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A Central Bank is the apex bank engaged in regulating Commercial Bank.

CRR is the fraction of the deposits which commercial banks are required under law to keep as cash reserves, with the central bank. CRR is a powerful instrument to control credit and lending capacity of the banks.

SLR is a part of deposits which Commercial Banks have to keep with themselves. Banks are required to keep a fixed percentage of its assets in cash, gold or other securities. SLR is raised to reduce the ability, of the banks to give credit.

(i) Bank of Issue: Refers to the legal right to issue currency. The Central Bank enjoys complete monopoly of note issue. This brings about uniformity in note circulation. At the same time, it gives the Central Bank power to influence money supply because currency with public is a part of money supply.

(ii) Banker’s Bank: Commercial Banks have to keep a certain percentage of its deposits as cash reserves with the Central Bank. The Central Bank uses these reserves to meet the emergency cash needs of the Commercial Banks. The Central Banks in this way gives loans to these banks. It makes the Central Bank the banker’s bank.

Statutory Liquidity Ratio is the fraction of total deposits of a Commercial Bank which it has to keep with itself in the form of specified liquid assets by the direction of Central Bank.

It is the rate of interest at which the central bank (Reserve Bank) accepts deposits from the commercial banks.

Bank rate is the rate at which central bank offers loans to the Commercial Banks as a lender of last resort. During inflation, when supply of credit is to be reduced, bank rate is increased. This reduces borrowing by the Commercial Banks implying a reduction in their cash reserve and therefore, a reduction in their capacity to create credit. Following increase in bank rate, market rate of interest is also raised, implying a check on borrowings from the Commercial Banks. Thus, overall supply of credit is reduced in the economy. Exactly opposite is done to combat deflation: bank rate is lowered to increase the supply of credit.

Reverse Repo Rate refers to the rate of interest paid by the Central Bank on deposits made by the Central Bank on deposits made by the Commercial Banks. When it is raised, commercial Banks are encourage to make more deposits with Central Bank. As a result, funds available for lending with the Commercial Banks decrease. Their capacity of lending declines and Credit Creation is less.

Detailed Answer:

The rate at which Central Bank borrows money from the banks is termed as Reverse Repo Rate. The Central Bank uses this tool when it feels there is too much money floating in the banking system. In case of a rise in the Reverse Repo Rate, it becomes more profitable for the Commercial Banks to lend to Central Bank, since they will now get higher amount against the amount lent. This implies higher the amount lent, higher are the returns. Thus, the Commercial Banks aim to transfer greater amount of funds to the Central Bank. This, in turn implies that the Commercial Banks are left with less surplus funds that they can lend to the general public. Hence, the lending capacity of the Commercial Banks reduces. This would further imply lesser amount of credit and money flowing within the economy, hence, lesser money supply. This results in the reduction in the credit creation capacity of Commercial Banks. A rise in reverse repo rate is desirable by the Central Bank if it aims at contracting monetary policy. However, on the contrary if the Central Bank aims at expansionary monetary policy, then it at first instance reduces the Reverse Repo Rate, which in tum makes the lending unattractive and discourages the Commercial Banks to lend to the Central Bank. Thereby, a fall in the reverse repo rate restricts the flow of money and credit in an economy. 

Repo rate is the rate at which commercial banks can borrow money from RBI to overcome the shortage of money. By varying the repo rates, the RBI can increase or decrease the supply of money. This rate relates to the loan offered by RBI with securities and only short term borrowings by the commercial banks. 

Repo rate is used as the main instrument of credit control. When the Central Bank raises the repo rate, there will be an increase in the cost of borrowing which reduces commercial banks borrowing from the Central Bank. Consequently, the flow of money from the commercial banks to the public reduces. Therefore, the supply of money reduces and bank credit creation is controlled.

(i) Margin Requirement: A margin refers to the difference between market value of the security offered for loan and the amount loan offered by the Commercial Banks. During inflation, supply of credit is reduced by raising the requirement of margin. During deflation supply of credit is increased by lowering the requirement  of ‘margin’. This measure is often used to discourage the flow of credit into speculative business activities.

(ii) Moral suasion: It refers to moral pressure exercised by the Central Bank on the Commercial Bank to be restricted and selective in lending during inflation, and to be liberal in lending during deflation. Generally, this measure is used as a selective credit control instrument to channelize the flow of credit to priority areas.

