AHSEC - Class 12: Banking Solved Question Paper' 2014 | Class 12 Banking Solved Question Papers

[Banking Solved Question Papers, AHSEC, Class 12, 2014]

Full Marks: 100
Time: 3 hours
The figures in the margin indicate full marks for the questions.

1. Answer as directed:          1x10=10

a) In which year the Imperial bank was established?
Ans: 1921
b) Where is the head office of the Reserve bank of India?
Ans: Mumbai
c) What is primary market?
Ans: Primary market which is also called new issue market represents a market where new securities i.e. shares and bonds that have never been previously issued are offered. It is a market of fresh capital.
d) Write the full form of NABARD.
Ans: National bank for agricultural and rural development
e) The board of directors of Reserve Bank of India consists of 20 members. (Fill in the blank)
f) What is overdraft?
Ans: Overdraft: An overdraft is an arrangement by which the customer is allowed to overdraw his account. It is granted against some collateral securities. The facility to overdraw is allowed through current account only. Interest is charged on the exact amount of overdrawn subject to the payment of minimum amount by way of interest.
g) The first development bank established in India was IFCI/IDBI/UTI/NABARD.      (Choose the correct answer)
h) Give an example of material alteration of cheque.
Ans: Alteration of the date of the cheque.
2. Define a cheque according to Sec. 6 of the Negotiable Instruments Act.      2
Ans: Ans: According to Section 6 of the Negotiable Instrument Act, 1881, “A Cheque is a bill of exchange, drawn upon a specified banker and payable on demand.”
3. State the minimum reserve system of note issue.         2
Ans: The minimum reserve system is a system in which the Central Bank is authorized to issue notes up to any limit by keeping a certain minimum reserve of gold and foreign securities. In India, the RBI is required to keep the minimum reserve of Rs. 200/- crore out of which Rs. 115/- crore should be kept in gold. The system is very elastic and economical for developing countries as it requires only a small and fixed amount of gold reserve. However, it lacks in public confidence due to non-convertibility of notes.
4. Define ‘holder in due course’.              2
Ans: Holder in due course means any person who, for consideration, become the possessor of a promissory note, bill of exchange or cheque, if payable to bearer, or the payee or endorsee thereof if payable to order, before the amount mentioned, in it became payable and without having sufficient course to believe that defect existed in the title of the person from whom he derived his title.
5. What do you mean by SLR?            2
Ans: Statutory Liquidity ratio of the total deposits of a bank which it has to maintain with itself in the form of liquid funds like government securities and cash in hand at any given conditions and point of time.
6. Who can cross a cheque?                  2
Ans: The Drawer: The drawer of a cheque may cross a cheque before issuing it. He may cross it generally or specially.
The Holder: The holder of a cheque can cross.
The Banker: The banker to whom the cheque is crossed specially may again cross it especially to another banker's agent, for collection. This is called double special crossing.
7. What are the main sub-markets of financial market?          3
Ans: The financial market consists of two major segments
a) Money market
b) Capital market
Money market deals in cash or near money or liquid assets of short-term nature. It also trade in bills, promissory notes, government papers. Money market is essentially concerned with lending and borrowings of cash and also the buying and selling of assets which are close substitutes for money and can be easily converted into money within a short period.
Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government.
8. State any three differences between bill of exchange and cheque.    3
Ans: Difference between cheque and bill of exchange  
Bills of Exchange
A cheque is always drawn on a bank or banker.
A bill of exchange can be drawn on any person including a banker.

A cheque does not require any acceptance.
A bill must be accepted before the Drawee can be made liable upon it.
A cheque is payable immediately on demand without any days of grace.
A bill of exchange is normally entitled to three days of grace unless it is payable on demand.

9. Draw a specimen copy of a cheque.       3

10. State the basic features of non-banking financial institutions.         3
Ans: The distinguish features of NBFIs are listed below:
a)      NBFI accept deposits repayable on the expiry of specified time and certain NBFI receive funds from government.
b)      The liabilities of NBFI are not accepted as money as a means of payment of debt.
c)       EBFI deals with medium and long-term funds in the capital market.
d)      NBFIs are heterogeneous group doing diverse business in the financial system of the economy.
e)      People invest their surplus fund with NBFI for earning income rather than safety and liquidity.
