Banking

Banking is the system that connects savings with loans, investment and economic growth.

When people deposit money in banks, that money does not remain idle. Banks use a part of these deposits to give loans to households, businesses, farmers, industries and governments. This process supports production, trade, employment and development.

In India, the Reserve Bank of India (RBI) is the central institution that regulates banks, controls money supply, issues currency, manages monetary policy and maintains financial stability.

Chapter 8 explains RBI, monetary policy, demand and time liabilities, NDTL, CRR, SLR, repo rate, reverse repo rate, MSF, LAF, open market operations, money supply, money multiplier, types of banks, capital adequacy ratio and Basel norms.

What Is Banking?

Banking refers to the process by which financial institutions accept deposits and provide loans, payment services and other financial facilities.

A bank mainly performs 2 basic functions:

• It accepts deposits from the public.
• It lends money to borrowers.

Banks are important because they convert public savings into productive credit.

Example: If a person deposits money in a bank, the bank can use a part of that deposit to provide loans to a business, farmer or homebuyer.

What Is RBI?

RBI stands for Reserve Bank of India.

It is the central bank of India.

The chapter states that RBI was set up under the RBI Act, 1934 and was nationalised in 1949.

RBI controls the banking system and plays a major role in India’s monetary and financial stability.

Historical Background Of RBI

The chapter mentions early discussions and commissions related to the creation of a central bank in India.

Important points:

• The Chamberlain Commission was linked with early central banking discussions.
• The Hilton Young Commission recommended the creation of a central bank and gave the name Reserve Bank of India.
• RBI was established under the RBI Act, 1934.
• RBI was nationalised in 1949.

Main Functions Of RBI

The chapter highlights 3 major functions of RBI, and these can be expanded into a clearer exam-ready form.

1. Printing And Issue Of Currency

RBI is responsible for issuing currency notes in India.

It ensures that enough currency is available for the economy.

However, coins are minted by the Government of India.

The chapter mentions currency printing and minting locations such as Nashik, Mumbai and Noida in the context of notes and coins.

2. Monetary Policy

RBI maintains the economic health of the country through monetary policy.

Monetary policy helps control:

• Inflation.
• Deflation.
• Money supply.
• Credit flow.
• Interest rates.
• Economic growth.

3. Maintaining Forex Reserves

RBI maintains India’s foreign exchange reserves.

Forex reserves help India manage external payments, import requirements and currency stability.

They also help the country face external shocks.

4. Banker To Banks

RBI acts as the banker to commercial banks.

Banks keep reserves with RBI and can borrow from RBI when required.

5. Regulator Of Banking System

RBI regulates banks and ensures that the banking system remains stable, liquid and trustworthy.

It sets rules related to reserves, lending, liquidity and financial discipline.

Printing Of Currency Depends On What?

The chapter notes that currency printing depends on factors such as:

• Rate of inflation.
• Amount of money in NDTL of commercial banks.
• Requirement of currency notes in circulation.

In simple language, RBI must ensure that the economy has enough money for transactions. But if too much money is supplied without matching production, inflation may rise.

Types Of Monetary Policy

The chapter explains different types of monetary policies:

• Accommodative monetary policy.
• Neutral monetary policy.
• Tight or dear money policy.
• Easy or cheap money policy.

Accommodative Monetary Policy

Accommodative monetary policy means expansion of money supply to support economic growth.

RBI may follow this policy when the economy needs more liquidity, more borrowing and more investment.

Possible steps include:

• Reducing policy rates.
• Reducing reserve requirements.
• Increasing liquidity in the banking system.

This policy is generally used during slowdown or weak demand.

Neutral Monetary Policy

Neutral monetary policy tries to balance inflation control and economic growth.

It neither strongly expands nor strongly contracts money supply.

The chapter describes it as a mild contraction in money supply while remaining neutral towards economic growth.

Tight Or Dear Money Policy

A tight money policy, also called dear money policy, is used during inflation.

Under this policy, RBI reduces money supply and makes credit costlier.

During inflation, RBI may:

• Increase CRR.
• Increase SLR.
• Increase repo rate.
• Sell government securities through open market operations.

