Central Bank | ICSE Class 10 Commercial Studies Notes

This note covers the meaning of a central bank, currency issue, banking services to government and commercial banks, clearing, emergency lending, credit control, reserve requirements, foreign exchange reserves, and differences between central and commercial banks.

What is a central bank and why is it needed?

Definition: A central bank is the institution that supervises, controls and regulates commercial banks and coordinates a country's currency and credit policies.

Currency means money in the form of notes and coins. Credit means an arrangement under which a lender provides money, goods or services in return for a promise of future payment. Currency and credit make payments and borrowing possible throughout an economy.

Almost every country has one central bank. The Reserve Bank of India (RBI) is India's central bank. India got its central bank in 1935. Its responsibilities concern the banking system as a whole, including currency, lending conditions and the supervision of banks.

How is its position different from ordinary banking?

A commercial bank accepts deposits from the public and lends part of these funds to borrowers. A deposit is money placed with a bank, which the bank owes to the depositor. Commercial banks connect people with surplus funds to people who need funds.

The central bank operates at a different level. It acts as banker to the government and as a bank to commercial banks. It also controls the money supply, meaning the stock of money available in the economy at a particular time.

Commercial bank lending creates deposits. Therefore, control over money involves more than issuing paper notes. The central bank must also influence the conditions under which banks lend and ensure that banks maintain required reserves, or funds set aside to meet banking requirements.

What connects its main functions?

The central bank's currency, reserve and credit functions are closely related. Banks need funds to meet withdrawals, while borrowers need loans. Supervision and reserve requirements help place limits on lending. Central banking therefore combines services to important institutions with control over the banking system.

Monetary policy means the central bank's policy for influencing money supply and credit conditions. Understanding this term helps connect its separate functions: issuing currency, holding bank reserves and influencing lending are parts of a wider monetary responsibility.

How does the central bank issue currency?

Currency issue is a central bank function. In India, the RBI issues currency notes on behalf of the central government. These notes pass into use through the banking system and provide a means of making payments for goods and services.

A commercial bank can supply cash to a customer withdrawing a deposit. This is different from issuing currency. The bank hands over existing notes; it does not acquire the authority to create its own currency notes by accepting deposits or granting loans.

What qualification is needed in the Indian context?

Note: In India, one-rupee notes and coins are issued by the Government of India. The RBI's note-issuing function should not be described as government minting of coins or as the issue of every denomination of paper money.

Denomination means the stated value of a note or coin. The distinction between the issuing authorities matters because the broad expression “issue of currency” must not hide the particular arrangement for one-rupee notes and coins.

Demand deposits are bank deposits repayable when the account-holder asks for payment. They also serve as money because payments can be made using bank accounts. Thus, money includes more than the physical currency people carry.

How does note issue differ from deposit creation?

The important distinction is between issuing notes and creating credit. Saying that commercial banks do not issue currency notes does not mean that their activities have no effect on money supply. Their deposit and lending operations are part of the money-creating system.

How does the central bank act as banker to the government?

As banker to the government, the central bank provides banking services for government transactions. A government receives money and makes payments, just as other organisations do, but these transactions relate to public administration and public finances.

What banking and agency services does it provide?

The central bank maintains government accounts, receives money on the government's behalf and makes authorised payments. These activities explain the word “banker”: the function concerns handling funds and accounts, rather than deciding how government departments should spend money.

It also acts as the government's agent, meaning an institution carrying out financial transactions on the government's behalf. It helps with government borrowing and the servicing of public debt, which is money owed by the government to its lenders.

Servicing debt means arranging payments of interest and repayment when due. Interest is the payment made for the use of borrowed money. The central bank's assistance with these transactions is distinct from the government's responsibility for deciding its borrowing and expenditure.

As a financial adviser, it advises the government on monetary and banking matters. This role draws on its position within the banking system. Advice, agency work and the keeping of government accounts are related responsibilities, but each describes a different service.

How can the three roles be distinguished?

The government-bank relationship should not be confused with banking for households. A household's savings account belongs to ordinary commercial banking. The central bank's government accounts form part of its institutional responsibilities, alongside currency issue and its relationship with commercial banks.

Nor does “banker to the government” mean that the central bank is a tax-making authority. Receiving government funds and handling payments describe banking operations. Choosing taxes and public spending concerns government policy, even when the resulting money passes through government bank accounts.

Why is the central bank called the bankers' bank?

