The Arts Academy
Economics
Chapter 9. – Money market and Capital market in India
By Anuja Inamdar
Q.1 Explain the functions of Central bank.
According to Dr. M.H. Kock,
“Central bank is one which constitutes the apex of the monetary
and banking structure of the country.”
India’s central bank is the Reserve Bank of India (RBI).
The functions of central bank are as follows:
1) Issue of Currency notes :
RBI has the sole right to issue currency notes of all
denominations, except one rupee note and coins. As per the,
‘Minimum reserve system’ of 1975, RBI is required to
maintain minimum gold and foreign exchange reserves of ₹.
200 crores, out of which at least ₹ 115 crores should be in gold
and the remaining ₹ 85 crores should be in terms of foreign
currency and government securities.
2) Banker’s bank :
RBI exercises statutory control over the commercial banks. All
scheduled banks are compulsory required to maintain
a certain minimum of cash reserves with the RBI against their
demand and time liabilities. RBI provides financial assistance
to banks in the form of discounting of eligible bills. Loans and
advances are also provided against approved securities.
3) Banker to the government :
RBI acts as a banker, agent and advisor to the government. It
transacts the business of both, central and state government.
It accepts money as well as makes payments on behalf of
these governments.
4) Custodian of Foreign exchange reserves:
RBI acts as a custodian of foreign exchange reserves. It has to
maintain the official rates of exchange of rupee as well as ensure
its stability. RBI also undertakes ti buy and sell the currencies
of all the members of the International Monetary Fund ( IMF).
5) Controller of credit:
As a supreme banking authority of the country, RBI has the
power to influence the volume of credit created by commercial
banks. It also monitors the purpose or use of credit.
Quantitative methods such a s bank rate, open market
operation, variable reserve ratios such as Cash Reserve Ratio,
Statutory Liquidity Ratio, etc. control the volume of credit
created. Qualitative methods such as fixing margin
requirement, credit rationing, moral suasion etc. regulate the
purpose or use of credit.
Apart from the above functions, central banks
also publishes statistical information related to banking and
other financial sectors. It also performs promotional
and developmental function to the economy.
Q.2 Explain the functions of Commercial bank.
According to Prof. Cairncross,
“A bank is a financial intermediary, a dealer in loans and debts.”
The functions of commercial banks are as follows:
1) Acceptance of deposits:
Deposit constitute the main source of funds for commercial banks.
Savings leads to creation of deposits. Deposits are categorized as:
a) Demand deposit:
Deposits that are withdrwable on demand are known as demand
deposits. They are in the form of Current deposit and Savings
account deposit.
Current account is usually opened by businessmen, corporations,
industrial houses etc. They are provided with overdraft facility.
Overdraft means withdrawal in excess of the balance in the
account.
Savings account are opened by large group of people, particularly
the salaried class, small traders etc. who wish to save a part of
their income with the bank.
b) Time deposit:
Deposits that are repayable after a certain period of time are known
as time deposits. They are in the form of recurring deposits and
time deposits.
Recurring deposit refers to a deposit wherein a customer deposits
a fixed amount at regular intervals for a specified period of time.
Fixed deposits refers to a lumpsum amount deposited by a
customer for a specified period of time. Compared to all other
deposits, fixed deposits carry a high rate of interest.
2)Providing loans and advances:
Commercial banks mobilize savings and lend these funds to
institutions and individuals for various purposes. Based on the
tenure, loans include call loan, short term, medium term and long
term loans. Longer the duration of the loans greater will be the
rate of interest. Besides this, banks also provide cash credit,
overdraft facility as well as discount bills of exchange.
3) Ancillary functions:
Commercial banks also provide a range of ancillary services such
as transfer of funds, collection of money, making periodical
payments on behalf of the customer, merchant banking, foreign
exchange, safe deposit lockers, D-mat facility, internet banking,
mobile banking etc.
4) Credit creation:
Credit creation is important function of commercial banks.
Commercial banks are creators of credit. Demand and time deposit
constitute the primary deposits of banks. After meeting the reserve
requirements out of net demand and time liabilities, the balance
amount is used for giving loans. Thus, secondary deposits or
derivative deposits are created out of the loans given by
commercial banks.
Q.3 Explain the sources of unorganised sector in India.
Ans: The unorganised money market in India comprises of indigenous bankers,
money lenders and unregulated non-bank financial intermediaries. The
activities of unorganized money market are largely confined to the rural areas.
The sources of unorganized sector are as follows:
1. Indigenous bankers: Refer textbook page no. 86
2. Money lenders : Refer textbook page no. 86
3. Unorganized Non-bank Financial intermediaries: Refer textbook page no. 86
Q.4 Explain the role of Capital market in India.
Capital market is a market for long term funds both equity and debt
raised within and outside the country. It is also an important constituent
of the financial system.
Role of capital market are as follows:
1) Mobilizes long term savings:
There is an increasing demand for investment funds by industrial
organizations and the government. But the availability of financial
resources is insufficient to meet this growing demand. Capital market
helps to mobilize long term savings from various section of the
population through the sale of securities.