The aim is to reduce excess demand and control price rise.

Easy Or Cheap Money Policy

An easy money policy, also called cheap money policy, is used during deflation or economic slowdown.

Under this policy, RBI increases money supply and makes credit cheaper.

During deflation, RBI may:

• Reduce CRR.
• Reduce SLR.
• Reduce policy rates.
• Purchase government securities through open market operations.

The aim is to increase demand, borrowing, investment and growth.

Tight Money Policy Vs Easy Money Policy

Basis	Tight Or Dear Money Policy	Easy Or Cheap Money Policy
Used During	Inflation	Deflation or slowdown
Money Supply	Reduced	Increased
Interest Rate	Increased	Reduced
CRR And SLR	Increased	Reduced
OMO Action	RBI sells securities	RBI purchases securities
Main Aim	Control inflation	Increase demand and growth

Demand Liabilities And Time Liabilities

Banks have different types of liabilities.

The chapter explains 2 important categories:

• Demand liabilities.
• Time liabilities.

Demand Liabilities

Demand liabilities are liabilities that banks must pay whenever demanded by the customer.

Examples:

• Current account deposits.
• Savings account deposits.
• Demand drafts.
• Other liquid forms of bank liabilities.

These are payable on demand.

Time Liabilities

Time liabilities are payable after a fixed time period.

Examples:

• Fixed deposits.
• Recurring deposits.
• Cash certificates.
• Security deposits.

The chapter notes that for banks, time liabilities are generally greater than demand liabilities.

Demand Liabilities Vs Time Liabilities

Basis	Demand Liabilities	Time Liabilities
Payment	Payable on demand	Payable after fixed time
Liquidity	More liquid	Less liquid
Examples	Current account, savings account, demand draft	Fixed deposit, recurring deposit, cash certificate
Bank’s Position	Can be withdrawn quickly	More stable deposit base

What Is NDTL?

NDTL stands for Net Demand and Time Liabilities.

It is the total demand and time liabilities of a bank after adjustments.

RBI uses NDTL to calculate reserve requirements such as:

• CRR.
• SLR.

Banks must maintain a certain percentage of their NDTL in different forms according to RBI rules.

Bank Rate

Bank rate is the rate at which RBI lends long-term loans to commercial banks without collateral.

It is an important monetary policy signal.

If bank rate increases, borrowing from RBI becomes costlier for banks. Banks may then increase lending rates for customers.

CRR – Cash Reserve Ratio

CRR stands for Cash Reserve Ratio.

It is the percentage of NDTL that every commercial bank must keep with RBI in cash.

The chapter explains that RBI decides a certain percentage of NDTL, and commercial banks must deposit that portion with RBI.

If banks fail to maintain CRR, a penalty may be imposed.

CRR Example

Suppose a bank’s NDTL is Rs 100 crore and CRR is 4 per cent.

The bank must keep:

4 per cent of Rs 100 crore = Rs 4 crore

with RBI as cash reserve.

Effect Of CRR

If CRR increases:

• Banks have less money to lend.
• Money supply falls.
• Credit becomes tighter.
• Inflation may reduce.

If CRR decreases:

• Banks have more money to lend.
• Money supply rises.
• Credit becomes easier.
• Growth may improve.

SLR – Statutory Liquidity Ratio

SLR stands for Statutory Liquidity Ratio.

It is the percentage of NDTL that banks must maintain in liquid assets.

These liquid assets may include:

• Cash.
• Gold.
• Government securities.
• Treasury bills.
• Government bonds.

The chapter also mentions PSU shares, bonds and some blue-chip securities in the context of liquid assets.

SLR Example

Suppose a bank’s NDTL is Rs 100 crore and SLR is 22 per cent.

The bank must maintain:

22 per cent of Rs 100 crore = Rs 22 crore

in liquid assets.

Effect Of SLR

If SLR increases:

• Banks must keep more money in liquid assets.
• Lending capacity falls.
• Money supply reduces.

If SLR decreases:

• Banks can lend more.
• Credit availability increases.