The central bank is called the bankers' bank because commercial banks keep reserves with it and can obtain funds from it. The relationship resembles an ordinary customer's relationship with a bank, but here the account-holders are themselves banking institutions.

Commercial banks need to balance lending with their ability to meet withdrawals. A bank would like to earn interest from loans, but it must also be able to repay depositors. Keeping reserves is therefore an important part of banking.

What does custody of bank reserves involve?

The central bank acts as custodian of cash reserves, meaning it holds the required cash balances of commercial banks. In India, banks keep required cash reserves with the RBI. These balances connect individual banks to the central monetary institution.

State Bank of India (SBI), a commercial bank, keeps deposits with the RBI as reserves. This illustrates the distinction between the two levels of banking: members of the public deposit money with a commercial bank, while the commercial bank keeps reserves with the central bank.

Reserve requirements restrict how far banks can expand lending. A bank cannot treat every deposit as available for a fresh loan without considering the reserves it must hold. The central bank's role is therefore both that of a bank for banks and a controller of credit.

How does supervision support this relationship?

Supervision means checking banking activity and compliance with requirements. The RBI monitors whether banks maintain cash balances. Banks also provide information about their lending. Keeping reserves and reporting activity allow banking supervision to work through information and enforceable requirements.

Draw boxes labelled “Public”, “Commercial banks” and “Central bank”. Label the connection from the public to commercial banks “Deposits” and the connection from commercial banks to the central bank “Required cash reserves”.

This diagram separates customer deposits from bank reserves. Both are banking balances, but they belong to different relationships. A central bank's reserve account is not the same thing as a household's savings account, even though both involve placing money with a banking institution.

How does the central bank help clear payments between banks?

Clearing is the process of working out what banks owe one another from payments made by their customers. Settlement means completing those payment obligations. The central bank's clearing-house role is associated with the accounts that commercial banks maintain with it.

What happens when a cheque involves different banks?

A cheque is an instruction to a bank to pay a specified amount from an account. A customer may deposit a cheque drawn on another bank. The collecting bank must then obtain payment from the bank on which the cheque was drawn.

Across the banking system, such payments create claims in both directions. One bank may have to pay other banks while also being entitled to receive payments from them. Net settlement means settling the difference between amounts payable and amounts receivable.

1. Customers' payments give rise to amounts owed between commercial banks.
2. The payment claims are brought together through the clearing arrangement.
3. Amounts payable and receivable are compared to establish settlement obligations.
4. The obligations are settled through adjustments in the banks' accounts.

What is the advantage of this arrangement?

The advantage of clearing is that mutual claims can be dealt with together. Settlement through bank accounts reduces the need to move cash separately for each payment between banks. This supports the payment services commercial banks provide to their customers.

Clearing is different from granting a loan. It deals with completing existing payment instructions between banks. Lending supplies borrowed funds. Both can involve the central bank and commercial banks, so the purpose of the transaction must be identified before naming the function.

The clearing-house description explains a central banking function. It does not mean that every retail payment is personally handled by the central bank. Commercial banks perform customer-facing collection and payment services within the wider arrangements for clearing and settlement.

What does lender of last resort mean?

Definition: The lender of last resort is the central bank in its role of providing funds to commercial banks when they cannot obtain the needed funds from other sources.

A commercial bank needing additional funds can seek them in the market or approach the central bank. The central bank's readiness to provide funds to banks is an important part of its role as the bank to the banking system.

Why can a bank need emergency funds?

Liquidity means the availability of cash, or assets readily convertible into cash, to meet payments. A bank may have funds tied up in loans while needing cash to meet immediate withdrawals. A liquidity difficulty concerns the timing and availability of payment funds.

A loan owed to a bank is an asset, meaning something the bank owns or a claim it has on others. Yet a loan due for repayment later does not automatically provide cash for withdrawals today. This explains why lending banks also need reserves.

The central bank can provide emergency financial assistance when other sources are unavailable. Such assistance supports the bank's ability to meet payments. This is the distinctive feature of last-resort lending, rather than ordinary lending to a household or business.

What are the limitations of this description?

Lender of last resort should not be understood as a promise of unlimited, unconditional loans to every bank. It identifies the central bank's position as the final source of assistance, subject to the conditions governing that assistance.

The function also differs from routine reserve holding. Custody of reserves concerns banks keeping funds with the central bank. Last-resort lending concerns funds moving from the central bank to a bank that needs assistance. The direction and purpose of the relationship differ.

