CBSE Class 12 Economics Money And Banking VBQs Set 05

CENTRAL BANK

1. Objective Type Questions

A. Multiple Choice Questions

Question. The central bank:
(a) is an apex bank
(b) is the sole agency of note-issuing
(c) focuses on stability and growth of the economy
(d) All of the options
Answer: (d) All of the options

Question. Liquid assets include:
(a) unencumbered approved securities
(b) cash
(c) gold
(d) All of the options
Answer: (d) All of the options

Question. SLR refers to:
(a) cash reserves with the bank
(b) gold reserves with the bank
(c) reserves of unencumbered securities
(d) All of the options
Answer: (d) All of the options

Question. With an increase in market rate of interest, cost of credit:
(a) decreases
(b) increases
(c) remains constant
(d) none of the options
Answer: (b) increases

Question. Which of the following is the function of central bank of the country?
(a) Bank of note-issuing
(b) Lender's last resort
(c) Custodian of foreign exchange
(d) All of the options
Answer: (d) All of the options

Question. Quantitative instruments of monetary policy:
(a) focuses on quantity of money across select sectors of the economy
(b) focuses on the overall supply of money in the economy
(c) focuses on inflationary and deflationary gaps in the economy
(d) both (b) and (c)
Answer: (d) both (b) and (c)

Question. Repo rate relates to:
(a) short-term borrowings by the commercial banks
(b) long-term borrowings by the commercial banks
(c) overnight borrowings by the commercial banks
(d) none of the options
Answer: (a) short-term borrowings by the commercial banks

Question. In order to correct the situation of deflation:
(a) securities are purchased by the commercial banks
(b) securities are sold by the commercial banks
(c) securities are purchased by the central bank
(d) securities are sold by the central bank
Answer: (c) securities are purchased by the central bank

Question. The rate at which commercial banks are allowed to park their surplus funds with the RBI is called:
(a) bank rate
(b) repo rate
(c) currency rate
(d) reverse repo rate
Answer: (d) reverse repo rate

Question. Moral suasion by the RBI relates to:
(a) pressure by the RBI to follow its directives
(b) persuasion by the RBI to follow its directives
(c) persuasion as well as pressure by the RBI to follow its directives
(d) none of the options
Answer: (c) persuasion as well as pressure by the RBI to follow its directives

Question. With an increase in SLR, flow of credit in the economy:
(a) increases
(b) decreases
(c) remains unchanged
(d) none of the options
Answer: (b) decreases

Question. Margin requirement =
(a) Current value of the security offered for loan - Value of loan granted
(b) Current value of the security offered for loan + Value of loan granted
(c) Current value of the security offered for loan x Value of loan granted
(d) Current value of the security offered for loan / Value of loan granted
Answer: (a) Current value of the security offered for loan - Value of loan granted

B. Fill in the Blanks

Question. That bank which is at the highest place in the banking organisation is called _______. (commercial bank/central bank)
Answer: central bank

Question. Buying and selling of securities is called _______. (open market operations/narrow market operations)
Answer: open market operations

Question. The increase in bank rate is often followed by _______ in the market rate of interest. (increase/decrease)
Answer: increase

Question. _______ is also called Repurchase Rate. (Repo rate/Reverse repo rate)
Answer: Repo rate

Question. Statutory liquidity ratio is the _______ method of credit control. (quantitative/qualitative)
Answer: quantitative

Question. At _______, central bank accepts deposits from the commercial banks. (bank rate/reverse repo rate)
Answer: reverse repo rate

Question. By the withdrawal of rationing of credit, _______ is controlled. (inflation/deflation)
Answer: deflation

C. True or False

Question. Central bank is the custodian of nation's foreign exchange reserves.
Answer: True

Question. Reserve Bank of India is the central bank of India.
Answer: True

Question. In India, CRR is fixed by the commercial banks.
Answer: False

Question. In order to control money supply, central bank increases the bank rate.
Answer: True

Question. Central bank accepts deposits from the commercial banks.
Answer: True

Question. In order to increase money supply in the economy, margin requirement is raised.
Answer: False

D. Very Short Answer Questions

Question. Define a central bank.
Answer: A central bank is an apex institution of a country that controls and regulates the cost of credit as well as the flow of credit in the economy with a view to achieving growth and stability.