CRR Vs SLR

Basis	CRR	SLR
Full Form	Cash Reserve Ratio	Statutory Liquidity Ratio
Maintained With	RBI	Bank itself
Form	Cash only	Cash, gold and approved securities
Based On	NDTL	NDTL
Purpose	Control liquidity and money supply	Ensure bank liquidity and safety
Income For Bank	No interest generally	Banks may earn interest on securities

CRR Plus SLR

The chapter states:

CRR + SLR = Statutory / Legal / Variable Reserve Requirements

These reserve requirements help RBI regulate how much money banks can lend.

Repo Rate

Repo rate is the rate at which RBI lends short-term money to commercial banks against government securities.

Repo means repurchase agreement.

Banks borrow money from RBI by selling government securities with a promise to repurchase them later.

Effect Of Repo Rate

If repo rate increases:

• Borrowing from RBI becomes costlier.
• Banks may increase loan rates.
• Credit demand may fall.
• Inflation may reduce.

If repo rate decreases:

• Borrowing becomes cheaper.
• Banks may reduce loan rates.
• Credit demand may rise.
• Growth may improve.

Reverse Repo Rate

Reverse repo rate is the rate at which RBI borrows money from commercial banks.

Banks park surplus money with RBI and receive interest.

If reverse repo rate increases, banks may prefer keeping money with RBI instead of lending more in the market.

This reduces liquidity.

Repo Rate Vs Reverse Repo Rate

Basis	Repo Rate	Reverse Repo Rate
Meaning	RBI lends to banks	RBI borrows from banks
Flow Of Money	RBI to banks	Banks to RBI
Used To	Inject liquidity	Absorb liquidity
Effect Of Increase	Loans may become costlier	Banks may park more funds with RBI
Main Purpose	Support bank liquidity	Control excess liquidity

LAF – Liquidity Adjustment Facility

LAF stands for Liquidity Adjustment Facility.

It is a facility through which RBI manages short-term liquidity in the banking system.

LAF mainly uses:

• Repo rate.
• Reverse repo rate.

Through LAF, banks can borrow from RBI or park surplus funds with RBI.

MSF – Marginal Standing Facility

MSF stands for Marginal Standing Facility.

It is an emergency borrowing window for scheduled commercial banks.

The chapter explains that MSF is used for short-term emergency loans to banks with government securities as collateral.

Banks may use a part of their SLR securities for borrowing under MSF.

Key Features Of MSF

• It is available to scheduled commercial banks.
• It is used in emergency liquidity situations.
• Borrowing is backed by government securities.
• It is costlier than normal repo borrowing.

Incremental CRR

Incremental CRR refers to an additional cash reserve requirement imposed by RBI on the increase in bank deposits over a certain period.

It is used when RBI wants to absorb extra liquidity from the banking system.

Example: If deposits suddenly rise sharply, RBI may temporarily require banks to keep an additional portion as reserves.

Reserve Deposit Ratio

Reserve Deposit Ratio, or RDR, shows the relationship between bank reserves and bank deposits.

In simple terms, it indicates how much reserve banks keep in relation to their deposits.

Higher reserve ratio means banks keep more funds as reserves and lend less.

Velocity Of Money Circulation

Velocity of money circulation means the number of times money passes from one hand to another in an economy.

If the same Rs 100 note is used several times for different transactions, its velocity is high.

High velocity means money is circulating actively in the economy.

RBI Credit Control Instruments

The chapter divides RBI’s monetary policy instruments into 2 types:

• Quantitative instruments.
• Qualitative instruments.

Quantitative Instruments

Quantitative instruments affect the total volume of credit and money supply.

They are also called general or indirect instruments.

The chapter lists:

• CRR.
• SLR.
• Open Market Operations.
• Repo Rate.
• Reverse Repo Rate.
• MSF.
• LAF.

Open Market Operations

Open Market Operations, or OMO, refer to buying and selling of government securities by RBI in the open market.

OMO During Inflation

During inflation, RBI sells government securities.

When banks and people buy these securities, money goes from the public to RBI.

This reduces liquidity and helps control inflation.

OMO During Deflation

During deflation, RBI purchases government securities.

Money flows from RBI to the market.

