AHSEC| CLASS 11| FINANCE| SOLVED PAPER

AHSEC| CLASS 11| FINANCE| SOLVED PAPER - 2017| H.S. 1ST YEAR

2017
FINANCE
Full Marks: 100
Time: 3 hours
The figures in the margin indicate full marks for the questions.

1. Answer the directed: 1x8=8

(a) In which year were the Presidency Banks of India amalgamated?

Ans:- In 1921.

(b) The Banking Regulation Act was passed in the year 1949. (Fill in the blank)

(c) What is barter system?

Ans:- Barter is an alternative method of trade where goods and services are directly exchanged for each other without using money as an intermediary.

(d) State a characteristic of inflation.

Ans: Following are the characteristics of inflation:

(i) Inflation is always accompanied by a rise in the price level. It is a process of continuous increase in prices.

(e) Write the full form of ATM.

Ans:- Automated teller machine.

(f) Who is a bank customer?

Ans:- In common parlance the term 'customer' refers to a person who has an account with a bank, although the term 'customer' appears in sec. 131 Negotiable Instruments Act, 1881 but not defined therein. Sir John Paget, an old banking expert, expressed his view, "To constitute a customer there must be some recognizable course or habit of dealing in the nature of regular banking business."

(g) Overdraft facility can be availed in current/ savings/fixed deposit account. (Choose the correct answer)

(h) Write what is indigenous banker.

Ans:- Indigenous banker system is the system of banking which involves private firms or individuals who act as banks by providing financial services such as lending and accepting deposits. The indigenous banking system is made up of indigenous bankers who do not come under the purview of the government.

2. What do you mean by trade cycle? 2

Ans:- In economics, the term ' trade cycle' refers to fluctuations in overall economic activity, particularly in employment, output and income. Business cycles are the ups and downs in economic activity.

According to Harberler, "The business cycle may be defined in a general sense as the alternation of periods of prosperity and depression, of good and bad business.

3. Give the meaning of Banking Ombudsman. 2

Ans:- Banking Ombudsman: An ombudsman in a bank is a person appointed to receive, investigate and report customer complaints against banking officials. It is a quasi-judicial authority constituted to resolve the complaints of the bank's customers.

4. Write two advantages of current account. 2

Ans:- The benefits of current account are as follows:

(i) Current account is mainly opened for businessmen like proprietor, partnership firm, public and private companies, trust, association of persons etc., which have several daily banking transactions, i.e., receipts and/or payments.

(ii) It enables the businessmen to carry out their business transactions properly and quickly.

5. Name any two public sector banks of India. 2

Ans:- There are two public sector banks in India:

(i) Bank of Baroda.

(ii) Bank of India.

6. State two important functions of commercial bank. 2

Ans:- Commercial banks have two functions:

(i) Accepting Deposits: Accepting deposits from the public is the most important function of a commercial bank. Deposits can be: Demand Deposits (Savings Deposits and Current Deposits) and Fixed Deposits (Fixed Deposits and Recurring Deposits)

(ii) Grant of loans: Commercial banks also provide loans to people and firms against suitable mortgage and at a fixed rate of interest to meet their funding needs.

7. What are the different types of e-banking services? 3

Ans:- E-banking is an arrangement between a bank or a financial institution and its customers that enables encrypted transactions over the Internet. Short for electronic banking, there are different types of e-banking that cater to different needs of the customers, which can be resolved online.

Types of E-Banking

The major types of e-banking are online internet banking, mobile banking, automated teller machines (ATMs), and debit and credit cards. There is a good chance that you have already heard about most of these. However, let's go through each and understand how they meet different customer needs.

(i) Mobile and Internet Banking: Internet banking and e-banking are almost synonymous, the latter being a broader term which includes the former. Any transaction - financial or non-financial - that you make through a web page (usually a bank's website) or a web application constitutes Internet banking.

(ii) Credit and Debit cards: Credit and debit cards are also a form of e-banking! Debit cards can help us to withdraw cash easily from ATMs and POS (Point of Scale) machines. On the other hand, credit cards allow customers to borrow money up to pre-approved limits and help them avail a variety of offers.

(iii) ATM: ATM was the first e-banking service provided by banks when they started going digital. ATM facilitates the process of withdrawing and depositing money.