This is the most crucial function played by any central bank in the modern times. Central Banks are supposed to regulate and control the volume and direction of the credit by using the:

(i) Quantitative techniques- are those techniques which influence the quantutm of credit in the economy like open market operations, bank rate policy, repo and reserve repo rate policy etc.

(ii) Qualitative techniques- or selective credit control techniques are the ones which influence the direction of credit in the economy like margin requirements and moral suasion.

Methods of regulating money supply

(i) Bank Rate

(ii) Cash Reserve Ratio

(iii) Statutory Liquidity Ratio

(iv) Repo Rate

(v) Reverse Repo Rate

(vi) Open Market Operation

(vii) Margin Requirements

Detailed Answer:

The following are the two principal methods of credit control used by central bank:

(i) Repo Rate: Repo rate is the rate at which the central bank lends money to the commercial banks. The increase (or decrease) in repo rate is often followed by increase (or decrease) in the market rate of interest. Accordingly, the cost of credit (also called the cost of capital) changes in the market. During inflation, the cost of capital is increased by increasing the repo rate. This reduces the flow of credit, as desired. On the other hand, during deflation the cost of capital is reduced by reducing the repo rate. This increases the flow of credit.

(ii) Open Market Operations: Open market operations refers to sale and purchase of securities by the central bank in the open market. To increase money supply (as during deflation) securities are purchased by the central bank. On the other hand, to decrease money supply (as during inflation) securities are sold off. By buying the securities, the central bank releases liquidity and hence, a rise in capacity to create credit of the commercial banks. By selling the securities, liquidity is sucked from the economy and hence, a reduction in capacity to create credit of the commercial banks.

Central Bank is the sole authority to issue currency in the country. Since no other authority is allowed, this ensures uniformity in issue of currency. Since currency with public is a part of money supply, it gives the Central Bank some control over money supply in the economy.

Detailed Answer:

Central Bank as "Bank of Issue" The Central Bank of a country has the sole authority of issuing currency notes and coins in the country. All the currency issued by the Central Bank are unlimited legal tenders. No other Commercial Bank or financial institution can issue these currency except Central Bank. Often, the Central Bank divides its functions into two departments Banking Department and Issue Department. It is the issue department that is responsible for note-issuing. It issues currency to cope with the demand for it, which depends upon the level of economic activity in the economy. Hence, Central Bank is also known as Bank of Issue.

In emergency situations, when a Commercial Bank fails to accommodate its financial requirement, the Central Bank acts as the "Lender of Last Resort." The Central Rank issues loans to a Commercial. Bank against specified and approach securities of the bank. In this way, the Central Bank ensures the smooth functioning of Commercial Banks and appropriate flow of credit in the economy. Due to the above stated reasons, the Central Bank is termed as "Lender of Last resort”.

(ii) Ministry of Finance

Central Bank is a banker to the Government like Commercial Banks are to the public. It accepts deposits from Government and gives loans to the Government in times of need.

(i) Repo rate is the rate of interest at central bank lends money to commercial banks for a short-term. The Central Bank fixes the Repo Rate and it plays the role of an indicator of lending rate and deposit rate fixation by the banks. Under inflationary conditions, Central Bank increases the Repo Rate.

(ii) marginal requirement refers to the difference between market value of the security offered for loans and the amount of loans offered by the Commercial Banks. The Central Bank fixes the margin requirements and under deflationary conditions Central Bank reduces the margin requirements.

(ii) Margin Requirements

Legal Reserve Ratio has two variants:

(i) Cash Reserve Ratio, and (ii) Statutory Liquidity Ratio.

Cash Reserve Ratio (CRR)-It refers to cash reserves of Commercial Banks with the Central Bank as a percentage of their deposits.

Statutory Liquidity Ratio (SLR) refers to reserves in the form of liquid assets (including (i) cash, (ii) gold, and (iii) approved securities) with the Commercial Banks themselves, as a percentage of their total deposits.

Both CRR and SLR are fixed by the Central Bank, and both are a legal binding for the Commercial Banks. In this sense, both CRR and SLR are legal reserve ratios.

Legal Reserve Ratio has two variants:

(i) Cash Reserve Ratio, and (ii) Statutory Liquidity Ratio.

Cash Reserve Ratio (CRR)-It refers to cash reserves of Commercial Banks with the Central Bank as a percentage of their deposits.

Statutory Liquidity Ratio (SLR) refers to reserves in the form of liquid assets (including (i) cash, (ii) gold, and (iii) approved securities) with the Commercial Banks themselves, as a percentage of their total deposits.