The two functions nevertheless support each other. Reserve requirements help banks maintain payment capacity, while emergency lending addresses a need for additional funds. A complete explanation identifies the institution receiving help, its difficulty in obtaining funds elsewhere and the central bank's supporting role.

How does the central bank control credit?

Credit control means influencing the amount and direction of lending. The central bank uses measures affecting the banking system's supply of funds and measures aimed at encouraging or discouraging particular lending activities. These are called quantitative and qualitative controls.

How do quantitative controls work?

Quantitative controls influence the overall extent of money supply and credit. Bank rate, open market operations and changes in reserve requirements belong to this group. Their mechanisms differ, so it is useful to connect each instrument to the immediate change it causes.

Bank rate is the rate at which the central bank lends to commercial banks. Raising it makes these loans more expensive and reduces money supply through its effect on banks' reserves. A fall in the bank rate can increase the money supply.

Open market operations are central bank purchases and sales of government bonds in the market. A government bond is a borrowing instrument through which the government promises payments to its holder. Buying and selling these instruments changes funds in the banking system.

1. The central bank buys government bonds in the open market.
2. It pays for the bonds, adding funds to the banking system.
3. The total reserves in the banking system increase.
4. The increase in reserves supports an increase in money supply.

A central bank sale works in the opposite direction: purchasers pay for the bonds, banking reserves fall and money supply is reduced. Keep the direction of the payment clear. A purchase puts funds into the system; a sale takes funds out.

How do qualitative controls work?

Qualitative controls influence the direction or terms of credit. Moral suasion means persuasion by the central bank, asking commercial banks to encourage or discourage lending in line with its policy. Persuasion should be distinguished from a compulsory reserve requirement.

A margin requirement is the proportion of the value of an asset offered as security that a bank will not finance through its loan. Security, or collateral, means an asset pledged to protect the lender if the borrower fails to repay.

Raising the margin reduces the loan available against a given security; lowering it permits a larger loan against that security. This concerns the terms of particular lending, whereas a general change in reserve requirements affects the wider capacity of banks to lend.

How do reserve requirements limit bank lending?

The Cash Reserve Ratio (CRR) is the required percentage of deposits that banks must keep as cash reserves with the central bank. A percentage expresses a quantity per hundred. A higher required percentage leaves less scope for lending from a given amount of funds.

The Statutory Liquidity Ratio (SLR) is the required proportion maintained in specified liquid assets. Liquid assets are assets that can readily meet payment needs. CRR and SLR both concern reserves, but should not be treated as identical requirements.

What do the reserve calculations show?

“Rs” denotes rupees. The following simplified examples assume one bank, a fixed initial cash reserve of Rs 100, and loans returning as deposits in that bank. Assume deposits equal cash reserves plus loans. The reserve percentages are illustrative assumptions, not statements of the rates currently in force.

In the calculations, “=” means equals, “÷” means divided by, “×” means multiplied by and “−” means subtract.

Worked example 1. A bank starts with deposits and cash of Rs 100. Its required reserve ratio is 20 per cent. Calculate the required reserve and the amount available for the first loan.

Answer: Required reserve = 20 ÷ 100 × Rs 100 = Rs 20. Amount available for the first loan = Rs 100 − Rs 20 = Rs 80.

The reserve is calculated on deposits. Keeping Rs 20 as required reserves means the bank cannot lend the whole initial Rs 100.

Worked example 2. The bank still has initial cash of Rs 100. After the first loan returns as a deposit, total deposits are Rs 180. The reserve ratio is 20 per cent. Calculate required reserves and the additional loan possible.

Answer: Required reserves = 20 ÷ 100 × Rs 180 = Rs 36. Additional loan possible = Rs 100 − Rs 36 = Rs 64.

The deposits now exceed the initial cash because lending has created another deposit. The required reserve rises with total deposits. The next loan is therefore calculated after allowing for the reserve requirement on the increased deposit balance.

Worked example 3. At the final position in the simplified process, deposits are Rs 500 and available cash reserves are Rs 100. The reserve ratio remains 20 per cent. Find required reserves and total loans.

Answer: Required reserves = 20 ÷ 100 × Rs 500 = Rs 100. Total loans = Rs 500 − Rs 100 = Rs 400. All available reserves are now required.

Worked example 4. Available reserves remain Rs 100, but the required reserve ratio rises to 25 per cent. In the same simplified system, calculate the maximum deposits supported and the corresponding total loans.