2) Provides equity capital:
Capital market provides equity capital or share capital to entrepreneurs
which could be used to purchase assets as well as fund business
operations.
3) Operational efficiency:
Capital market helps to achieve operational efficiency by lowering the
transaction costs, simplifying transaction procedures, lowering
settlement timings in purchase and sale of stocks.
4) Quick valuation:
Capital market helps to determine a fair and quick value of both equity
(shares) and debt ( bonds, debentures) instruments.
5) Integration:
Capital market leads to integration among real and financial sectors,
equity and debt instruments, government and private sector, domestic
and external funds etc.
Q.5 Explain the role of Money market in India.
Role of money market in economic development in India are as
follows:
1) Short term requirement of borrowers:
Money market provides reasonable access for meeting the short-
term financial needs of the borrowers at realistic prices.
2) Liquidity Management :
Money market is a dynamic market. It facilitates better
management of liquidity and money in the economy by the
monetary authorities. This in turn, leads to economic stability and
development of the country.
3) Portfolio Management:
Money market deals with different types of financial instruments
that are designed to suit the risk and return preferences of the
investors. This enables the investors to hold a portfolio of
different financial assets which in turn, helps in minimizing risk
and maximizing returns.
4) Equilibrating mechanism:
Through rational allocation of resources and mobilization of
savings into investment channels, money market helps to
establish equilibrium between the demand for and supply of short
term funds.
5) Financial requirements of the government :
Money market helps the government to fulfill its short term
financial requirements on the basis of Treasury bills.
Q.6 Distinguish between.
1. Money market and Capital market
Money market Capital market
1. Money market deals with short 1. Capital market deals with long
term funds. term funds.
2. Money market transactions are for 2. Capital market transactions are
less than one year. for more than one year.
3. Money market offers very high 3. The risk factor is relatively higher
liquid assets as they are easily in capital market.
converted into cash.
4. The credit instrument in money 4. The credit instruments in capital
market are government securities, market are treasury bills, commercial
shares, bonds and currency notes. papers etc.
5. The transactions in money market 5. The transaction of capital market
involve buying and selling of involve buying and selling of shares
instruments issued by financial issued by industrial units in the
institutions such as commercial open market.
banks.
2. Organized sector and Unorganized sector
Organized sector Unorganized sector
1. All the transactions in money 1. All the transactions in money
market which are regulated by market which are not regulated by
Central bank is known as Organized Central bank is known as
sector. Unorganized sector.
2. The transaction in organized 2. The transaction in unorganized
money market is high in volume and money market is lower in volume and
with large amount. in small amount.
3. The rate of interest is controlled 3. The rate of interest which is not
and regulated under Central bank. controlled and regulated by the
Central bank is found to be quite
high.
4. Organized money market is found 4. Unorganized money market is
to be in urban areas. found to be in semi urban and
especially, in rural areas.
5. Call money market, treasury bills, 5. indigenous bankers, Money
Commercial papers, trade bills are lenders, loan companies are the
the examples of organized money examples of unorganized money
market. market.
3. Central bank and Commercial bank
Central bank Commercial bank
1. The central bank is the apex 1. A commercial bank is a profit
banking institution whose main seeking institution which basically
function is to control, regulate and accept deposits from public and
stabilise the monetary system of the lends to others who need fund and
country in the national market. create credit.
2. There is only one Central bank in 2. There are numbers of Commercial
the country. banks in the country.
3. Central bank is owned by the 3. Commercial banks may not be
government. owned by the government or owned
privately.
4. central is the monetary authority 4. Commercial banks are the profit
which controls the banking system in seeking institutions.
the country.
5. central bank has the sole 5. Commercial bank has no power of
authority of issuing currency. issuing currency.
6. Central bank has the 6. Commercial bank does the credit
responsibility of controlling credit creation in the economy.
creation in the economy.
4. Demand and Time deposit
Demand deposit Time Deposit
1. Demand deposit are withdrawn as 1. Time deposits are not withdrawn
and when they are demanded by at any time, as and when they are
their depositors. demanded.
2. Demand deposits have no fixed 2. Time deposits have a fixed
maturity period. maturity period.
3. Demand deposits are kept not for 3. Time deposits are kept for a
a specific period of time. specific period of time.
4. Demand deposits are kept either 4. Time deposits are kept for getting
for transaction purpose or saving returns on keeping the deposits in
purpose. the banks.
5. The rate of interest which is 5. The rate of interest which is
offered is very low on demand offered is very high on time deposits.
deposits.
6. Demand deposit in which not a 6. Time deposit is the one in which a
fixed amount deposited by public. specific amount is kept by the public.
6. Current deposit and Saving deposit
Current deposit Saving deposit
1. Current deposit is usually opened 1. This account is opened by the
by businessmen, industrial households, salaried class, small and
enterprises, public bodies etc. medium traders etc.
2. This account facilitates regular 2. The main purpose of saving
business transactions. account is to encourage saving
habits among the people.