11. Write a brief not about capital market.          3
Ans: Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government. The long-term funds are made available through various instruments such as debentures, preference shares, and common shares. The capital market can be local, regional, national, or international.
Features of Indian Capital Market
a)      Dealing in Securities: It deals in long-term marketable securities and non-marketable securities.
b)      Segments: It included both primary and secondary market. Primary market is meant for issue of fresh shares and secondary market facilitates buying and selling of second hand securities.
c)       Investors: It includes both individual investors and institutional investors.
12. Explain briefly the system of issuing currency notes by the Reserve Bank of India.       5
Ans: The first function or the primary function of money is to issue paper currency. The Central Bank has the sole power to issue paper currency. The notes are legal tender money. In India, the RBI issue currency notes of all types except One Rupee note which are issued by the Ministry of Finance, Govt. of India. But the notes are issued following some methods. The Central Banks follows different methods or system according to the currency or banking regulations to issue notes. These systems are:
a)      Simple Deposit system.
b)      Fixed fiduciary system.
c)       Proportional reserve system.
d)      Minimum reserve system.
e)      Maximum reserve system.
The simple deposit system is also knows as full reserve system. Under this system, the Central Bank is required to keep 100% of metal, either gold or silver or both as reserve for every note issued. The notes so issue becomes representative paper money. The advantage of this system is that it enjoys a public confidence and there is no danger of over issue of currency notes. But it is very costly and money supply cannot be increase as and when required.
The system of fixed fiduciary was first introduced in England in 1844. Under this system, the Central Bank issue currency notes up to a certain limit against reserves of Govt. securities. The notes issued beyond the limit set by the law have to be fully banked by metallic reserves. Though the system inspires public confidence and ensures convertibility of currency notes without any danger of over issue, yet the system is uneconomical and un-elastic as it requires sufficient gold reserves and the supply of money cannot be increased easily at time of emergency.
The proportional system of issuing currency is very simple and elastic. According to this system, the notes issued by Central Bank are banked by both metallic reserves and securities. A certain percentage (25 to 40%) of the total notes issued has to be backed by gold or silver reserves and the remaining by Govt. securities. The system guarantees the convertibility of paper money and is economical to use.
The minimum reserve system is a system in which the Central Bank is authorized to issue notes up to any limit by keeping a certain minimum reserve of gold and foreign securities. In India, the RBI is required to keep the minimum reserve of Rs. 200/- crore out of which Rs. 115/- crore should be kept in gold. The system is very elastic and economical for developing countries as it requires only a small and fixed amount of gold reserve. However, it lacks in public confidence due to non-convertibility of notes.
The system in which the Central Bank is authorized to issue notes up to a certain limit without any gold reserves is known as Maximum Reserve System. Under this system, the Central Bank is given power to determine the maximum limit and also the power to reserve the limit from time to time according to the needs of the economy. This system is elastic and economical to use. But it involves the danger of over issue of notes and lacks public confidence.
13. Discuss briefly the functions of stock exchange.        5
Ans: As the barometer measures the atmospheric pressure, the stock exchange measures the growth of the economy. it performs the following vital functions:
a)      Ready market and liquidity: Stock exchange provides a ready and continuous market where investors can convert their money into securities and securities into money easily and quickly. It provides a convenient meeting place for buyers and sellers of securities.
b)      Evaluation of securities: Stock exchange helps in determining the prices of various securities that reflect their real worth. The forces of demand and supply act freely in the stock exchange and help in the valuation of securities.
c)       Mobilisation of savings: Stock exchange helps in mobilising surplus funds of individuals and institutions for investment in securities. In the absence of facilities for quick and profitable disposal of securities, such funds may remain idle.
d)      Capital formation: Stock exchange not only mobilises the existing savings but also induces the public to save money. It provides avenue for investment in various securities which yield higher returns. It helps in allocation of available funds into the most productive channels.
e)      Regulation of corporate sector: Stock exchanges frame their rules and regulations. Every company which wants its securities to be dealt in at the stock exchange has to follow the rules framed by the stock exchange in this regard.
What are the differences between Money Market and Capital Market?