8. Explain the types of loans given by the commercial bank. 3

Ans:- A commercial is a financial institution that accepts deposits from the public and provides loans for consumption or investment purposes. Types of loans offered by commercial banks are:

(i) Term Loan: A term loan is a loan provided for business purposes only which needs to be paid back within a specified time frame. It typically has a fixed interest rate, monthly or quarterly repayment schedule – and includes a set maturity date. Term loans can be both secured (i.e., some collateral is provided) and unsecured.

(ii) Bank overdraft facility: Commercial banks also provide overdraft facility. But what is overdraft? A bank overdraft is a financing form that allows current account holders to withdraw funds from their accounts up to a specific limit. There is no need to complete any written formalities for availing a bank overdraft.

(iii) Letter of Credit: It is a direct payment method in which the issuing bank makes payment to the beneficiary. In contrast, a standby letter of credit is a secondary payment method in which the bank pays the beneficiary only if the holder cannot.

9. State the procedure of opening joint account. 3

Ans:- When an account is opened by two or further persons concertedly in their names, it's called a joint account. Without obtaining an application from the persons interested in the account, a banker should not open a joint account. Joint account holders jointly and severally enter a contract with the bank, so that each of them has a right against the bank, and the banker has the right to honour all checks or transactions in the name of which the joint account is held. Has been opened.

(i) Fill up the Bank Account Opening Form: Proposal Form: The proposal form should be duly filled in all respects. required details Regarding name, address, occupation, and other details should be filled wherever required. Two or three specimen signatures are required on the specimen signature card. If the account is opened in joint names, the form should be signed jointly. Nowadays banks ask the applicant to submit copies of his/her latest photograph for the purpose of his/her identification.

(ii) Give a reference to open your bank account: The bank normally requires a reference or introduction of the prospective account holder by any existing account holder for that type of account. The introducer introduces his specimen signature in the column provided for the purpose. The reference or introduction is necessary to protect the interest of the bank.

(iii) Submit Bank Account Opening Form and Documents: The duly filled proposal form should be submitted to the bank along with the required documents. For example, in the case of a joint stock company, the application must be accompanied by a resolution of the board for opening the account. Also certified copies of the articles and memorandum of association must be produced.

(iv) The officer will verify your bank account opening form: The bank officer verifies the proposal form. He checks whether the form is complete in all respects or not. The attached documents are verified. If the officer is satisfied, he clears the proposal form.

(v) Deposit the initial amount in the newly opened bank account: After the proposal form is approved, the required amount is deposited in the bank. After depositing the initial money, the bank provides a pass book, a check book and payment slip book in case of a joint account. In case of Fixed Deposit, Fixed Deposit Receipt is issued. In case of current account, check book and pay in slip book are issued. Pass book and pay in slip book are issued for recurring account.

10. Explain why Central Bank is called 'lender of last resort'. 3

Ans:- The central bank is referred to as the lender of last resort because it protects banks from potential failure and protects the banking system from potential breakdown. If commercial banks fail to meet their financial requirements from other sources, they may approach the central bank for loans as a last resort.

The central bank is called the lender of last resort because it can lend – and must lend to prevent the failures of solvent banks – in periods when no other lender is either able to lend or has been prevented from lending. Willing to lend a substantial amount or eliminate a financial panic.

11. State any three stimulating effects of inflation. 3

Ans:- There is a great controversy among economists whether inflation promotes economic growth. A group of economists, including Keynes, believed that inflation promotes economic growth. Following is his arguments.

(i) Increases investible profits: Inflation redistributes income and wealth in favour of the entrepreneurial classes who have a higher propensity to save. This redistribution will increase profits and savings in the economy. The increased savings will be used for investment purposes, thereby increasing income, production, and employment in the economy.

(ii) Creates Optimistic Conditions: Inflation creates optimistic conditions in the economy and provides new opportunities for new business activities, because during inflation, costs rise less rapidly than prices, profit margins allow businessmen to enter new Tempted to invest more and more. productive enterprise.

(iii) Stimulates Entrepreneurship: Inflation encourages adventurous entrepreneurship and rewards investors at the expense of conservative savers and renters.

12. Discuss the general utility functions of a bank. 5

Ans:- utility functions of the bank:

(i) Issue of letters of credit, travellers’ cheques, etc.

(ii) Safe custody of valuables, important documents, and securities by providing safe deposit vaults or lockers.

