1. The State Bank of India is the oldest and largest bank still in existence in India, originating from banks established in the 1800s. 2. Commercial banks accept deposits, grant loans, and make investments with the aim of earning profits. They act as financial intermediaries by facilitating the flow of savings from households to productive sectors. 3. Through the process of money creation, commercial banks are able to generate credit and deposits in excess of initial deposits by requiring reserves of only a fraction of deposits set by the central bank.

1. BANKIN
G
Priyanka Chhabra 1
By Priyanka
Chhabra

2. HISTORY OF BANKING
Among the first banks were the Bank of Hindostan, which
was established in 1770 and liquidated in 1829–32; and
the General Bank of India, established in 1786 but failed
in 1791.
The largest and the oldest bank which is still in existence
is the State Bank of India (S.B.I). It originated and started
working as the Bank of Calcutta in mid-June 1806. In
1809, it was renamed as the Bank of Bengal. This was
one of the three banks founded by a presidency
government, the other two were the Bank of Bombay in
1840 and the Bank of Madras in 1843. The three banks
were merged in 1921 to form the Imperial Bank of India,
which upon India's independence, became the State
Bank of India in 1955. Priyanka Chhabra 2

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9. COMMERCIAL BANKS
• It is an institution which performs the functions of accepting
deposits, granting loans and making investments, with the aim of
earning profits.
• Like business, it also aims to earn profit and thereby offers variety
of services
• Savings of household sector is made available to productive sector
for further investment
• It acts as a financial intermediaries
• The rate at which commercial banks accepts deposits is known as
‘borrowing rate’ and the rate at which banks lend out their reserves
to investors is called the ‘lending rate’
• The difference between the two rates known as ‘spread’ i.e. profits
of bank
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11. 1. ACCEPTING DEPOSITS
Demand
Deposits
Time Deposits
Saving Deposits
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12. 2. ADVANCING LOANS
Cash Credit
Demand Loans
Short Term
Loans
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13. 3. SECONDARY FUNCTIONS
• Customer can
overdraw his
current account
Overdraft
facility
• Holder can get
the bill discounted
before maturity
Discounting
Bills of
Exchange
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14. 4. AGENCY FUNCTIONS
Transfer of funds
Collection and payment of various items
Purchase and sale of Foreign Exchange
Purchase and sale of Securities
Income Tax consultancy
Trustee and Executor
Letters of reference
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15. 5. GENERAL UTILITY FUNCTIONS
Locker facility
Traveller’s cheque
Letter of credit
Underwriting securities
Collection of statistics
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16. MONEY
CREATION
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17. It is one of the most important activities of commercial
banks. Through the process of money creation, commercial
banks are able to create credit, which is in far excess of the
initial deposits.
Assumptions:
• The entire commercial banking system is one unit and is
termed as ‘Banks’.
• All receipts and payments in the economy are routed
through the Banks
• The deposits held by Banks are used for giving loans.
However, banks cannot use the whole of deposit for
lending. Priyanka Chhabra 17

18. • It is legally compulsory for the banks to keep a
certain minimum fraction of their deposits as
reserves.
• The fraction is called the Legal Reserve Ratio
(LRR) and is fixed by the central bank.
• Banks do not keep 100% reserves against the
deposits.
• They keep reserves only to the extent indicated
by the Central Bank.
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19. Legal reserve ratio refers to the minimum fraction of deposits
which the banks are mandate to keep as cash themselves. The
legal reserve ratio is fixed by Central bank. Legal Reserve
Ratio has two components:
Cash Reserve Ratio (CRR)-It refers to cash reserves of
Commercial Banks with the Central Bank as a percentage of
their deposits.
Statutory Liquidity Ratio (SLR) refers to reserves in the form
of liquid assets (including (i) cash, (ii) gold, and (iii) approved
securities) with the Commercial Banks themselves, as a
percentage of their total deposits.
Both CRR and SLR are fixed by the Central Bank, and both arePriyanka Chhabra 19

20. Why only Fraction of deposits is kept as Cash
Reserves?
Banks keep a fraction of deposits as Cash Reserves
because a prudent banker, by his experience, knows two
things:
(i) All the depositors do not approach the banks for
withdrawal of money at the same time and also they do
not withdraw the entire amount in one go.
(ii) There is a constant flow of new deposits into the banks.
So, to meet the daily demand for withdrawal of cash, it is
sufficient for banks to keep only a fraction of deposits as
cash reserve.
It means, if experience of the banks show that withdrawalsPriyanka Chhabra 20

21. Suppose, initial deposits in banks is Rs 1,000 and
LRR is 20%.
It means, banks are required to keep only Rs 200 as
cash reserve and are free to lend Rs 800.
Suppose they lend Rs 800.
Banks do not lend this money by giving amount in
cash.
Rather, they open the accounts in the names of
borrowers, who are free to withdraw the amount
whenever they like. Priyanka Chhabra 21