Question. Define bank rate.
Answer: The bank rate is the rate at which the central bank of the country offers loans to the commercial banks by discounting the securities. It is also called discount rate: the rate at which securities are discounted for purpose of loans. It does not involve any collateral.

Question. What is repo rate?
Answer: Repo rate (or policy interest rate) is the rate of interest at which commercial banks can raise short-term loans from the central bank by offering 'unencumbered securities' as collateral.

Question. What is reverse repo rate?
Answer: Reverse repo rate is the rate of interest at which commercial banks can park their surplus funds with the central bank.

Question. Define cash reserve ratio.
Answer: Cash reserve ratio refers to the legal reserve ratio (fixed by the RBI) indicating some percentage of demand deposits of the commercial banks to be kept as cash reserves with RBI.

Question. Define statutory liquidity ratio.
Answer: Statutory liquidity ratio refers to liquid assets of the commercial banks which they are required to maintain (on daily basis) as a minimum percentage of their total deposits.

Question. Define legal reserve ratio.
Answer: Legal reserve ratio refers to CRR (as well as SLR) as fixed by the central bank and which the commercial banks are required to maintain as a percentage of their demand deposits.

Question. What do you mean by open market operations?
Answer: Open market operations refer to the sale and purchase of government securities in the open market by the central bank of the country.

Question. Define margin requirement.
Answer: Margin requirement refers to the difference between market value of the security offered for loans and the amount of loans offered by the commercial banks.

Question. Define moral suasion.
Answer: Moral suasion refers to persuasion as well as pressure exercised by the central bank on the commercial banks to be restricted and selective in lending during inflation, and to be liberal in lending during deflation.

2. Reason-based Questions 

Read the following statements carefully. Write 'True' or 'False' with a reason.

Question. The central bank is the banker's bank.
Answer: True. The central bank is an apex bank of all banks in the country. Because, all banks are to work according to guidelines and directives of the central bank.

Question. The central bank is the currency authority.
Answer: True. The central bank is the sole-issuing authority in the country. It has the exclusive right of note-issuing.

Question. The central bank offers loans to the government.
Answer: True. The central bank offers loans to the government against government securities or treasury bills. It is a bank to the government of the country.

Question. Bank rate is the rate of interest charged by the bank on commodity loans.
Answer: False. Bank rate is that rate at which central bank gives loans to the commercial banks.

Question. Open market operations are meant to increase or decrease the supply of money in the economy.
Answer: True. In order to increase or decrease the money supply in the economy, central bank purchases or sells securities in the open market. Supply of money increases when securities are purchased and it decreases when securities are sold by the RBI.

Question. Reverse repo rate is the rate at which the central bank offers short period loans to the commercial banks.
Answer: False. Reverse repo rate is the rate at which commercial banks are allowed to park their surplus funds with the RBI.

Question. The goal of central bank is to maximise profit.
Answer: False. The goal of central bank is to achieve stability and growth of the economy.

Question. Qualitative instruments control the flow of credit to select sectors of the economy.
Answer: True. Qualitative instruments focus on select sectors of the economy. These instruments control the flow of credit to select sectors not by varying policy rates and ratios, but by issuing advisories to the commercial banks.

Question. If reverse repo rate is 4%, then repo rate will be lower than this.
Answer: False. If reverse repo rate is 4%, then repo rate will be higher than this. Because, the standard practice is to keep 'reverse repo rate' lower than the 'repo rate'. It is like lending rate being higher than the borrowing rate by the bank.

Question. A fall in SLR increases money supply in the economy.
Answer: True. Money supply in the economy increases when SLR decreases, because fall in SLR enhances capacity of the commercial banks to create credit.

Question. In order to curb inflation, repo rate is decreased.
Answer: False. In order to curb inflation, repo rate is increased. Increase in repo rate causes increase in market interest rate (rate of interest charged by the commercial banks from the general public). Accordingly, the cost of credit (also called the cost of capital) increases. This reduces the flow of credit, as desired to curb inflation.

Question. To reduce money supply in the economy, securities are purchased by the central bank of the country.
Answer: False. To reduce money supply in the economy, securities are sold by the central bank. Sale of securities soaks purchasing power from the money market. When liquidity is soaked/reduced, cash reserves of the commercial banks are squeezed. Implying a check on their credit creation capacity, and a cut in money supply.