This increases liquidity and supports demand.

Quantitative Easing And OMO

The chapter notes that OMO is a regular phenomenon in India, while quantitative easing is a broader phenomenon often discussed in countries such as the US.

In simple terms, both involve central bank action in securities markets, but quantitative easing is usually a larger and more extraordinary liquidity support programme.

Qualitative Instruments

Qualitative instruments control the direction and purpose of credit rather than only the total amount of credit.

The chapter lists the following qualitative instruments:

• Loan-to-value requirements.
• Consumer credit control.
• Credit rationing.
• Priority sector lending.
• Moral suasion.

Loan-To-Value Requirements

Loan-to-value, or LTV, decides how much loan can be given against the value of collateral.

Example from the chapter:

If a person gives gold worth Rs 1 lakh as collateral and the bank gives Rs 60,000 loan, the LTV is 60 per cent.

During inflation, RBI may reduce LTV to reduce money supply.

During deflation, LTV may be relaxed to increase credit flow.

If this is applied to bonds and securities, it is also known as margin requirement.

Consumer Credit Control

Consumer credit control means regulating the terms of consumer loans.

RBI can influence down payment, instalment structure and credit availability depending on inflation or deflation.

During inflation, consumer credit may be tightened to reduce demand.

During deflation or slowdown, consumer credit may be relaxed to support consumption.

Credit Rationing

Credit rationing means dividing or directing loans to different areas or sectors according to need.

Example: If the agriculture sector needs more support, a larger share of credit may be directed towards agriculture.

The chapter links this with priority sector lending.

Priority Sector Lending

Priority sector lending means banks must give a certain share of loans to important sectors such as:

• Agriculture.
• Small industries.
• Weaker sections.
• Education.
• Housing.

The chapter mentions a ceiling or target where RBI may impose priority sector lending requirements, such as 40 per cent.

Moral Suasion

Moral suasion is a method where RBI persuades banks to follow certain lending or credit behaviour without using strict legal force.

It is a qualitative credit control instrument.

Example: RBI may advise banks to reduce lending to speculative activities during inflation.

Currency Deposit Ratio

Currency Deposit Ratio, or CDR, is the ratio of money held by the public in currency to public deposits in banks.

Formula:

CDR = Money Held By Public / Public Deposits In Banks

If people hold more cash and deposit less money in banks, CDR rises.

A higher CDR can reduce banks’ ability to create credit.

Money Multiplier

The chapter gives:

Money Multiplier = M3 / M0

Where:

• M0 = Reserve money or high-powered money.
• M3 = Broad money.

Money multiplier shows how much broad money is created from reserve money.

If banks lend more and people deposit more, the money multiplier may rise.

Measures Of Money Supply

The chapter gives the measures of money supply as:

• M0
• M1
• M2
• M3
• M4

M0 – Reserve Money Or High-Powered Money

M0 is also called:

• Reserve money.
• High-powered money.
• Government money.

It includes:

• Currency in circulation.
• Bankers’ deposits with RBI.
• Other deposits with RBI.
• Currency held in bank vaults for day-to-day operations.

M1 – Narrow Money

M1 is called narrow money.

It includes:

• Currency with the public.
• Demand deposits.
• CASA deposits, meaning current account and savings account deposits.

M1 is highly liquid.

M2

M2 includes:

M2 = M1 + Post Office Savings Deposits

Only savings deposits of post offices are included here.

M3 – Broad Money

M3 is called broad money.

M3 = M1 + Time Deposits

Time deposits include fixed deposits, recurring deposits and similar deposits.

M3 is an important measure of money supply in India.

M4

M4 includes:

M4 = M3 + Total Post Office Deposits

This includes savings and time deposits of post offices.

Order Of Liquidity And Quantity

The chapter gives:

Order of Liquidity:

M1 > M2 > M3 > M4

This means M1 is the most liquid and M4 is the least liquid among these measures.

Order of Quantity:

M4 > M3 > M2 > M1

This means M4 is the widest measure and M1 is the narrowest.

