Question

Give reasons or explain.

1. Clearing house system economises the use of cash.
2. Central Bank acts as a lender of the last resort.
3. The CRR affects the lending capacity of the banks.
4. As a banker to the government, the Central Bank transfers government funds.
5. A Central Bank may take 'Direct Action' against the defaulting commercial banks.

Answer 1

1. All the commercial banks are mandatorily required to keep a certain percentage of their deposits with the Central Bank. The Central Bank accepts the deposits from the commercial banks and helps in the settlement of interbank claims. This is regarded as a clearing house function of commercial banks. As a clearing house it settles inter-bank claims and reduces the need for cash reserves by the commercial banks.

2. The Central Bank acts as the lender of last resort for the commercial banks and the government. When a commercial bank faces financial crisis and fails to obtain funds from other sources, the Central Bank plays the vital role of ‘lender of last resort’ and provides them with financial assistance in the form of credit.

3. CRR refers to the minimum portion of the total deposits that the commercial banks have to maintain with the Central Bank in the form of reserves. CRR has a great impact on the lending capacity of the banks. An increase in CRR means lesser portion of the deposits would be left for distribution as loans and a decrease in CRR means a greater portion would be available for further loans.
Suppose the total assets of a bank are worth Rs. 200 Crores and the minimum CRR is 10%, the amount that the commercial bank has to maintain with the RBI is Rs. 20 Crores. If this ratio rises to 20%, the reserve with RBI increases to Rs. 40 Crores. Thus, less money will be left with the commercial bank for lending. This will eventually lead to considerable decrease in the money supply. Therefore, CRR is used to affect the lending capacity of the commercial banks.

4. Central Bank acts as a banker to the government. On behalf of the government, the Central Bank buys and sells government securities, maintains its books of accounts, manages its public debt and also grants loans and advances to the government. Thus, as a banker to the government, the Central Bank transfers government funds by accepting receipts and making payments on behalf of the government.

5. Direct action refers to the actions taken by the Central Bank against commercial banks which fail to adhere to the directions of the Central bank. In other words, it refers to the actions taken by the Central Bank against defaulting commercial banks. Direct action is used as a selective credit control measure by the Central Bank. This may be achieved by either threatening the defaulting banks or by refusing them the rediscounting and loan facilities or by imposing penalties on these banks.