3. HOTS & Applications

Question. Is money ever used as a commodity?
Answer: Money is used as a commodity when intrinsic value of money (value of the metal the coins are made of) exceeds its face value. People will then sell coins as a metal, rather than using them at their face value.
Example: Silver coins in circulation during the British rule in India are now used as a commodity rather than money.

Question. There is no equivalent cash to the amount of demand deposits with the banks. Why should then demand deposits be taken as a part of money supply?
Answer: This is because all demand deposits are chequeable deposits and can be used as money by way of issuing the cheques.

Question. Distinguish between 'face value' and 'intrinsic value of money'.
Answer: Face value refers to what is indicated on a note or a coin, like five rupees or ten rupees.
Intrinsic value refers to market value of the material with which money is made of. In olden days, coins were made of gold and silver. Intrinsic value of a coin then implied the market value of gold or silver that the coin was made of.

Question. Distinguish between 'money' and 'near money'.
Answer: Money refers to notes and coins or things like cheques which are commonly accepted as a medium of exchange.
Near money refers to all such financial instruments (likes Kisan Vikas Patra) which are sometimes used like money as a medium of exchange or for the store of value or for the transfer of value from one individual to the other.

Question. What is credit creation?
Answer: Credit creation refers to creation of demand deposits with the commercial banks on the basis of their cash reserves. Often, the deposits are created many times more than the cash reserves (the ratio between the cash reserves and deposits is called cash reserve ratio). This is based on the historical experience of the banks that cash withdrawal of funds is only a small percentage of the total demand deposits. If against the cash reserves of Rs. 100, demand deposits of Rs. 1,000 are created, it is called credit creation by a multiple of 10 or 10 is treated as credit multiplier.

Question. What is selective credit control?
Answer: Selective credit control refers to credit control policy of the central bank that seeks to increase the flow of credit to priority sectors of the economy. It would also mean restricting the flow of credit to certain sectors, particularly those related to speculative business activity.

Question. How is quantitative credit control different from qualitative credit control?
Answer: Quantitative credit control refers to overall credit control in the economy, affecting all sectors of the economy equally and without discrimination. Qualitative credit control refers to selective credit control that focuses on allocation of credit to different sectors of the economy. Flow of credit is encouraged to the priority sectors, while it is discouraged to the non-priority sectors (particularly those engaged in speculative business activity).

Question. While performing their primary functions of accepting deposits and making advances, the commercial banks happen to be the suppliers of money. Explain.
Answer: The commercial banks make advances many times more than cash reserves. Where does the money come from? From no where. They just open account in favour of the borrower and show his borrowing as demand deposits. The value of demand deposits far exceeds the value of cash reserves of the banks which is what adds to the supply of money in the economy. The banks are required to keep only a small fraction of demand deposits in the form of cash (CRR). These demand deposits serve as money as these are chequeable deposits. This is how banks happen to be the suppliers of money while they perform their primary functions of accepting deposits and making advances.

4. Analysis & Evaluation

Question. If CRR is scrapped as a legal requirement, do you think the banks can create unlimited amount of money supply?
Answer: No. Even if CRR is scrapped as a legal requirement, the commercial banks must continue to hold some cash reserves as a percentage of their demand deposits. Because, in the absence of these reserves, the banks may sink into 'crises of confidence'. People may start withdrawing their deposits from the banks enmass and the banks will simply have no reserves to cope with the withdrawals. If CRR is not fixed by the Apex Bank (like RBI in India), the banks on their own must hold cash reserves on the basis of their historical experience, as to how much of cash reserves should be enough to cope with the routine cash withdrawals by the depositors. This practice (of voluntarily holding cash reserves) has been followed in many countries like UK and Canada.

Question. Imagine yourself the RBI Governor. How would you use the instrument of CRR to increase investment in the economy?
Answer: CRR refers to that ratio of demand deposits of the commercial banks which they are legally bound to keep as reserves with the RBI. To increase the investment in the economy, it would be appropriate to reduce the CRR. Reduction of CRR increases credit creation capacity of the commercial banks. Accordingly, the flow of credit increases in the market.
Also, rate of interest tends to decrease when the availability of credit increases. Consequently, demand for credit increases for the purpose of investment.

Question. In the present scenario when the industrial growth is low, do you think a cut in repo rate by the RBI would accelerate the pace of industrial growth?
Answer: If repo rate is cut, industrial growth is expected to accelerate in two ways, as under: