BANKING CLASS 12 NOTES

This post specifically deals with Banking chapter belonging to MACRO ECONOMICS BOOK of class 12th . By reading this post one can understand the whole Banking chapter and that too in full details . Banking class 12 notes has been provided in this post and that too with proper detailed explanations . Explanations would NOT be the part of Banking class 12 notes . However , explanations would help digesting the concepts in an easy manner .

COMMERCIAL BANKS

 

• Definition – Commercial bank is a financial institution which performs the functions of ACCEPTING DEPOSITS & GRANTING LOANS , with the aim of earning profits .
• Eg. – State bank of India ( SBI ) , ICICI , Punjab National Bank ( PNB ) , Kotak Mahindra , Allahabad Bank , Canara Bank etc..

FUNCTIONS OF COMMERCIAL BANKS

The functions of Commercial banks can be classified into 2 categories –

1. Primary Functions.
2. Secondary Functions.

PRIMARY FUNCTIONS

Commercial banks perform two primary functions –

1. Accepting deposits
2. Granting loans OR Advancing loans .

ACCEPTING DEPOSITS

• Commercial banks accept deposits of several forms . Primarily , commercial banks accept 2 forms / types of deposits, namely Demand deposits and Term / Time deposits .
• Demand deposits are accepted by commercial banks are kept under 2 types of accounts , namely Current account and Savings account .
• The Time deposits OR Term deposits are also kept under 2 types of accounts , namely Fixed deposit account and Recurring deposit account .

Q – What are Demand deposits ?

Ans. Demand deposits are those deposits which can be withdrawn anytime i.e. which are repayable by bank on demand . Also , against demand deposits , cheques can be issued and hence demand deposits are also called CHEQUEABLE DEPOSITS . 

Q – What are Time deposits OR Term deposits ?

Ans. Time deposits or Term deposits are those deposits which can be withdrawn only after the completion of certain time period . In other words , Time deposits or Term deposits are those deposits which are repayable by banks only after the completion of a fixed period , which is pre-decided .

Q – What is Current account ?

Ans – Following are the features of Current account –

1. Current account is an account in which demand deposits are kept .
2. Current accounts are generally maintained by businessmen .
3. Amount deposited under Current account can be withdrawn by the depositor by issuing cheque . That is why , deposits kept under Current account are also called chequeable deposits .
4. Generally , there are no restrictions in terms of amount which can be withdrawn and also in terms of number of transactions .
5. Banks generally do not pay any interest on the deposits kept under current account , rather banks impose service charges for running these accounts .

Q – What is Saving account ?

Ans. – Following are the features of Saving account –

1. The deposits kept under Saving account contains the features of both current account deposits and fixed account deposits .
2. Depositor can withdraw his / her deposits by issuing cheque ( i.e. they are chequeable deposits ) .
3. However , restrictions are imposed in terms maximum amount which can be withdrawn and in terms of number transactions which can be done .
4. Banks pay interest to the depositors , who have kept money under Saving account . However , the rate of interest paid here is less than , which is paid on fixed deposits .

Q – What is Fixed Deposit OR Fixed deposit account ?

Ans. – Following are the features of Fixed deposit OR Fixed deposit account –

1. Fixed deposits refer to those deposits in which the amount is deposited with bank for a FIXED PERIOD / TIME / TERM .
2. Against the amount deposited into Fixed deposit account , Cheques can not be issued . In other words , Fixed deposits do not enjoy chequeable facility .
3. Commercial banks provide highest rate of interest on Fixed deposits .

Q – What is Recurring Deposit OR Recurring deposit account ?

Ans. – Following are the features of Recurring deposit OR Recurring deposit account –

1. Under Recurring deposit , fixed amount is deposited for a fixed period on recurring basis . In other words , under recurring deposit , fixed amount say Rs. 5000 would be deposited every month for 2 years ( say ) .
2. Commercial banks provide interest on recurring deposits which is higher than saving account deposit but lower than that of fixed deposits .
3. Against recurring deposits , cheques can not be issued . So , Recurring deposits are non – chequeable deposits .

GRANTING LOANS / ADVANCING LOANS

• Commercial banks , when receive deposits from the depositors , keep certain percentage as reserve and the rest amount is advanced as loan to the borrowers .
• Borrowers pay interest to the banks. This interest is the main source of income for the banks .
• Generally banks charge higher interest from borrowers and pay lesser interest to depositors. The between the depositors’ interest and the borrowers’ interest is called as the MARGIN or PROFIT to the banks .
• Banks provide various kinds of loans and advances , few of them are – Cash credit , Demand loans , short – term loans .

Q – What is Cash credit ?

Ans . –

• Cash credit refers to the loan provided to borrower against current assets like shares , stocks , bonds etc..
• Under it , a credit limit is sanctioned and the borrower can withdraw any amount within the sanctioned credit limit.
• However , interest is charged by bank on the amount actually withdrawn .

Q – What are Demand loans ?

Ans. –

• Demand loans are the loans which can be recalled by bank on demand .
• Interest is charged on the entire amount provided as loan .

Q – What are Short – term loans ?

Ans. –

• Short – term loans are provided as personal loans against the collateral security .
• Interest is charged on the entire amount paid as loan.

SECONDARY FUNCTIONS

Apart from Primary function of Accepting deposits and Advancing loans , Commercial banks also perform various other functions such as Overdraft facility , Discounting of Bills of Exchange , Agency functions , General utility functions.

1. OVERDRAFT FACILITY

• Under overdraft facility , a customer is allowed to overdraw the current account up to an agreed limit .
• OD facility , generally provided to trustworthy and respectable customers .
• OD facility is for short period only .
• Interest is charged by bank on the overdrawn amount .

 

2. DISCOUNTING OF BILLS OF EXCHANGE  

• Under it , any individual who is holding a bill of exchange can get the bill discounted with bank before maturity  .
• Holder of the bill is paid with money by the bank after deducting the commission / discounting charges .
• On the date of maturity , the party who has accepted the bill , directly pays the amount to the bank .

3. AGENCY FUNCTIONS

• Transfer of funds – Safe , easy and economical transfer of funds is provided by banks to different places via instruments like Demand drafts , mail transfers etc..
• Collection and payment of various items – Banks collect cheques , interest , dividend , bills and other periodical receipts on behalf of its’ customer and also banks pay taxes , insurance premiums etc.. on the instructions of customers .
• Purchase and sale of foreign exchange – Banks purchase and sell forex on behalf of their customers and hence help in promoting international trade .
• Purchase and sale of securities – Banks buy and sell securities on behalf of their customers .
• Income tax consultancy – Banks give advice to customers regarding income tax and help in filing ITR .
• Letter of reference – Banks provide information regarding economic position of customers to traders and traders’ information to its’ customers .

4. GENERAL UTILITY FUNCTION 

• Locker facility – Banks provide safety vaults or lockers to customers  .
• Travellers’ cheque – To avoid risk of taking cash , banks provide travellers’ cheque facility .
• Letter of credit – To certify the creditworthiness of its’ customers , banks issue Letter of Credit .

CENTRAL BANK(Banking class 12 notes)

• Definition – Central bank is an “Apex body “ that controls , operates , regulates , and directs the entire banking and monetary structure of the country .
• Q – Why central bank is called Apex body ?
• Ans.- Because central bank occupies the top most position in the monetary and banking system of the country.
• Indias’ central bank is Reserve Bank of India .
• RBI was established on 1st April 1935 , as per Reserve bank of India act 1934 .
• USA’s central bank = Federal reserve system ; UK’s central bank = Bank of England .

FUNCTIONS OF CENTRAL BANK(Banking class 12 notes)

Reserve bank of India ( RBI ) , being the central of country performs following functions –

1. Currency authority ( Bank of issue )
2. Banker to the government
3. Banker’s bank and supervisor
4. Controller of money supply and credit
5. Custodian of foreign exchange reserves

CURRENCY AUTHORITY ( BANK OF ISSUE )

• RBI ( as the central bank ) has the sole authority to issue paper currency notes ( Except one rupee notes and coins , which are issued by Ministry of Finance ) .
• The paper currency issued by the central bank ( RBI ) is it’s MONETARY LIABILITY . In other words , Central bank is bound to back the currency with assets of equal value , in order to enhance the public confidence in paper currency .
• Assets , in terms of which central bank backs paper currency usually consists of GOLD , FOREX , GOVERNMENT SECURITIES .

Q – What is the advantage of having only one sole authority to issue paper currency , OR

what are the benefits of having single currency issuing authority in the country , OR

What benefits one can trace out of having sole currency authority ?

Ans . – Following are the benefits / merits / advantages of having sole / single authority to issue paper currency –

1. It leads to uniformity in terms of currency circulation .
2. It enables central bank to influence money supply in the economy .
3. Ease to the government in terms of proper supervision and control over the central bank w.r.t issue of notes .
4. Ensures public faith in currency system .
5. Helps stabilizing internal and external value of currency .

NOTE – Central government faces Fiscal deficit , numerous times . To finance the fiscal deficit , government provides Treasury bills / Government securities to Central bank ( RBI ) . Against this , Central bank prints currency and pays the amount to government . This is known as “ Deficit financing OR Monetizing the government’s debt ” .

BANKER TO THE GOVERNMENT

• RBI acts as a banker , agent and a financial advisor to the central government and all state governments .
• RBI accepts receipts and makes payments for the government and carries out exchange , remittances and other banking operations .
• RBI provides advances and loans to the government for short / temporary periods . Government borrows money by selling Treasury bills / Government securities to RBI .
• Central bank maintains current account for keeping cash balances of the government .
• As an agent , central bank manages public debt .
• As a financial advisor , central bank advises government on economic and monetary matters .

BANKER’S BANK & SUPERVISOR (Banking class 12 notes)

• Central bank regulates and supervises the functioning of commercial banks.
• Central bank , being the apex bank acts as Banker to the commercial banks.

As banker to banks , central bank performs three important functions :-

1) Custodian of Cash Reserve
Commercial banks keep certain proportion of their NDTL with central bank (CRR).Hence, central bank acts as custodian of cash reserve.

2) Lender of the last resort

Whenever commercial banks face financial crisis and finds it difficult to meet their financial requirements, they approach to central bank for loans and advances at lender of the last resort. Commercial banks can put some collateral with central bank in terms of securities or bonds etc… and can get credit.

3) Clearing house function

Central bank keeps cash reserves of all commercial banks and due to this reason it becomes easier for the central bank to discharge the function of clearing house.
Also, all commercial banks maintain their accounts with central bank and hence the central bank can easily settle down the claims of various commercial banks against each other by debiting or crediting their accounts.

As a supervisor, Central bank performs following functions :-

• Central bank regulates commercial banks in terms of licensing , branch expansion , liquidity of assets , management , merging , winding up etc..

CONTROLLER OF MONEY SUPPLY AND CREDIT

• Central bank i.e. Reserve Bank of India (RBI) controls money supply and credit with the objective of doing best to the economy. Also , RBI being the sole currency issue authority, it becomes easier for it to control money supply in the economy.
• To control money supply or for credit control RBI has qualitative and quantitative tools.

Quantitative tools are:-

1) Repo (repurchase) rate
2) Bank rate (or discount rate)
3) Open market operation
4) Legal reserve requirement –
a.) CRR
b.) SLR

5) Margin requirements

Qualitative tools are:-

1.) Selective credit control
2) Moral suasion
3)Direct action

QUANTITAVE TOOLS

1) Repo (repurchase) Rate –

• Repo-rate is the rate at which the central bank of a country are (RBI in case of India) lends money to commercial banks to meet their short-term requirements.
• To raise funds at Repo-rate commercial banks need to put assets ( bonds, Govt-securities ) as collateral with central bank.

Q- What will happen if Central bank increases Repo rate?

Ans. If central bank increases Repo – rate , it would simply mean that cost of borrowings for commercial banks would increase. An increase in cost of borrowings for commercial banks would ultimately increase the lending rates for general public. An increase in lending rates by commercial banks would discourage the borrowers to borrow from commercial banks.

Q- What will happen if Central bank decreases Repo- rate?

Ans. If central bank decreases Repo-rate, it would simply mean that cost of borrowings for commercial banks would decrease. A decrease in cost of borrowings for commercial banks would ultimately decrease the lending rates for general public.
A decrease in lending rates would mean borrowers would borrow more and more money from commercial banks and money supply into the economy would increase.

Q- How Repo-rate can be used by central bank to control/ combat inflation in the economy?

Ans. Inflation refers to an economic situation where general price levels in the economy is high.
If the economy is facing inflation , central bank will increase the repo- rate to control or combat inflation.

An increase in Repo- rate would mean cost of borrowings for commercial banks would increase.
This would ultimately discourage the commercial banks in terms of borrowings. So, one effect of increase in repo-rate is commercial banks would borrow less money from central bank to lend into the economy.

On the other hand, due to increase in cost of borrowings for commercial banks, lending rates for borrowers would also be increased by commercial bank. This is second effect of increase in repo-rate.

Both these effects , when clubbed together would result into commercial banks borrowing less from central bank and hence lending less into the market and at the same time borrowers would borrow less from commercial banks due to increase in lending rates.
This would ultimately decrease the money supply in the economy and hence inflation would be controlled , as demand will fall .