(iii) To facilitate foreign exchange transactions to the customers

(iv) Underwriting of shares and debentures

(v) dealing in foreign exchange

(vi) Social welfare program

(vii) Project Report

(viii) Standing Guarantee on behalf of its customers etc.

13. State about licencing of banks. 5

Ans:- General bank license allows a bank to engage in all banking activities, such as retail banking, merchant acquisition, cash management, asset management and trading. An applicant can apply for a limited banking license, such as an offshore banking license.

Under the provisions of Section 22 of the Banking Regulation Act, 1949, every banking company is required to obtain a license from the Reserve Bank of India to undertake banking business in India. No company can do banking business in India unless it has a license issued by the Reserve Bank of India. Every banking company in existence on the commencement of this Act shall, before the expiry of six months from such commencement, and every other company before commencing the business of banking, apply in writing to the Reserve Bank for a licence. Section 22 of the Banking Regulation Act, 1949 deals with licensing of banking companies in India.

Conditions to be satisfied for license of banking companies

Before granting any licence, the Reserve Bank may be satisfied by inspection of the books of the company or otherwise that the following conditions are fulfilled:

(i) the company is or will be able to pay its depositors, present or future, in full as per their claims.

(ii) the affairs of the company are not being or are not likely to be conducted in a manner prejudicial to the interests of present or future depositors.

(iii) the general character of the proposed management of the company shall not be prejudicial to the public interest or the interest of its depositors.

(iv) The company has adequate capital structure and earning potential.

(v) The public interest would be served by the grant of a license to the company to carry on the business of banking in India.

(vi) Keeping in view the banking facilities available in the proposed core area of operation of the company, the likely scope for expansion of banks already existing in the area and other relevant factors, the grant of license shall not be prejudicial to the operations. and consolidation of the banking system in a manner consistent with monetary stability and economic growth.

(vii) the fulfilment of any other condition which is necessary to ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors.

14. What are the differences between Commercial Bank and Central Bank? 5

Ans:- Difference between Central Bank and Commercial Bank are:

Central bank:

(a) The central bank is the apex body of the monetary and banking system of the country.

(b) The Central Bank controls the monetary system and the overall credit operations of the banks.

(d) The central bank is usually owned by the state.

(e) The central bank is closely related to the government as its banker, agent, and advisor.

(f) The central bank helps in the establishment of financial institutions to strengthen the money and capital market in the country.

(g) The Central Bank has the monopoly to issue notes.

Commercial Bank:

(a) Commercial bank is only a constituent unit of the banking system.

(B) The commercial bank is subordinate to the central bank.

(d) Commercial banks are mostly privately owned.

(e) Commercial banks act as bankers and advisors to the general public.

(f) Commercial bank helps industry by underwriting shares and debentures.

(g) This right is no longer with the commercial banks.

15. Describe the characteristics of regional rural bank. 5

Ans:- Some of the features of Regional Rural Banks are:

(i) The area of operation of a rural bank is limited to a specified area consisting of one or more districts.

(ii) These banks cannot have a lending rate which is higher than the prevailing lending rate of co-operative credit societies in a particular state.

(iii) The pay structure of the employees of these banks has been fixed in line with the pay structure of State Government employees, local officers of comparable level and status in the region.

(iv) These are public sector banks. The paid-up capital of each bank is Rs. 25 lakhs. 50 per cent of the capital is contributed by the Central Government. The concerned state government contributes 15 per cent. 35 per cent is contributed by the sponsoring public sector commercial banks.

16. Explain the techniques of creating credit by a commercial bank. 5

Ans:- In very simple words, credit creation differentiates a bank from other financial banks. Credit creation is an extension of deposits. Also, banks can raise their demand deposits as multiples of their cash reserves as demand deposits serve as a major medium of exchange.

Demand deposits are a very important component of the money supply. Expansion of demand deposits means expansion of money supply. The entire banking structure is based on credit. Credit means receiving purchasing power now and a promise to pay at some point in the future. And bank credit means bank loans as well as advances. A bank maintains a certain part of its deposits as minimum reserves to meet the demands of its depositors and the rest is lending to earn income. The credit is given to the browser's account. Each bank creates an equivalent deposit in the bank. Hence credit creation means expansion of bank deposits.

Two Crucial Aspects of Credit Creation

(i) Liquidity: Banks are bound to pay cash to their depositors when they exercise their right to call for cash against their depositors.