Both CRR and SLR are fixed by the Central Bank, and both are a legal binding for the Commercial Banks. In this sense, both CRR and SLR are legal reserve ratios.

Bank Rate is the rate at which Central Bank gives loans to the Commercial Banks.

CRR is the ratio of bank deposits which a bank is required to keep with the central bank.

CRR is the ratio of bank deposits which a bank is required to keep with the central bank.

CRR is the ratio of bank deposits which a bank is required to keep with the central bank.

Commercial Banks are required to keep a certain minimum percentage of deposits as cash reserves with the Central Bank. Central Bank uses these reserves to meet emergency requirements of Commercial Banks. It is called Banker's Bank function of the Central Bank.

Currency Authority function means that the Central Bank has the sole authority to issue currency. It brings uniformity in note circulation. It also gives power to the Central Bank to directly control money supply.

Detailed Answer:

The principal functions of the Central Bank are as follows:

(i) Issuing of Notes or Currency Authority-The Central Bank is the sole note issuing authority in the country. Large number of Central Banks have divided their functions into two parts - Banking department and issue department. It is the issue department that is responsible for issuing note.

(ii) Banker to the Government-Central Bank acts as a banker, agent and financial advisor to the government. It keeps the accounts of all government banks and manages government treasuries. The loans are given to the government without any interest for short-terms. It also transfers government funds. It also buys and sells securities, treasury bills on behalf of the government. Being the apex bank of the country, it advises the government from time to time on economic, financial and monetary matters.

Although Central Bank does not deal with public, it deals with government. It conducts the same banking operations for government as Commercial Bank do for public, it gives them loans, does interbank transfers etc. for government.

Detailed Answer:

"Government Banker’s Function of the Central Bank"-Central Bank acts as a banker advisor and agent to the Central and State Governments. As the Common Public keep their cash balance, demand deposits and time deposits with Commercial Banks; a Central Bank manages the cash reserves and demand deposits of governments in current accounts. It carries out the exchange, remittance and other banking operations on behalf of government.

It issues loans and advances to the government and does buying and selling of securities on behalf of government. It also advises the government to frame monetary policy of the country to control the credit creation and money market. That is why the Central Bank is a 'Governments Banker.'

Commercial Banks are required to keep a certain percentage of deposits with the Central Bank as reserves. Beside Central Banks accepts deposits from Commercial Banks and gives them loan in times of need. In this way, Central Banks is banker’s bank.

Detailed Answer:

Banker's Bank-As banker's bank, the Central Bank offers loans to the Commercial Banks to tide over their financial crises. It also accepts surplus funds of the Commercial Banks as deposits. The rate at which the Central Bank offers loans to the Commercial banks is called Repo Rate (Bank Rate) and the rate at which the Central Bank accepts deposits from the Commercial Banks is called 'Reverse Repo Rate'.

While discharging its supervisory functions, the Central Bank regulates and controls credit creation activity of the Commercial Banks by fixing '2 ratios' and '2 rates' which are to be followed in practice by the Commercial Banks as a matter of legal binding. The 2 ratios are: (i) CRR (Cash Reserve Ratio), and (ii) SLR (Statutory Liquidity Ratio). The 2 rates are: (i) Repo Rate, and (ii) Reverse Repo Rate.

It is by varying these rates and ratios that the Central Bank supervises/monitors the functioning of Commercial Banks.

(i) Bank of issue

(ii) Governments bank

(iii) Bankers Bank

(iv) Controller of credit

Detailed Answer:

The principal functions of the Central Bank are as follows:

(i) Issuing of Notes or Currency Authority-The Central Bank is the sole note issuing authority in the country. Large number of Central Banks have divided their functions into two parts - Banking department and issue department. It is the issue department that is responsible for issuing note.

(ii) Banker to the Government-Central Bank acts as a banker, agent and financial advisor to the government. It keeps the accounts of all government banks and manages government treasuries. The loans are given to the government without any interest for short-terms. It also transfers government funds. It also buys and sells securities, treasury bills on behalf of the government. Being the apex bank of the country, it advises the government from time to time on economic, financial and monetary matters.

CRR refers to the percentages of deposits required to keep with the Central Bank Raising CRR reduces funds with the Commercial Banks for lending. Credit creation decreased.

