country is labour reforms. Labour laws are outmoded in India, and some of these date back to the last century.

India’s complex labour laws have been blamed for keeping manufacturing businesses small and hindering job creation. Industry hires labour informally because of complex laws and that is responsible for low wages.

• Which types of structural problems are faced by the agricultural sector?
• “It is necessary to create employment in the formal sector rather than in the informal sector.’’ Defend or refute the given statement with valid argument.
• Hired labour comes in …………………. (Informal organisation / formal organisation)
• What do you mean by MSMEs?

Case Study 3

People spend to acquire information relating to the labour market and other markets like education and health. This information is necessary to make decisions w.r.t investment in human capital and its efficient utilization. Thus, expenditure incurred for acquiring information relating to the labour market and other markets is also a source of human capital formation.

Q1. Which of the following is the source of human capital formation in India?

• Acquiring information
• All of these (ans)

Q2. Education provides

• Private benefit
• Social benefit
• Both 1) and 2) (ans)

Q3. __ persons contribute more to the growth of an economy.

Q4. Training given by a company to its employees is generally__________

• Investment (ans)
• Social wastage
• Both 1) and 2)

Tips to Solve Case Study Questions in Economics

Let’s understand how you can solve case study questions in class 12 Economics. The two books are Macroeconomics and Indian Economic Development.

• Read the passage thoroughly
• Can follow a reversal pattern, especially macroeconomics questions, i.e. read questions first and then look for the answers in the passage.
• In case the question asked is about Indian Economic Development, read the passage very carefully as most of the answers would be hidden in the passage itself.
• Macro Economics questions will be more application-based and would test your conceptual clarity.
• Answer briefly and precisely.

Important Chapters – Economics Case Study Questions

Following are some of the very important topics that need to be prepared very thoroughly under CBSE class 12 Economics. We expect that CBSE will certainly ask case-based questions from these chapters.

• National income and its aggregates
• Government budget
• Current challenges faced by the Indian economy

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3 thoughts on “Class 12 Economics Case Study Questions”

thanks for your information, dont forget to visit airlangga university website https://www.unair.ac.id/mahasiswa-unair-dan-y20-indonesia-diskusikan-isu-resesi-ekonomi/

thank you for Economics MCQs

https://mcqquestions.net/economics

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