(ii) Profitability: Banks are always in search of profit. They are profit-driven enterprises. That is why a bank should provide loans in a way that helps it earn more interest than it pays on its deposits.

A bank's credit process assumes that only a small number of customers will actually need cash at any given time. Also, on the other hand, banks assume that all their customers will not demand cash against their deposits at the same time.

Learn the basic concepts of credit building

(i) Bank as a Business Institution: It must be recognized that bank is a business institution which always tries to maximize profit through loans and advances received from deposits.

(ii) Bank Deposits: Bank deposits are the basis of credit creation. There are two types of bank deposits:

(a) Primary Deposit: A bank accepts cash from customers and opens a deposit in their name. This is called primary deposit and does not mean credit creation.

These deposits are simply converted from fiat currency to deposit money. These deposits form the basis of credit creation.

(b) Secondary or Derivative Deposits: A bank grants loans and advances. Instead of giving cash to the borrower, the bank opens a deposit account in his name. This is called a secondary or derivative deposit.

Every loan creates a deposit and the creation of a derivative deposit means the creation of credit.

Process of Credit Creation by Commercial Banks:

A central bank is the primary source of the money supply in a nation's economy through the circulation of currency. It ensures the availability of currency to meet the transaction needs of an economy. It also facilitates various economic activities such as production, distribution, and consumption. For this purpose, the central bank needs to rely on the reserves of commercial banks which are the secondary source of money supply in the economy.

The most important objective of a commercial bank is the creation of credit. This is the reason why the money given by commercial banks is called credit money. All commercial banks create credit by advancing loans and purchasing securities. They lend money to individuals as well as businesses out of deposits accepted from the public.

Commercial banks are not allowed to use the entire number of public deposits for lending purposes. They are accepted to keep a certain amount as reserve with the central bank. This is to meet the cash requirements of the depositors.

Commercial banks can lend the remaining part of public deposits after keeping the requisite amount of reserve.

Factors Affecting Credit Creation by Commercial Banks:

The factors affecting the creation of credit are as follows:

(i) Banks The ability of banks to create credit which is a matter of availability of cash deposits with banks. Furthermore, the ability to create credit depends on the factors that determine their cash deposit ratio.

(ii) Willingness of banks to create credit.

(iii) Demand for credit in the market.

Advantages and Limitations of Credit Creation by Commercial Banks

On the profitable side, depositors can access a wide range of products offered by intermediaries that can be easily converted into cash. Investing in company shares (Mutual Funds) can also be done in a very easy way.

On the downside, there are several limitations, these are as follows:

(i) Shortage of securities.

(ii) Business environment

(iii) Cash crunch

(iv) Habits of the people

(v) leak

17. What are the main phases of trade cycle? 5

According to Harberler, "The business cycle may be defined in a general sense as the alternation of periods of prosperity and depression, of good and bad business.

A trade cycle is generally divided into four phases viz.

(a) Prosperity: Economic activities are expanding from a revival phase to an upward trend. So, the revival of upward trend in the economy is the starting point of prosperity. This stage is characterized in the following way.

(i) High level of production and trade.

(ii) High level of effective demand.

(iii) Higher level of employment and income

(iv) Rising structure of interest rate.

(v) A large expansion of bank credit.

(vi) High marginal efficiency of capital.

(vii) A price inflation

(viii) Overall business optimism.

(ix) The tendency of an economy to operate almost at full capacity along the production possibilities frontier.

(b) Recession: When prosperity ends, recession begins. It is related to a turning point rather than a phase. During prosperity, investment, production, employment, reaches the maximum extent. Cut-throat competition arises on raw material, labour, capital etc. As a result, the cost of production increases and the profit margin decreases. Since the goods are available in the market, there is no possibility of selling the goods in the market. The confidence of businessmen wavers. Everyone feels pessimistic about the future profitability of investments. Therefore, there will be a drastic reduction in investment and production of capital goods industries will fall.

(c) Depression: It starts from the stage of recession. Business activity in the country is well below normal in this phase. It is characterized by a sharp reduction in output, mass unemployment, low employment, falling prices, falling profits, low wages, contraction of credit, high rates of business failures, and an atmosphere of all-round despair and hopelessness. The decline in production or output is accompanied by a decrease in the amount of employment. The prices of manufactured goods fall. level. The producers must bear huge financial losses. Many of these firms have had to close due to accumulated losses.