Ans: Difference between capital market and money market
Basis of  Distinction
Capital Market
Money Market
1)   Meaning
The market dealing in long-term funds is known as capital market.
The market dealing in short-term funds in known as money market.
2)   Constituents
These include new issue market, stock market, stock brokers and intermediaries.
These include call money market, bill market and discounting market.
3)   Participants
Individual and institutional investors operate in the capital market.
Only the institutional investors operate in the money market.
4)   Amount of funds
Capital market arranges large amount of funds.
Money market arranges comparatively small amount of funds.
5)   Instruments
The instruments in the capital market include shares debentures bonds etc.
Trade bills T-bills, certificate of deposits, commercial papers etc. are the instruments of money market.
14. Briefly explain the utility services of commercial bank.              5
Ans: General Utility functions: These are certain utility functions performed by the modern commercial bank which are:
1.       Locker facility: Banks provides locker facility to their customers where they can their valuables.
2.       Traveler’s cheques: Bank issue travelers cheques to help their customers to travel without the fear of theft or loss of money.
3.       Gift cheque: Some banks issue gift cheques of various denominations to be used on auspicious occasions.
4.       Letter of Credit: Letter of credit are issued by the banks to their customers certifying their credit worthiness. Letter of credit are very useful in foreign trade.
5.       Foreign Exchange Business: Banks also deal in the business of foreign currencies.
Under what conditions banker must pay a cheque?
Ans: The Paying banker is bound to pay the cheque if the following conditions are satisfied
a)      When the cheque has been drawn on the proper form i.e. on the forms supplied by the banker.
b)      When the cheque bears a date and which is due.
c)       When there is sufficient fund in the account of the customer to pay the cheque in full.
d)      When the fund is properly applicable for the payment of the cheque.
e)      When the amount of the cheque is mentioned in both words and figures and they are same.
f)       When the banker has no doubt regarding the signature of the drawer i.e. it has not been forged.
g)      Incase of joint account, when all the account holders have signed the cheque.
h)      When the cheque has been drawn on the particular bank and branch in which the account has been opened by the customer.
15. Explain the duties and responsibilities of a collecting banker.          5
Ans: The duties of a collecting banker towards his customers are as follows:
a)      Due care and Diligence in the collection of cheques: The collecting banker is bound to show due care and diligence in the collection of cheques presented to him. In case a cheque is entrusted with the banker for collection, he is expected to show it to the drawee banker within a reasonable time.
b)      Presentation of cheque for payment within reasonable time: The collecting banker should present the cheque of his customer to the drawee banker within a reasonable time. If the banker makes undue delay in presentation of cheque and the customer suffers a loss then the banker will be held responsible for the loss and shall be required to reimburse the loss.
c)       Remittance of proceeds to the customer: It is the duty of the collecting banker to inform his customer immediately about the collection of the cheques. When the proceeds are collected, the banker may debit his customer’s account in respect of his commission and credit the gross proceeds to the customers account.
d)      Serving Notice of Dishonour: When the cheque is dishonoured, the collecting banker is bound to give notice of the same to his customer within a reasonable time. If he fails to give such a notice, the collecting banker will be liable to the customer for any loss that the customer may have suffered on account of such failure.
16. Differentiate between unit banking and branch banking.     5
Ans: Difference between Branch Banking and Unit Banking
Branch Banking
Unit Banking
1.Operational freedom
Less operational freedom because branches are controlled by Head Office.
More operational freedom because of its single unit.
2. Decision Making
Delay is decision making because branches are dependent on Head Office.
Decision making is quick because External consultation is not required.
3. Rate of Interest
Rate of Interest is uniform.
Rate of interest depending on demand and supply of fund. 
4. Cost of Supervision
Cost of Supervision is very high.
Cost of Supervision is less as compared to branch banking.
5. Funds
Funds are transferred from one branch to another.
Funds are localized in one unit.
17. What are the objectives of World Bank?                5
Ans: The objectives of World Bank are:
a)      To provide long-run capital to the member countries for reconstruction and development.
b)      To promote private capital investment by providing guarantee on private loans and capital investment.
c)       To maintain equilibrium in balance of payments and balanced development of international trade.
d)      When private capital is not available on reasonable terms, to supplement private investment by providing finance for productive purpose on suitable conditions.
e)      To encourage the development of productive facilities and resources in less developed countries.