Money Supply Measures At A Glance

Measure	Meaning	Liquidity
M0	Reserve money or high-powered money	Base money
M1	Currency with public plus demand deposits	Most liquid
M2	M1 plus post office savings deposits	Less liquid than M1
M3	M1 plus time deposits	Broad money
M4	M3 plus total post office deposits	Widest measure

Classification Of Banks

The chapter classifies banks into different categories.

Major categories include:

• Commercial banks.
• Cooperative banks.
• Regional rural banks.
• Payment banks.
• All India Financial Institutions.

Commercial Banks

Commercial banks are banks that accept deposits and provide loans for profit.

They include:

• Public sector banks.
• Private sector banks.
• Foreign banks.
• Special banks.

Commercial banks are the main part of the banking system.

Cooperative Banks

Cooperative banks are banks owned and operated on cooperative principles.

The chapter mentions categories such as:

• Urban cooperative banks.
• State cooperative banks.
• Central cooperative banks.
• PACS – Primary Agricultural Credit Societies.

They are important for rural credit and local financial needs.

Regional Rural Banks

Regional Rural Banks, or RRBs, provide banking services in rural areas.

They support agriculture, small farmers, rural labourers and rural businesses.

Payment Banks

Payment banks are banks that provide payment and deposit services but have restrictions on lending.

They help improve financial inclusion and digital payments.

All India Financial Institutions

The chapter mentions several All India Financial Institutions.

Important examples include:

Institution	Area Of Work
NABARD	Agriculture and rural development
EXIM Bank	Export-import finance
NHB	Housing finance
SIDBI	Small industries

These institutions support specific sectors of the economy.

Capital Adequacy Ratio – CAR

CAR stands for Capital Adequacy Ratio.

It shows the proportion of a bank’s assets that must be held as capital.

The chapter explains that if CAR is 10 per cent, and the bank has loans or risk assets of Rs 100, the bank must keep Rs 10 as capital.

Why CAR Is Important

CAR protects depositors and strengthens banks.

It ensures that banks have enough capital to absorb losses.

If a bank gives loans and some borrowers fail to repay, capital helps the bank remain stable.

Basel Norms

Basel is a place in Switzerland where the Bank for International Settlements (BIS) is located.

The chapter describes BIS as an institution that works like a central bank for central banks.

Basel norms are international banking standards used to regulate capital, risk and stability in the banking system.

CAMELS Principle

The chapter mentions banking regulation through the principle of CAMELS.

CAMELS stands for:

Letter	Meaning
C	Capital adequacy
A	Asset quality
M	Management
E	Earnings
L	Liquidity
S	Sensitivity or system control

CAMELS helps assess the health of banks.

Basel I

Basel I was introduced in 1988.

It mainly focused on credit risk.

Credit risk means the risk that borrowers may fail to repay loans.

Basel II

Basel II was introduced in 2004.

It focused on broader banking stability and included:

• Credit risk.
• Operational risk.
• Market risk.

Basel III

Basel III was introduced in 2010 after the global financial crisis.

It aimed to strengthen banks by improving capital, liquidity and risk management.

The chapter links Basel III with lessons from financial crises.

Basel I Vs Basel II Vs Basel III

Basel Norm	Year	Main Focus
Basel I	1988	Credit risk
Basel II	2004	Credit risk, operational risk and market risk
Basel III	2010	Financial crisis response, stronger capital and liquidity

Inflation And Deflation Policy Summary

The chapter gives a simple policy rule:

During Inflation

• CRR increases.
• SLR increases.
• Tight or dear money policy is followed.
• RBI sells government securities through OMO.

During Deflation

• CRR decreases.
• SLR decreases.
• Easy or cheap money policy is followed.
• RBI purchases government securities through OMO.

Important Banking Formulas

Concept	Formula Or Meaning
CRR	Percentage of NDTL kept with RBI in cash
SLR	Percentage of NDTL kept by banks in liquid assets
CRR + SLR	Statutory or legal reserve requirements
Money Multiplier	M3 / M0
CDR	Money held by public / Public deposits in banks
CAR	Bank capital / Risk-weighted assets
M2	M1 + Post office savings deposits
M3	M1 + Time deposits
M4	M3 + Total post office deposits

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