(d) Recovery or Revival: It refers to the increase in business activity after reaching the lowest point of depression. During this phase, initially, there is a slight recovery in economic activities. Entrepreneurs begin to realize that the economic situation is not as bad as it was in the earlier stages. This leads to further improvement in business activity. Industrial production grows slowly and gradually. The amount of employment also increases continuously. There has been a slow, but steady rise in prices with a marginal increase in profits. Wages also rise, though they do not rise in the same proportion as prices. Attracted by rising profits, new investments are made in capital goods industries. Banks extend credit. Merchandise also starts increasing gradually. The pessimism and gloom of the operating period has been replaced by an atmosphere of all-round cautious hope.

Explain the meaning of depression. 5

Ans:- Depression is a severe and prolonged decline in economic activity. A depression can be defined as an extreme recession that lasts for three or more years or that leads to a decline of at least 10% in real gross domestic product (GDP) each year.

Depressions are much less common than milder recessions. Both occur with relatively high unemployment and relatively low inflation.

18. State any two selective credit control techniques adopted by the RBI. 5

Ans:- The regulation or control of credit for specific purposes or branches of economic activity is called selective or qualitative credit control. It attempts to differentiate between productive and unproductive uses for which bank loans are given. It encourages loans for essential purposes and discourages loans for non-essential purposes. Its purpose is to regulate not only the total amount of credit but also the amount of credit available to each sector of the economy. Selective credit control affects both lenders and borrowers in a particular way. Selective credit control resources are margin requirement, regulation of consumer credit, moral solicitation, rationing of credit, instruction, direct action, publicity etc.

Describe the procedure of opening a bank account in the name of a minor. 5

Ans:- A person who has not attained or completed the age of 18 years is known as a minor. A minor is not capable of making a valid contract and a contract made by a minor is void. The bank can open a savings, fixed or recurring deposit account in the name of a minor.

Following are the main steps to open a bank account:

(a) Age for opening an account: A banker should allow a minor to open a savings bank account in his own name only if he is between 10-14 years of age and can read and write in English, Hindi or any other language. other language. If the minor has such a quality, the banker must open his account in the joint name of the minor and his guardian.

(b) Selection of Account Type: The first step is to select the type of account to be opened. An account can be of many types like Current, Savings Fixed Account. The account can be opened jointly or singly. A banker can open a savings bank account in the name of a minor. The banker should not open a current account in the name of a minor.

(c) Bank and Branch Selection: The prospective account holder should now select the bank.

(d) Obtaining Account Opening Form: The account opening form is obtained from the bank. It should be read carefully and filled with utmost care.

(e) Obtaining references: One or two references are obtained by the prospective account holder. People who give references sign the form and give their account number. and name and address.

(f) Form Submission: Now the form should be submitted along with the required documents. These documents differ from account to account.

(g) Giving Specimen Signature: Now, the account holder signs a card which is called Specimen Signature Card. These signatures are matched with the check of the account holder.

(h) Making Initial Deposit: The applicant is allotted an account and is asked to make an initial deposit in his account through a deposit slip.

(i) Account is opened: The account is opened as soon as the initial deposit is made.

(j) Receipt of Check Book / Fixed Deposit Certificate: Finally, a check book is issued which contains the account number of the applicant. Money can be withdrawn with the help of these cheques.

19. Discuss the evolution, origin, and growth of banking in India. 8

Ans:- Modern joint stock commercial banking in India dates back to the early 19th century. The early commercial banks were known as agency houses and were started by employees of the East India Company. Bank offices were largely confined to the port cities of Bombay, Calcutta and Madras (now Mumbai, Kolkata, and Chennai). Agency houses were primarily trading establishments and combined banking and trading functions. Many banks were established mainly by the English Agency Houses based on unlimited liability.

Alexander and Company established the first joint stock, The Bank of Hindustan, in Calcutta in 1770. It was finished in 1832. Banks set up by agency houses failed due to mismanagement and speculation. Hence to revive the situation, the East India Company established the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. These banks were known as Presidency Banks. In 1860, an act was passed allowing the establishment of banks on a limited liability basis. The creation of joint stock banks was very slow from 1865 until the end of the 19th century. Some banks like the Allahabad Bank were started during the last quarter of the 19th century. The Avadh Commercial Bank and the flotation were followed by a banking crisis during 1913–17.