22. Suppose borrowers withdraw the entire amount of
Rs. 800 for making payments.
As all the transactions are routed through the
banks, the money spent by the borrowers comes
back into the banks in the form of deposit accounts
of those who have received this payment.
It will increase the demand deposits of banks by
Rs. 800.
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23. With new deposits of X 800, banks keep 20% as
cash reserves i.e. Rs. 160 and lend the balance Rs
640.
Borrowers use these loans for making payments,
which again comes back into the accounts of those
who have received the payments.
This time, banks deposits rise by Rs 640.
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24. The deposits keep on increasing in each round by
80% of the last round deposits.
At the same time, cash reserves also go on
increasing, each time by 80% of the last cash
reserve.
Deposit creation comes to end when total cash
reserves become equal to the initial deposit.
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25. Deposits
Rs
Loans
Rs
Cash Reserves
(LRR = 20%)
Initial Deposit
Round I
Round II
–
–
–
1,000
800
640
–
–
–
800
640
512
–
–
–
200
160
128
–
–
–
Total 5,000 4,000 1,000
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26. Banks are able to create total deposits of Rs 5,000
with the initial deposit of just Rs. 1,000.
It means, total deposits become ‘five times’ of the
initial deposit i.e.
Five times is nothing but the value of ‘Money
Multiplier’
Total Deposit = Initial Deposit x Money Multiplier
Money Multiplier or Deposit multiplier measures the
amount of money that the Banks are able to create
in the form of deposits with every unit of money itPriyanka Chhabra 26

27. Money Multiplier = 1/LRR
In the given example, LRR is 20% or 0.2.
So,
Money Multiplier = 1/0.2 = 5
It signifies that for every unit of money kept
as reserves, banks are able to create 5 units
of money. The value of money multiplier is
determined by LRR.
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28. Higher the value of LRR,
lower is the value of money
multiplier and less money is
created by the banking
system.
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29. PRACTICE QUESTIONS
1.Calculate the value of money multiplier and
total deposit created if initial deposit is of Rs.
500 crore and LRR is 10%
2.If total deposit created by commercial banks is
Rs. 12000 crore and LRR is 25%, then
calculate amount of initial deposit.
3.Calculate LRR if initial deposit is Rs. 200
crore leads to creation of total deposit of Rs.
1600 crore.
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30. CENTRAL BANK
It is an apex body that controls, operates, regulates and
directs the entire banking and monetary structure of the
country
It has occupied the top most position in the monetary and
banking system of the country
All the financially developed countries have their own central
bank
India’s central bank is RBI, which was established on
01/04/1935 in Kolkata under RBI Act 1934
In UK it is known as Bank of England and in USA it is known
as Federal Reserve SystemPriyanka Chhabra 30

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32. ISSUE OF CURRENCY
• RBI has sole authority for issuing currency in the country
except one rupee notes and coins which are issued by
Ministry of Finance
• Currency issued by RBI is its monetary liability
• It leads to uniformity in note circulation
• RBI can influence money supply
• It ensured public faith in the currency system
• It helps in stabilizing the value of currency
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33. BANKER TO THE GOVERNMENT
• It acts as a banker, agent and a financial advisor to the
government
• It maintains current account of government for keeping
cash balances
• It accepts receipts and makes payments for the
government
• It gives loans and advances to the government for short
period
• It has the responsibility of managing public debt
• It advices government on the monetary, financial andPriyanka Chhabra 33

34. BANKER’S BANK
• RBI regulates and supervise the commercial banks of the
country
• It acts as a banker to the other bank
• It has the same relationship with the bank as commercial
banks have with general public
• It acts as a custodian of cash reserves of commercial
banks
• It also acts a ‘Lender of the last resort’
• It acts as a clearing house
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CUSTODIAN OF FOREX
• RBI acts as a country’s stock of gold and
reserves of forex
• All forex transactions are routed through RBI
only
• It helps bank in stabilizing the external value of
currency
• It helps in framing a coordinated policy towards
the BoP of a country

36. CONTROLLER OF MONEY SUPPLY
• RBI controls money supply by changing following
reserve requirements of commercial banks
• Repo Rate
• Bank Rate
• Open Market Operations
• LRR
• Margin requirements
• Moral Suasion
• Selective Credit Control
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DEFICIT FINANCING
It is a practice in which a government spends more money
than it receives as revenue, the difference being made up by
borrowing or minting new funds.
For this government borrows money from RBI by selling its
treasury bills
Although budget deficits may occur for numerous reasons,
the term usually refers to a conscious attempt to stimulate
the economy by lowering tax rates or increasing government
expenditures.
It is also known as ‘Monetizing the Government’s Debt’

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