Answer: 25 per cent expressed as a decimal is 0.25. Maximum deposits = Rs 100 ÷ 0.25 = Rs 400. Total loans = Rs 400 − Rs 100 = Rs 300.

Why does a higher reserve ratio restrict credit?

The last two examples show the policy effect. With the same reserves, the higher ratio supports a smaller deposit total and a smaller loan total. Reserve requirements therefore place a limit on credit creation rather than allowing banks to lend without restriction.

These examples distinguish additional lending in a particular round from total loans at the final position. Rs 64 is the additional loan in the second round; Rs 400 is the total loan amount in the final 20 per cent case.

What does custody of foreign exchange reserves mean?

Foreign exchange means foreign currencies and claims payable in foreign currencies. Foreign exchange reserves are official external reserve assets, including foreign currency assets, gold and reserve claims on the International Monetary Fund. The central bank is the custodian of the economy's foreign exchange reserves.

How is this different from holding bank cash reserves?

Cash reserves maintained by commercial banks relate to banking requirements within the country. Foreign exchange reserves include foreign currency assets, gold and other official reserve assets. Both use the word “reserves”, but the assets involved and the purpose of the description differ.

Calling the central bank a custodian means that it holds and manages these reserves. The description concerns the country's official reserve holdings. It does not mean that every foreign currency transaction made by a business or individual is itself an official reserve transaction.

Foreign exchange is needed in dealing with payments involving different national currencies. Centralised custody of official reserves places an important part of the country's external monetary resources with its central bank. This responsibility belongs alongside its domestic currency and banking functions.

What should be kept distinct?

These are separate functions, even though all concern money. An explanation of foreign exchange custody should identify foreign currency resources. Repeating that the RBI holds commercial banks' cash reserves would describe the bankers' bank function instead.

The distinction also prevents confusion between domestic money, meaning money used within the country, and foreign exchange resources. The central bank's responsibility for both does not make them interchangeable terms. Each should be named according to the function being explained.

How does a central bank differ from commercial banks?

The clearest comparison uses the same basis on both sides. Compare objectives with objectives, customers with customers, and currency functions with currency functions. This makes the difference between an institution directing the banking system and institutions conducting ordinary banking business explicit.

Which differences are most important?

The difference in objective needs care. Saying that profit is not the central bank's primary objective does not mean it can never earn income. Likewise, commercial banks' earning activities do not remove their responsibilities to depositors or their obligation to follow banking requirements.

Commercial banks can be in the public or private sector. A public sector bank has a major government stake, meaning government ownership interest. Public sector banks usually need to emphasise social objectives more than profitability. Such ownership does not turn it into the central bank. The institution's functions determine the distinction being made.

Which types of bank exist, and which laws govern them?

Banks are classified into commercial banks, cooperative banks, specialised banks and the central bank. The focus of banking is varied and its needs are diverse, so different kinds of bank are needed to meet them.

Commercial banks are governed by the Banking Regulation Act 1949. Under it, banking means accepting deposits of money from the public for the purpose of lending or investment. Public sector banks include State Bank of India (SBI), Punjab National Bank (PNB) and Indian Overseas Bank (IOB). Private sector banks, owned, managed and controlled by private promoters and free to operate as per market forces, include HDFC Bank, ICICI Bank, Kotak Mahindra Bank and Jammu and Kashmir Bank.

Cooperative banks are governed by the provisions of the State Cooperative Societies Act. They exist essentially to provide cheap credit to their members and are an important source of rural credit, that is, agricultural financing in India. Specialised banks include foreign exchange banks, industrial banks, development banks and export-import banks. They provide financial aid to industries, heavy turnkey projects and foreign trade.

How can a banking activity be classified?

Start by identifying who deals with whom. A bank accepting the public's deposits is carrying out commercial banking. A central bank holding the reserves of commercial banks is acting as bankers' bank. A central bank handling government accounts is acting as government banker.

Next identify the purpose. Supplying emergency funds when other sources are unavailable indicates last-resort lending. Buying government bonds to affect reserves indicates credit control. Helping settle obligations between banks indicates the clearing-house role. The same institutions can interact for different purposes.

The central bank and commercial banks therefore form connected parts of the banking system. They are neither identical institutions nor unrelated ones. Commercial banks serve depositors and borrowers, while central banking provides monetary direction, supervision and banking services at the institutional level.