In 1920, the "Imperial Bank of India Act" was passed to amalgamate the three Presidency banks. The Imperial Bank of India was established in 1921 by merging three Presidency banks. The bank was empowered to hold government funds and manage the public debt.

The Second World War brought a radical change in the Indian banking system. Heavy wartime expenditure resulted in an increase in bank deposits. The banking scenario in India completely changed after independence. The entire system registered rapid progress. The change became possible with the passing of the Banking Regulation Act 1949. It is considered a major milestone in the history of commercial banking in India. This act was passed with the aim of strengthening and regulating the banking system in India. The State Bank of India was established in 1955 by nationalizing the Imperial Bank of India. In 1959, the State Bank of India and its Associates Act was passed and accordingly the public sector banks were expanded. Fourteen (14) major Indian commercial banks were nationalized in 1969 and six more banks were nationalized in 1980. National Bank for Agriculture and Rural Development (NABARD) was established in 1982 for the development of agriculture sector.

Another development of banking institutions in India is the establishment of various industrial development banks to facilitate industrial development and balanced economic growth. Such institutions are IDBI, IFCI, LIC, ICICI, IDBI, SFC etc.

Exim Bank was established in 1982 with the objective of financing and promoting India's foreign trade.

What do you mean by internal and external organization of commercial bank? Describe the different departments of a commercial bank. 4+4=8

Ans:- The internal organization of a commercial bank refers to the carrying out of the banking business by the management. The shareholders are the true owners of any company. But the company delegates its authority to a board of directors for its functioning. The Board of Directors appoints a chairman who is in overall charge of the management, direction, and proper control of the bank's activities. He has been appointed as the "full-time President". Some other subordinate officers help him in the discharge of his duties.

The overall internal organization of a commercial bank may be as follows:

The external organizations of a commercial bank are formed based on prevailing banking laws. The structure of commercial bank's external organizations can be either public, private, or co-operative. Furthermore, organizations can be either sole proprietorship, partnership, or joint stock company. It can also be established and managed in the public or private sector.

Commercial banks are usually established based on joint stock company. Therefore, the formalities of the Indian Companies Act must be followed for setting up such companies. But with the passing of the Banking Regulation Act 1949, the banks must follow the rules and regulations included in the act. Therefore, entrepreneurs must comply with both the Acts, namely the Indian Companies Act 1956 and the Banking Regulation Act 1949, in order to form a bank.

The different departments of commercial banks are:

(i) Secretarial Department: It looks after the secretarial work within the department like taking necessary action for holding meetings, preparing agenda etc.

(ii) Legal Department: It deals with the matters related to law. Such as payment of income tax on behalf of shareholders, payment of sales taxes etc.

(iii) Accounts Department: Accounts Department is responsible for maintaining the books of accounts like profit and loss, income, and expenditure.

(iv) Statistics Department: Statistics Department oversees keeping the statistical reports of various activities of the bank. For example, systematic record of performance of different departments which can help in future comparison etc.

(v) Credit Department: Large commercial banks have a credit department which deals with credit related policies. For example, to whom to give loan, how to give loan etc.

(vi) Inspection Department: Inspection Department looks after the working of various departments. Future and programs are prepared based on reports by this department.

(vii) Regional or Branch Manager's Department: The main function of the regional or branch manager's department is to see whether the principles and procedures of the banks are working effectively or not.

(viii) Printing and Publications Department: Printing and Publications Department arranges for the printing of necessary forms. Like counter file check, bank report etc.

20. Discuss the causes and effects of inflation. 8

Ans:- The causes of inflation are:

Inflation is caused by many factors, here are some:

(i) Money Supply: Excess money (money) supply in the economy is one of the primary causes of inflation. This happens when the supply/circulation of money in a country outpaces the economic growth, therefore depreciating the value of the currency. In the modern era, countries have shifted from traditional methods of valuing money with the amount of gold they hold. Modern methods of valuing money are determined by the amount of currency in circulation, which in turn is determined by the public's perception of the value of that currency.

(ii) National Debt: There are many factors that affect the national debt, including the borrowing and spending of nations. In a situation where a country's debt increases, the country concerned is left with two options: Taxes can be increased internally. Additional money can be printed to pay off the debt.

(iii) Demand-Pull Effect: The demand-pull effect states that as wages rise in an economy in a growing economy, people will have more money to spend on goods and services. An increase in demand for goods and services will result in companies increasing the prices that consumers will bear to balance supply and demand.