3. There is no interest paid by the 3. The saving deposit earns a
bank. nominal rate of interest.
4. There is no restrictions on 4. There are some restrictions like
withdrawals. withdrawals are allowed to certain
limited amount.
7. Current deposit and recurring deposit
Current deposit recurring deposit
1. It is a kind of demand deposit 1. These are deposits under which
which is mostly held by companies, people pay a specified amount at a
institutions, government and regular interval of time for a given
individuals for the sake of business period of time.
transactions.
2. It is suitable for business firms for 2. It is suitable for the salaried, small
the purpose of transactions. and medium income group who can
save a certain amount of money
regularly every month.
3. There are no restrictions on 3. The amount can be withdrawn
withdrawals. after a certain specific period of time.
4. There is no interest paid. 4. The interest rate is higher.
8. Fixed deposit and saving deposit
Fixed deposit Saving deposit
1. Fixed deposits are time bound 1. Saving deposits are kind of
deposits, where money is deposited demand deposits, which is held by
for a specific period of time. households or individuals for the
purpose of savings.
2. The main objective is to earn high 2. Safety is the major objective of
interest and to get lumpsum amount saving accounts.
on maturity.
3. It cannot be withdrawn before 3. Withdrawals are allowed subject to
maturity but one can close the certain restrictions.
account before maturity is loss of
interest.
4. The rate of interest is high. I can 4. The saving account earns nominal
be 6% to 10% depending upon the rate of interest. At present it is about
period of deposit. 4 to 4.5% per annum.
9. Current deposit and Fixed deposit
Current deposit Fixed deposit
1. It is a kind of demand deposit 1. Fixed deposits are a kind of time
which is usually held by companies, deposits which is deposited for a
institutions, government and specific period.
individuals for the sake f business
transactions.
2. There are no restrictions on 2. The amount deposited cannot be
withdrawals. withdrawn before maturity period.
3. No interest is paid to current 3. The rate of interest paid is high.
account or deposit.
4. The main purpose of current 4. The main purpose is to get a
account is to facilitate regular lumpsum amount on the maturity of
transactions. the deposit.
10. Quantitative method and Qualitative method of credit control
Quantitative method of credit Qualitative method of credit
control control
1. This method aims at controlling 1. It aims at controlling credit the
credit by expanding or contracting purpose or use of the credit.
the volume of credit in the banking
system.
2. The important quantitative 2. Selective control measures include
measures to control credit are: the following:
a) Bank rate a) Margin requirements
b) Open Market Operation b) Regulation of consumer credit
c) Cash Reserve Ratio c) Issue of directives
d) Rationing of credit
e) Moral suasion
3. During inflation quantitative 3. The main strategy of selective
measures adopt the strategy of credit control measures is to ensure
contracting the volume of credit so as that credit money doesn’t reach
to reduce money supply. During undesirable and non- productive
Depression, such methods are channels.
applied to encourage expansion of
credit and expand money supply.
4. They are macro economic in 4. They are micro in nature and do
nature and influence the whole not influence the whole economy.
economy.
Q.7 State with reasons whether you ‘Agree’ or ‘disagree’ with the following
statements.
1. Commercial banks do not create money.
No, I disagree with this statement.
1) Commercial banks are the creators of credit. Credit creation is an
important function of commercial banks.
2) Demand and time deposits constitute the primary deposits of banks.
After meeting the reserve requirements out of the net demand and time
liabilities, the balance amount is used for giving loans. Thus, secondary
deposits or ‘ derivative deposits’ are created out of loans given by the
banks.
3) For instance, when the bank provides loan to its customer, the loan
amount is credited into the bank account of the customer. The bank that
receives the loan amount as a deposit, keeps aside a certain portion in a
form of reserves. After meeting the reserves requirements, the bank lends
the remaining amount. This producer is followed by the entire banking
system in the country, leading to creation of credit. In short, commercial
banks create deposits out of the loans given thereby lending to creation.
2. There are four tier co-operative credit bank structure in India.
No, I disagree with this statement.
There are three tier of credit cop-operative bank structure i.e. at -
Primary level, district level and state level.
State
level
Distrcit level
Primary level
Co-operative banks came into existence with the enactment of the
Co-operative Credit Societies Act of 1904. Co-operative banks
supplement the effort of commercial banks by meeting the credit
needs of small and medium income groups. The Co-operative credit
sector comprises of o-operative credit institutions such as primary,
district co-operative credit societies, district central cop-operative
banks. There are three tier of credit co-operative bank structure i.e.
at-
Primary level- Primary co-operative credit societies.
District level – District Central co-operative banks
State level- State co-operative banks
3. Activities of Money lenders have been restricted by RBI.
4. Unit Trust of India was the first development financial institution in India.
5. Money market consist only unorganized sector in India.
6. Credit creation is important function of Central bank.
7. Finance is the backbone of the Indian economy.
8. The money market in India is dichotomous in nature.
9. Current account is withdrawal on demand.
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