Glossary

• Central bank — Institution supervising the banking system and coordinating currency and credit policies for the economy.
• Commercial bank — Institution accepting deposits from the public and lending part of those funds to borrowers.
• Money supply — The stock of money available in an economy at a particular point in time.
• Demand deposit — A bank deposit repayable when its account-holder asks the bank to make payment.
• Public debt — Money owed by the government to lenders from whom it has borrowed funds.
• Bankers' bank — The central bank in its capacity as reserve-holder and provider of banking services to commercial banks.
• Clearing — The process of establishing amounts owed between banks arising from their customers' payments.
• Lender of last resort — The central bank providing funds to commercial banks when the necessary funds are unavailable elsewhere.
• Liquidity — Availability of cash or readily convertible assets to meet payments when they fall due.
• Bank rate — The rate at which the central bank lends funds to commercial banks.
• Open market operations — Central bank purchases and sales of government bonds in the market to influence money supply.
• Cash Reserve Ratio — Required percentage of deposits that commercial banks must keep as cash reserves with the central bank.
• Moral suasion — Persuasion by the central bank to encourage commercial banks to follow its credit policy.
• Margin requirement — Proportion of the value of pledged security that the lender will not finance through a loan.
• Foreign exchange reserves — Official external reserve assets available to the monetary authority.

Common errors and misconceptions

• Misconception: A central bank is simply a large commercial bank. Correct: It supervises commercial banks, coordinates currency and credit policies, and acts as banker to government and banks.
• Misconception: The RBI issues every Indian note and coin. Correct: One-rupee notes and coins are issued by the Government of India; the RBI has the central bank's note-issuing role.
• Misconception: A commercial bank issuing cash to a customer is issuing currency. Correct: Paying out existing notes differs from creating and issuing currency notes.
• Misconception: Banks can lend the whole of their deposits without restrictions. Correct: They must maintain required reserves, which limit credit creation.
• Misconception: Buying government bonds reduces banking reserves. Correct: Central bank purchases add reserves; sales reduce reserves and money supply.
• Misconception: Lender of last resort means a lender serving ordinary business customers. Correct: The function concerns central bank assistance to banks unable to obtain needed funds elsewhere.
• Misconception: Cash reserves of banks and foreign exchange reserves mean the same thing. Correct: The former concern required banking balances; the latter concern official external reserve assets.
• Misconception: Government ownership makes a commercial bank the central bank. Correct: A public sector commercial bank remains distinct from the institution directing and supervising the banking system.

Exam-style questions with model answers

Q1. Define a central bank and name India's central bank. [2 marks]

1. A central bank supervises and regulates commercial banks and coordinates the country's currency and credit policies.
2. India's central bank is the Reserve Bank of India, abbreviated as RBI.

Q2. Explain the central bank's roles as banker, agent and financial adviser to the government. [3 marks]

1. As banker, it maintains government accounts, receives funds on the government's behalf and makes authorised payments. These are banking services for government transactions.
2. As agent, it assists with government borrowing and servicing public debt, including arrangements for interest payments and repayment when due.
3. As financial adviser, it provides advice on monetary and banking matters, drawing on its responsibilities within the banking system.

Q3. Explain four aspects of the central bank's relationship with commercial banks: reserves, supervision, clearing and emergency lending. [4 marks]

1. It holds required cash reserves that commercial banks keep with it, acting as custodian of those balances.
2. It supervises banking activities, including checking compliance with cash reserve requirements and obtaining information about lending.
3. Its clearing-house role supports the settlement of amounts owed between banks through adjustments in their accounts.
4. It acts as lender of last resort by providing funds to commercial banks when needed funds cannot be obtained elsewhere.

Q4. Explain five central bank functions: currency issue, government banking, bankers' bank, credit control and custody of foreign exchange reserves. [5 marks]

1. Currency issue: The central bank issues currency notes. In India, the RBI performs this role, with the exception of one-rupee notes issued by government.
2. Government banking: It maintains government accounts, receives funds and makes authorised payments, providing banking services for the government's financial transactions.
3. Bankers' bank: It holds required cash reserves of commercial banks and provides banking services to them, linking banks to the central monetary institution.
4. Credit control: It influences money supply and credit through instruments such as bank rate, open market operations and changes in reserve requirements.
5. Foreign exchange custody: It holds and manages the economy's official foreign exchange reserves, a responsibility distinct from custody of commercial banks' cash balances.