(iv) Cost-push effect: This theory states that when companies face increased costs on raw materials and wages to manufacture consumer goods, they pass on the increased production costs to the final consumer in the form of increased prices. By doing this, you will maintain your profitability.

(v) Exchange Rates: An economy with exposure to foreign markets mostly functions on the basis of the value of the dollar. In a trading global economy, exchange rates are an important factor in determining the rate of inflation.

(vi) Effects of Inflation: When there is inflation in the country, the purchasing power of the people goes down because the prices of goods and services are high. The value of the currency unit decreases which affects the cost of living in the country. When the inflation rate is high, the cost of living also increases, leading to a decline in economic growth.

However, a healthy inflation rate (2-3%) is considered positive as it directly increases wages and corporate profitability and maintains capital inflows into a growing economy.

Effects of Inflation: Inflation has its own effects and this can be discussed under two sub-headings.

(i) Effect on production

(ii) Effect on distribution

(i) Effect on production: Output is highly affected by inflation. Mild inflation acts as a stimulant to the economy. An increase in the money supply in an economy where resources are not yet fully employed, resulting in a gradual increase in the price level. In such an economy the cost of production does not rise in proportion to the prices. Higher increase in prices results in higher profit margin. It creates optimism in business. This induces more investment. Productive activities start increasing. The factors of production are the process of over-planning. The income of the agent of production increases. Investment and employment remain for some time. The economy can reach the point of full employment. If the money supply increases past the point of full employment, causing more investment pressure, prices tend to rise faster. This leads to hyperinflation. Excessive inflation is disastrous for the economy. This will adversely affect the productive system and create unemployment.

(ii) Effects on Distribution: A long period of persistent inflation results in redistribution of income and wealth. Inflation does not affect all sections of the society equally. Some gain during inflation, while others lose. These 'gains' and 'losses' result in redistribution of income and wealth within the society. The effects of inflation on different sections of the society can be discussed as follows -

(a) Farmers: Generally, farmers benefit during inflation. The prices of agricultural products rise, but the cost of production was comparatively lower than before. It provides additional benefits to the farmers. Also, farmers can get more profit by repaying their loans borrowed earlier when purchasing power is high, on the other hand small farmers suffer during inflation.

(b) Entrepreneurs and business community: The business community and entrepreneurs gain during inflation because the prices are low when they buy raw materials and by the time they reach the market as finished products for sale, they are high. sell at higher prices and hence make higher profits.

(c) Investors of equity holders: Holders of equity shares, stocks etc. get the benefit of inflation. The rate of return on equity varies with profit. During inflation business houses make abnormal profits. A part of the additional profit is received by the equity holders. That is why they get benefited.

(d) Wage and salary earners: Wage and salary earners generally lose out during inflation. Although their wages and salaries tend to rise in the face of rising prices, wages and salaries generally do not rise in the same proportion as prices or their cost of living.

(e) Government: Government belongs to flexible income group. Due to inflationary increase in prices, its revenue collection also increases. However, its cost also increases. His monetary expenditure may increase but the actual expenditure may not. It is believed that the increase in prices can increase the revenue but it fails to restore the pre-inflationary expenditure. Repayment of public debt provides benefits to the government.

(f) Debtors and Creditors: Debtors stand to gain during inflation because they borrowed when the purchasing power of money was high and now pay back the loan when the purchasing power of money is low. Creditors, on the other hand, suffer losses as they may get back less than what they lent in case of goods and services.

(g) Fixed Income Group: The fixed income group loses to inflation. Pensioners, fixed interest investment holders get fixed income. Fixed income allows them to buy fewer goods during inflation. It discourages savings and capital formation.

21. Explain in brief the various functions of the Central Bank. 8

Ans: The functions of the Central Bank are as follows:

(a) Issue of notes: The Central Bank of a country is given the monopoly power to issue notes. This means that it is authorized by law to print currency notes.

The central bank is given the exclusive right to issue notes for the following reasons:

(i) A central bank which has been given the monopoly of note issue is better equipped to control undesirable credit expansion by commercial banks.

(ii) It gives a special status to currency notes.

(iii) When the central bank issues notes, they have the property of being identical.

(iv) It is possible and easy for the states to control and supervise the irregularities in note issue.

