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Money and Banking – Class 12 Economics notes, important questions and MCQs

NCERT Class 12 Economics, chapter 7. Notes, key terms, important questions with answers and MCQs.

Chapter overview

Money removes the problems of barter and serves as a medium of exchange, unit of account and store of value. Money supply is measured as currency held by the public plus deposits in banks. Commercial banks create credit by lending a part of deposits, and the Reserve Bank of India controls money supply and credit using tools such as the cash reserve ratio, statutory liquidity ratio, repo rate and open market operations.

Money and its functions

Barter requires a double coincidence of wants and lacks a common measure of value and a way to store value.
Functions of money: medium of exchange, unit of account (measure of value), store of value and standard of deferred payments.
Money supply is a stock: M1 = currency held by the public + net demand deposits with banks + other deposits with RBI; M3 = M1 + net time deposits of banks (broad money).

Credit creation by banks

Banks keep a fraction of deposits as reserves (cash reserve ratio) and lend the rest; loans return to the banking system as new deposits.
Total deposits created = initial deposit × money multiplier, where the multiplier is 1 ÷ reserve ratio in the simple case.
For example, with an initial deposit of ₹1,000 and a reserve ratio of 20 per cent, total deposits can rise to ₹5,000.

The Reserve Bank of India

The RBI, established in 1935, is India's central bank: it issues currency, is banker to the government and to banks, and is lender of last resort.
Quantitative tools: cash reserve ratio (CRR), statutory liquidity ratio (SLR), repo rate, reverse repo rate, bank rate and open market operations.
Raising CRR or the repo rate reduces credit and money supply; lowering them expands credit.

Key terms

Barter system: direct exchange of goods for goods without money
Money supply: the total stock of money held by the public at a point of time
Cash reserve ratio: the share of deposits banks must keep with the RBI as cash reserves
Repo rate: the rate at which the RBI lends short-term funds to commercial banks against securities
Money multiplier: the ratio of total deposits (or money supply) created to the initial deposit or reserves

Important questions with answers

What are the functions of money?2 marks

Money acts as a medium of exchange, removing the need for barter; a unit of account, measuring the value of goods and services; a store of value, allowing wealth to be saved; and a standard of deferred payments, allowing future payments such as loans to be expressed in money.

Explain how commercial banks create credit.3 marks

Banks keep only a fraction of deposits as reserves and lend the rest. The borrowers spend the money, and the receivers deposit it in banks, creating new deposits. Banks again keep a fraction and lend the rest. This process continues, so total deposits become a multiple of the initial deposit, equal to the initial deposit × 1 ÷ reserve ratio.

Explain the functions of the Reserve Bank of India and the tools it uses to control money supply.5 marks

The Reserve Bank of India, set up in 1935, is the central bank of India. It has the sole right to issue currency notes (except one-rupee notes and coins issued by the government). It is the banker to the government, managing its accounts and public debt. It is the banker's bank, holding a part of commercial banks' reserves and supervising them, and it acts as lender of last resort in crises. It manages foreign exchange reserves and controls money supply and credit. Its quantitative tools are as follows. The cash reserve ratio is the share of deposits banks must keep with the RBI; raising it reduces banks' lending capacity. The statutory liquidity ratio is the share of deposits banks must keep in liquid assets such as government securities. The repo rate is the rate at which the RBI lends to banks against securities; a higher repo rate makes credit costlier and reduces borrowing, while the reverse repo rate is the rate at which it borrows from banks. The bank rate is the rate at which it lends to banks over the longer term. Open market operations are sale and purchase of government securities; selling securities absorbs money and buying them injects money. Using these tools, the RBI controls inflation and supports growth.

Quick revision

Functions: medium, unit, store, deferred payments.
M1 = CU + DD + OD; M3 = M1 + time deposits.
Multiplier = 1 ÷ reserve ratio.
RBI tools: CRR, SLR, repo, reverse repo, OMO.

Exam tips

Learn M1 and M3 components exactly.
Practise one credit creation example with a table of rounds.

Practice MCQs

The main problem of barter is the lack of
1. people
2. goods
3. a double coincidence of wants
4. markets
Show answer
Answer: (c) a double coincidence of wants. Both parties must want each other's goods.
The central bank of India is the
1. State Bank of India
2. SEBI
3. NABARD
4. Reserve Bank of India
Show answer
Answer: (d) Reserve Bank of India. It was set up in 1935.
Money serving as a common measure of value is its function as a
1. store of value
2. unit of account
3. medium of exchange
4. deferred payment
Show answer
Answer: (b) unit of account. Prices are expressed in money.
M1 includes currency held by the public, net demand deposits and
1. time deposits
2. other deposits with RBI
3. gold reserves
4. foreign exchange
Show answer
Answer: (b) other deposits with RBI. Time deposits are in M3.
The rate at which RBI lends to commercial banks for short periods against securities is the
1. reverse repo rate
2. SLR
3. CRR
4. repo rate
Show answer
Answer: (d) repo rate. A rise in it makes loans costlier.
To reduce money supply, the RBI may
1. lower the CRR
2. sell government securities in the open market
3. lower the repo rate
4. buy securities
Show answer
Answer: (b) sell government securities in the open market. Selling securities absorbs money.
With an initial deposit of ₹1,000 and a reserve ratio of 20 per cent, maximum total deposits are
1. ₹1,200
2. ₹2,000
3. ₹5,000
4. ₹20,000
Show answer
Answer: (c) ₹5,000. 1,000 × (1 ÷ 0.2).
Why is the RBI called the lender of last resort
1. it lends only to farmers
2. it never lends
3. it provides funds to banks in a crisis when other sources fail
4. it lends to foreign governments only
Show answer
Answer: (c) it provides funds to banks in a crisis when other sources fail. It protects the banking system.

All chapters of Class 12 Economics

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.