Q5. Distinguish between central and commercial banks on six bases: objective, banking relationships, currency notes, credit, reserves and supervision. [6 marks]

1. Objective: The central bank primarily concerns itself with monetary management and the public interest; commercial banks conduct banking business and seek profits while meeting their obligations.
2. Banking relationships: The central bank acts as banker to government and commercial banks; commercial banks accept deposits from and lend to the public and businesses.
3. Currency notes: The central bank has the note-issuing function, subject to the Indian exception for one-rupee notes; commercial banks do not issue their own currency notes.
4. Credit: The central bank controls credit conditions and money supply; commercial banks create credit through their deposit and lending operations.
5. Reserves: The central bank holds required cash reserves of commercial banks; commercial banks maintain the required balances with the central bank.
6. Supervision: The central bank supervises and regulates commercial banks; commercial banks conduct their activities subject to that supervision and applicable banking requirements.

Q6. Explain how a central bank purchase of government bonds in the open market increases money supply. Give four linked points. [4 marks]

1. The central bank purchases government bonds, which are instruments through which the government borrows and promises payments to their holders.
2. It pays the sellers for the bonds, introducing funds into the banking system through the purchase transaction.
3. These payments increase the total reserves available within the banking system, supporting the banks' capacity to provide credit.
4. The increase in reserves supports an increase in money supply. An open market purchase therefore increases the amount of money available.

Q7. In a simplified single-bank system, all loans return as deposits, available reserves remain Rs 100, and no cash is held outside the bank. Assume deposits equal reserves plus loans. The required reserve ratio is initially 20 per cent and later 25 per cent. Calculate maximum deposits and total loans at each ratio. [4 marks]

1. At 20 per cent, maximum deposits are Rs 100 ÷ 0.20 = Rs 500. Here 0.20 is the reserve percentage written as a decimal.
2. At 20 per cent, total loans are deposits less reserves: Rs 500 − Rs 100 = Rs 400.
3. At 25 per cent, maximum deposits are Rs 100 ÷ 0.25 = Rs 400. Here 0.25 is the new reserve percentage written as a decimal.
4. At 25 per cent, total loans are Rs 400 − Rs 100 = Rs 300. The higher reserve ratio therefore restricts lending.

Q8. What is meant by lender of last resort? Explain why a bank can need this assistance and distinguish it from holding reserves. [3 marks]

1. The lender of last resort is the central bank providing funds to commercial banks when they cannot obtain the necessary funds from other sources.
2. A bank can need assistance because money tied up in loans is not immediately available to meet withdrawals, creating a shortage of payment funds.
3. Holding reserves involves commercial banks keeping funds with the central bank; last-resort lending involves the central bank providing additional funds to a bank needing assistance.

Key takeaways

• The Reserve Bank of India is India's central bank, supervising commercial banks and coordinating currency and credit policies.
• The central bank's note-issuing function differs from commercial banks paying out existing notes or creating deposits through lending.
• As government banker, the central bank handles accounts and payments, alongside its agency and advisory responsibilities.
• The bankers' bank holds required cash reserves, supports interbank settlement and provides funds to commercial banks.
• Last-resort lending concerns banks needing funds when other sources are unavailable; it is distinct from ordinary lending to businesses.
• Bank rate, open market operations and reserve requirements influence money supply through their effects on the banking system.
• With unchanged reserves, a higher required reserve ratio supports less lending and a smaller deposit total.
• Foreign exchange reserves are official external reserve assets, distinct from commercial banks' required domestic cash reserve balances.

Test yourself

What does RBI stand for?

RBI stands for Reserve Bank of India, the country's central bank.

Does a commercial bank create currency notes when it grants a loan?

No. Commercial bank lending creates deposits; it does not give the bank the authority to issue its own currency notes.

What makes the central bank the bankers' bank?

Commercial banks keep required reserves with it and can obtain funds and banking services from it.

What is the difference between clearing and lending?

Clearing establishes amounts owed between banks from payments. Lending provides borrowed funds, creating a repayment obligation.

What happens to banking reserves when the central bank sells government bonds?

Purchasers pay for the bonds, reducing reserves in the banking system and reducing money supply.

What happens to lending capacity when the reserve ratio rises and available reserves stay unchanged?

The bank must hold a larger proportion of deposits as reserves, reducing the deposits and loans its available reserves can support.

What is moral suasion?

It is central bank persuasion encouraging commercial banks to follow its credit policy by encouraging or discouraging lending.

Why does government ownership not make a commercial bank the central bank?

The distinction rests on functions. A government-owned commercial bank conducts ordinary banking, while the central bank directs and supervises the banking system.