18. Discuss the role and functions of non-banking financial institutions.                5
Ans: Role of indigenous and non-banking financial institution (NBFI’S)
The role and importance of non-bank financial institution is very great in the economy of India. There are playing many functions and from this function we can understand their role as importance:
a)      They are financial intermediaries as they transfer funds from the savers to the investors. Financial intermediation is economical and less expensive to both small business and small savers.
b)      Non-bank financial intermediaries play an important role in promoting savings in the country. These institutions provide a wide range of financial assets as store of value and make available expert financial services to the savers.
c)       NBFI provides highly efficient mechanism for mobilising savings. These institutions mobilise small savings and provide high liquidity of funds. These institutions enter into contract with savers and provide them various types of benefit over the long periods.
d)      The objective of NBFI’s is to earn profit by investing the mobilised savings. The borrowers can meet bigger needs for funds. The role of interest charged by financial institutions is generally lower than that charged by other lenders.
e)      Financial intermediaries in general are of great importance to the economy as a whole because they not only promote economic development in the country, but also help in the implementation of national monetary policy.
Discuss briefly about the different types of loans and advances granted by a commercial bank.
Ans: Different types of loans and advances granted by a commercial bank are discussed below:
(i)      Cash Credit: Cash Credit is a type of advance wherein a banker permits his customer to borrow money upto a particular limit by a bond of credit with one or more securities. The advantage associated with this system is that a customer can withdrawn money as and when required. The bank will charge interest only on the actual amount withdrawn by the customer. Many industrial concerns and business houses borrow money in this form.
(ii)    Overdraft: An overdraft is an arrangement by which the customer is allowed to overdraw his account. It is granted against some collateral securities. The facility to overdraw is allowed through current account only. Interest is charged on the exact amount of overdrawn subject to the payment of minimum amount by way of interest.
(iii)   Loan: Loan is an advance in lump sum amount the whole of which is withdrawn and is supported to be rapid generally wholly at one time. It is made with or without security. It is given for a fixed period at in agreed rate of interest. Repayments may be made in installments or at the expiry of a certain period.
(iv)  Discounting of Bills of Exchange: The bank also gives advances to their customers by discounting their bills. The net amount after deducting the amount of discount is credited to the account of customer. The bank may discount the bills with or without any security from the debtor in addition to the personal security of one or more person already liable on the bill.
19. What do you mean by endorsement? Discuss the different forms of endorsement.      2+6=8
Ans: The term “Endorsement” of a negotiable instrument means writing of a person’s name of the back of the instrument for the purpose of negotiation. According to Section 15 of the Negotiable Instrument Act, 1881, “When the maker or holder of a negotiable instrument sings his name, otherwise than such maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed thereto he is said to have endorsed the instrument.” The person who puts his signature is called the “endorser” and the person in whose favour it is being endorsed in called the “endorsee”.
Endorsement of negotiable instruments can be made only by the following parties of to the instrument:
a) The Payee b) The holder c) The drawer of a bill of exchange d) The endorsee e) The maker.
Different kinds of endorsement with their respective significance are explained below:
a)      Blank or General Endorsement: An endorsement is said to be blank or general, if the endorser sings on the back or on the face of the instrument without specifying the name of any endorsee. The effect of his endorsement makes the instrument payment to bearer even though originally it was payable to order. For example, a cheque payable to Mr. X or order and Mr. X endorse the cheque by simply affixing her signature. The effect of this endorsement makes the instrument payable to bearer even though originally it was payable to order.
b)      Full or Special Endorsement: If an endorser signs his name and adds a direction to pay the amount mentioned in the instrument to or to the order of a specified persons, such an endorsement is said to be a full or special endorsement.  For example, “Pay to Mr. X or order” S/d Mr. Y is an example of full endorsement. Here Mr. Y is the endorser and he has mentioned the name of the endorsee – Mr. X.