(v) Since the central bank of a country looks after the monetary affairs of the state, it is better equipped to handle the problem related to note issue. De Kock mentions four reasons for the concentration of note-issuance in the central bank.

These:

(i) Uniformity in note circulation to achieve effective state supervision.

(ii) Control over undue credit expansion by commercial banks.

(iii) To give a specific prestige to the note issue.

(iv) To provide for the State's share in the profits of the Central Bank.

(b) Banker to the Government: The central bank acts as the banker to the government. It also acts as fiscal agents and advises government departments, banking accounts of state governments on fiscal matters. As banker to the government, the central bank maintains government enterprises. The Central Bank deals with the purchase and sale of foreign currency for the government. It gives short-term loans to the government and extraordinary advances in times of crisis. In its capacity as financial agent and advisor to the government, it manages the national debt and guides the government on matters relating to economic policy.

The government has the ultimate responsibility for setting monetary policy and maintaining the monetary standard. In the formulation of monetary policy, the central bank is not only consulted by the government, but is given a free hand and assisted by the government whenever possible in carrying out such monetary policy.

(c) Banker's Bank As a banker's bank, the central bank acts as the custodian of the cash reserves of the member banks. It is customary for commercial banks to keep a portion of their demand and fixed deposits with the Central Bank. In return, the central bank rediscounts the bills of commercial banks, and facilitates remittances to them, thereby providing them credit against these reserves.

The advantages of centralization of cash reserves are as follows:

(i) Centralization of cash reserves with the central bank strengthens the confidence of the general public in the strength of the country's banking system.

(ii) The concentration of cash reserves in the central bank is a source of great strength to the banking system in the country.

(iii) When the cash reserves are accumulated with the central bank, it can utilize them in the interest of national welfare.

(iv) Centralization of cash reserves also enables the central bank to control the creation of credit by commercial banks.

(v) The central bank may provide additional funds to commercial banks on a temporary basis and on a short-term basis to overcome their financial difficulties.

(vi) Reserves enable the central bank to rediscount the bills of exchange of the commercial bank.

(d) Lender of Last Resort: This is one of the most important functions of the central bank. By providing accommodation in the form of rediscounting and collateralized advances to commercial banks, bill brokers and dealers or other financial institutions, the central bank acts as: Astha Resort. Central bank to help such institutions in times of crisis to save the country's financial structure from collapse. It acts as a lender of last resort through discount houses on a "front door" basis for Treasury bills, government securities and bonds. The second method is to grant temporary housing directly through the "backdoor" to commercial banks. The difference between the two methods is that front door lending is at the bank rate in the second case and at the market rate in the second case. The central bank as a lender of last resort is a major source of cash and affects the prices and market rates.

(e) Custodian of Foreign Exchange Reserves: The Central Bank maintains and manages the foreign exchange reserves of the country. It is an official reserve of gold and foreign currencies. It sells gold at fixed prices to the monetary authorities of other countries. It also buys and sells foreign currencies at international prices. It fixes the exchange rates of the domestic currency with respect to foreign currencies. It keeps these rates in a narrow range keeping in view its obligations as a member of the International Monetary Fund and tries to bring stability in foreign exchange rates. It manages exchange control operations by supplying foreign currencies to importers and persons going abroad on business, studies etc. keeping in view the rules laid down by the government.

(f) Acting as a clearing house: The central bank acts as a clearing house for commercial banks. Since it holds the cash reserves of commercial banks, it becomes easier and more convenient for it to act as the country's clearing house. All commercial banks have their accounts with the Central Bank. As a result, the central bank can settle claims and counterclaims of commercial banks with minimal use of cash. Thus, the clearing house function of the central bank as a clearing house is that it helps the bank to reduce the use of cash by the banks. Commercial banks have another advantage to create credit on a large scale as the demand for cash automatically reduces as a result of the functioning of the clearing system in the country.

(g) Credit Controller: Of all the functions provided by the Central Bank, the control of credit is the most important. It is the function which covers the most important questions of central banking policy and through which practically all other functions are united and made to serve a common purpose. With the increasing popularity of bank loans, this function has assumed importance. Commercial banks have the power to change the total amount of money in circulation through the mechanism of credit creation.

Explain the functions of Central Bank as (a) Bank of note issue and (b) Banker's bank. 4+4=8

Ans:- (a) Issue of notes: The Central Bank of a country is given the monopoly power to issue notes. This means that it is authorized by law to print currency notes.