FAQs on Banking System

Question 1

1. What is the difference between commercial banks and central banks in India's banking system?

Accepted Answer

Ans. Commercial banks accept deposits and provide loans to individuals and businesses, while the Reserve Bank of India (RBI), as the central bank, regulates monetary policy, manages currency supply, and supervises the entire banking sector. The RBI acts as the banker to the government and other banks, controlling interest rates and inflation to maintain financial stability across India's economy.

Question 2

2. How does the money multiplier effect work in banking and why does it matter for the economy?

Accepted Answer

Ans. The money multiplier describes how initial deposits create multiple rounds of lending throughout the banking system, expanding the money supply beyond the original amount. When banks lend deposits to borrowers, those funds are redeposited, creating new lending capacity. This mechanism amplifies economic activity but also increases inflation risk. Understanding money multiplier effects helps explain how central banks control liquidity and inflation through reserve requirements.

Question 3

3. What are statutory liquidity ratio (SLR) and cash reserve ratio (CRR), and how do they control inflation?

Accepted Answer

Ans. SLR requires banks to maintain a percentage of deposits in government securities, while CRR mandates reserves held at the RBI. Both tools restrict the lending capacity of banks, reducing money supply during inflationary periods. When the RBI increases CRR or SLR, banks have fewer funds available for loans, cooling economic activity and controlling price rises. These regulatory instruments form the RBI's quantitative monetary policy framework.

Question 4

4. Why do banks charge different interest rates on loans and savings accounts, and what determines these rates?

Accepted Answer

Ans. Banks charge higher lending rates than savings rates to cover operational costs, manage default risk, and generate profit margins. The RBI's repo rate sets the baseline; banks adjust their lending and deposit rates accordingly based on market conditions and credit risk assessment. Competition, inflation expectations, and individual creditworthiness also influence rate variations. This spread between lending and borrowing rates sustains banking profitability.

Question 5

5. What role do scheduled commercial banks play in implementing government schemes and expanding financial inclusion?

Accepted Answer

Ans. Scheduled commercial banks distribute government welfare schemes, provide subsidised credit through priority sector lending, and establish branches in underserved rural areas. They issue Jan Dhan accounts for unbanked populations and participate in digital payment initiatives. By reaching marginalised communities, these banks support inclusive growth, reduce inequality, and strengthen financial integration across India's economy.

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