c)       Conditional Endorsement: An endorsement is conditional or qualified if it limits or neglects the liability of the endorser.  For example, “Pay to Mr. X on his marriage” s/d Mr. Y is a conditional endorsement. In case of conditional endorsement, the liability of the endorser and the rights of the endorsee becomes conditional on the happening of a particular event.
d)      Restrictive Endorsement: An endorsement is said to be Restrictive, when it prohibits or restrictive the future negotiability of the instrument, it merely entitles the holder of the instrument to receive the amount on the instrument for a specified purpose. For example,”Pay to Mr. X only” s/d Mr. Y. This endorsement confers all the rights of an endorser to the endorsee except the right of negotiation.
e)      San Recourse endorsement and San frais endorsement: In San recourse endorsement, the endorser by his expressed words excludes his own liability and in San frais endorsement, the holders have no right against the endorser if the instrument is dishonoured. For example, ”Pay to Mr. X or order – Notice of dishonour waived.” These types of endorsement are generally used to avoid personal liability.
f)       Facultative endorsement: In such type of endorsement, the endorser by his express words increases his liability or give up some of his rights.
g)      Partial Endorsement: When the endorser intends to transfer to the endorsee only a part of the amount of instrument by endorsement, the endorsement is said to be partial. A partial endorsement does not operate as a negotiation of the instrument. For example, when a cheque of Rs. 10,000 is endorsed for Rs. 5000 is an example of partial endorsement.
h)      Forged endorsement: When a negotiable instrument is endorsed with the forged signature of the endorser, the endorsement is called forged endorsement.
What do you mean by crossing of cheque? Explain briefly about different types of crossing with suitable illustrations.                8
Ans: Crossing of a cheque: A cheque is said to be crossed when two parallel transverse line with or without any words are drawn on the left hand corner of the cheque. The negotiability of a cheque doesn’t affect for crossing. Crossing of a cheque refers to the instruction to the banker relating to the payment of the cheque. A crossing is the direction to the paying banker that the cheque should be paid only to a banker. Crossing of cheque is very safety because the holder of the cheque is not allowed to cash it across the counter. A crossed cheque provides protection not only to the holder of the cheque but also to the receiving and collecting bankers.
Types of crossing:
1. General crossing: A general crossing is a crossing where a cheque simply bears two parallel lines with or without any words and without any specification. According to Sec. 123 of the Negotiable Instrument Act, 1881, “When a cheque bears across its face an addition of the words. “and company” or any abreactions thereof between two parallel transverse line or of two parallel transverse lines simply either or without the words, “Not Negotiable” that addition shall be deemed a general crossing. Simplify, In case of General crossing words such as “and company”, “not Negotiable”, “Account payee” etc. may be inserted between the lines.
A general crossing cheque protects the drawer and also the payee or the holder thereof. Whenever a drawer desires to make payment to an outstation party, he can cross the cheque so that even if the cheque is lost, only a piece of paper is lost and nothing beyond that. If by any chance, it is encashed by a third and unauthorized person, it is possible to find out to whose account the amount is credited and the unauthorized person can be identifies and suitable action taken against him.
2. Special crossing: Section 124 of the Negotiable Instruments Act, 1881 defines special crossing as “where a cheque bears across its face, an addition of the name of a banker with or without the words “not negotiable”, that addition shall be deemed a crossing and the cheque shall be deemed to be crossed specially and to be crossed to that banker.”
Thus, in case of special crossing, the name of a particular bank is written in between the parallel lines. The main implication of this type of crossing is that the amount of the cheque will be paid to the specified banker whose name is written in between the lines. Special crossing is in a particular bank and by special crossing, he is assured of double safety, safety to the drawer and safety to the payee.
3. Account payee crossing: This type of crossing is done by adding the words ‘Account Payee’. This can be made both in general crossing and special crossing. The implication of this type of crossing is that the collecting banker has to collect the amount of the cheque only for the payee. If he wrongly credits the amount of the cheque to another account, he will be held responsible for the same. 
4. Not negotiable crossing: When the words ‘not negotiable’ is added in generally or specially crossed cheques, it is called not negotiable crossing. A cheque bearing not negotiable crossing cannot be transferred. If a cheque bearing ‘Not negotiable crossing’ is transferred, care must be taken regarding the ownership of title of both the transferor and transferee.
