Currency issued by Central Bank is called:

“High Power Money”

It is backed by supporting reserves consisting mainly of gold and foreign exchange reserves under the “minimum reserve system”, which was introduced in 1956.

Minimum reserve requirement :

Total Minimum Reserve : Worth Rs. 515 crore

◦ Foreign Securities : Worth Rs. 400 Crore◦ Gold : Worth Rs. 115 Crore

In 1957, minimum requirement is being reduced to only gold worth of Rs.115crore mainly due to the scarcity of foreign exchange to meet essential import bill.

Second source of Money Supply.

Money supply by commercial bank is called Credit Money (secondary deposits/derivative deposits) which is created by:

Primary Deposit, are made by the public for following reasons:

Household savings Payment received (by cheque and draft) from

Central Bank for sale of Govt. bonds Payment received from abroad

The process of “Credit Creation” begins with banks lending money out of “primary deposits”.

Banks cannot loan out the entire primary deposits as they are required to maintain a certain proportion of primary deposit in the form of Cash reserves , which are two kinds:

◦ Statuary Cash Reserve (SCR) : mandatory requirement by central bank

Excess Reserve ( ER) : bank’s requirement of cash in addition to SCR to meet the cash demand by the depositors.

The amount of Secondary deposits/derivative deposits depends on:

The amount of primary deposits The rate of required reserves Demand for bank loans by the society

Efficiency of the banking system

Assumptions:

No. of bank’s demand deposit should be high.Bank Cash reserve requirement is 20%

;

Balance sheet of the Bank : Rs. In Thousand Liabilities Amount Assets

Amount

A’s deposit 100.00 CRR 20.00

Excess Reserve 80.00

TOTAL Total 100.00

Excess reserve Rs. 80.00 can be lent to an individual “B”.

There are two ways of lending.

1.Either Bank can hand over Rs. 80 thousand to “B”

2.Or the bank can open an account in B’s name and credit the account.

Liabilities Amount Assets Amount

A’s deposit 100.00 CRR (20+16) 36

B’S deposit 80.00 LOAN TO B 80

EXCESS RESERVE 64

TOTAL 180.00 TOTAL 180.00

Liabilities Amount Assets Amount

A’s deposit 100.00 CRR (20+16+12.80) 48.80

B’S deposit 80.00 LOAN TO B 80.00

C’s deposit 64.00 loan to C 64.00

Excess Cash Reserve 51.20

TOTAL 244.00 TOTAL 244.00

A Primary deposit leads to the creation of Secondary deposits.

dm = Total Additional Deposits Total Additional Cash Reserve

= TD = 244 = 5 TR 48