Detailed Answer:

CRR refers to the minimum proportion of the total deposits that the commercial banks has to maintain with the central bank in the form of reserves. An increase in CRR, would mean that banks would be required to keep a greater portion in form of deposits with the central bank. This implies that the commercial banks are left with lesser amount of funds to lend out. Hence, the lending capacity of the banks reduces, leading to fall in the money supply. On the contrary, a fall in CRR will lead to an increase in the money supply.

CRR = Deposits with the banks

=> Cash reserve of the bank

=> Lending capacity of banks 

=> Money supply CRR 

=> Deposits with the banks

=> Cash reserve of the bank

=> Lending capacity of bank

=> Money supply

Purchase or sale of government securities by the central bank (RBI) to the general public is called open market operations.

In order to reduce the supply of money RBI will start selling government securities. Those who buy make payments by cheques. This reduces deposits with banks and this in tum reduces deposits with banks and this in turn reduces credit creation by banks. Thus money supply is reduced.

Detailed Answer:

Open Market Operations: Open market operations refers to sale and purchase of securities by the Central Bank in the open market. To increase money supply (as during deflation) securities are Purchased by the central bank. On the other hand, to decrease money supply (as during inflation) securities are sold off. By buying the securities, the central bank releases liquidity and hence, a rise in capacity to create credit of the commercial banks. By selling the securities, liquidity is sucked from the economy and hence, a reduction in capacity to create credit of the commercial banks.

(iii) Both (i) and (ii)

Creation of credit is one of the crucial functions performed by a commercial bank in modern times. The commercial bank is responsible for putting money (produced/created by central bank) in circulation through the  process of credit creation or the lending process.

Numercial Illustration, may be based on the following assumption:

(i) There is only one bank in the economy.

(ii) Initial deposits are say Rs.10000 crores and the legal reserve requirement proposed by the central bank is 10%.

(iii) Credit Creation = Initial deposits x 1/LRR

= 10000/0.1

= Rs.100000 crores

Students may provide a schedule for deriving the same.

Bank rate is the rate at which central bank offers loans to the Commercial Banks as a lender of last resort. During inflation, when supply of credit is to be reduced, bank rate is increased. This reduces borrowing by the Commercial Banks implying a reduction in their cash reserve and therefore, a reduction in their capacity to create credit. Following increase in bank rate, market rate of interest is also raised, implying a check on borrowings from the Commercial Banks. Thus, overall supply of credit is reduced in the economy. Exactly opposite is done to combat deflation: bank rate is lowered to increase the supply of credit.

In the year 1935.

It decreases the credit.

Direct action is adopted by the central bank when commercial banks do not follow the methods and polices suggested by the central bank and issued by it from time to time. In such, an event, it has legal right to take direct action. In direct action, the central bank may refuse rediscounting of bills, or charge a huge rate of interest on it. In this way, commercial banks have to start following the norms suggested by the Central Bank.

The name of monthly bulletin published by RBI is ‘RBI Bulletin’.

(b) Government

(c) the year 1949

When central bank wants to contract the credit.

Cash reserve ratio means depositing a percentage of the net demand and time liabilities in the form of liquidity or cash by banks with the central bank.

(b) The rate at which central bank rediscounts the bills of commercial banks.

(a) Issue of currency

(c) Open market operation

(c) Moral suasion

It is the rate at which the central bank of a country borrows money from the commercial banks within a country.

Repo rate is the rate at which the central bank of a country lends short-term loans to the commercial banks in the event of any shortfall of funds.

Two main functions of central bank are :

1. Note issuing authority
2. Banker of Banks

The Central bank is a banker, agent and financial advisor to the government. As a banker to the government, it manages the accounts of the government. As an agent to the government, it buys and sells securities on behalf of the government. The Central bank offers loans to the government against government securities or treasury bills.

It is the rate at which the central bank of a country (Reserve Bank of India, in case of India) borrows money from the commercial banks within the country. It is the monetary policy instrument which can be used to control the money supply in the country. When this rate is increased, banks increase their savings in the central bank, which makes their loan-giving ability weaker. And if this rate is decreased, than banks decrease their savings from the central bank which increases their ability of giving loans. At present, this rate is 5.75%.

Repo Rate is that rate at which the central bank of a country lends money to the commercial banks in the event of any shortfall of funds. Repo rate allows repurchase of the securities. The holders of securities can repurchase them at a later date. Therefore, repo rate is also called repurchase rate. Repo rates relates to short-term borrowings by the commercial banks. At present, this rate is 6.25%.