20. Discuss how Reserve Bank of India controls money and credit in the economy.     8
Ans: The regulation of credit creation capacity of the commercial banks and other banking institutions by the Central Bank to achieve some definite objectives is known as Credit Control. The objectives of the Central Bank for Credit Control of the other banks are:
a)      To establish stability in the internal price level by adjusting the supply of credit.
b)      To maintain stability in the foreign exchange rates by eliminating fluctuations in the exchange rates.
c)       To eliminate cyclical fluctuations in the production, employment and prices of goods.
d)      To stabilize money market of the economy.
e)      To achieve full employment of resources and accelerate economic growth with stability.
The principle methods or instruments of Credit Control used by the Central Bank are:
1)      Quantitative or General Methods
2)      Qualitative or Selective methods
1)      Quantitative or General Methods: These are the traditional or general methods of credit control. These methods one used by Central Bank to expand or contract the total volume of credit in the economy neglecting the purpose for which it is used. These methods are :-
a)      Variation in the bank rate
b)      Open Market operations:
c)       Variation in cash reserve ratio:
d)      Variation in the statutory liquidity ratio:
e)      ‘Repo’ Transactions:
a)      Variation in the bank rate: Bank rate or discount rate is the rate at which the Central Bank of a country makes advances to the banks against approved securities or rediscounts the eligible bills. The purpose of change in the rate is to make the credit cheaper or expensive depending upon whether the purpose is to expand or control credit. An increase in bank rate result, in increase in lending rate of commercial banks lending to contraction of credit while a decrease in bank rate leads to decrease in lending rates of commercial banks lending to expansion of credit.
b)      Open Market operations: Open market operations means deliberate and direct buying and selling of securities and bills in the market by the Central Bank. The open market operations of the RBI are mostly confined to government securities. In order to increase money supply in the market, the RBI purchases securities in the open market. On the other hand, in order to contract credit, the RBI starts selling the securities in the open market.
c)       Cash reserve ratio: Every scheduled bank in India is required to maintain a minimum percentage of their deposits with the RBI. Larger the reserve, lesser is the power of the banks to create credit and smaller the reserves, greater is the power of the banks to create credit.
d)      Statutory liquidity ratio: Statutory liquidity ratio is another reserve requirement used by the RBI to control money supply. In India, besides maintaining the cash reserve, every bank has to maintain a statutory reserve of liquid assets in terms of cash, gold or unencumbered securities. This is termed as statutory liquidity ratio. In increase in the liquidity ratio implies a transfer of banking funds to Government and corresponding reduction in credit available to the borrowers.
e)      ‘Repo’ Transactions: ‘Repo’ stands for repurchase. Repo or repurchase transactions are undertaken by the Central Bank in the money market to manipulate short term interest rates and to manage liquidity levels. In case the RBI desire to inject fresh funds in the economy it conducts ‘Repo’ transactions. On the other hand, to absorb liquidity the RBI ‘Reserve Repo’ transactions. The securities eligible for carrying out this operation are selected by the RBI. It includes government promissory notes, treasury bills and public sector bonds.
3)      Qualitative or Selective Methods: These are basically the selective and general methods of credit control. These methods are used for controlling the use and direction of credit. They have nothing to do with the control of the total volume of credit in economy. These methods are :
a)      Directions: Sec. 21 of the Banking Regulation Act gives wide power to the RBI for controlling granting of advances by an individual bank or by banking as a whole. The RBI can give directors to any particular bank or all banks in general in regard to the purposes for which advances may or may not be made, the maximum amount of advance to any individual, firm or company etc.
b)      Margin requirement: Margin means the difference between the market price of security and loan amount. Changing margin requirement is another credit control method followed by the RBI. This system was introduced in 1956. By requiring higher margin while accepting a commodity as a security, the RBI can decrease the flow of credit to particular sector or vice versa.
c)       Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc is fixed in advance. This can help in checking the credit use and then inflation in a country.
d)      Publicity: This is yet another method of selective credit control. Through it Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. This published information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy.
e)      Credit Rationing: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.
f)       Moral suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes.
g)      Direct action: Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates.
21. Explain the term ‘cash reserve’ and ‘cash credit’.      4+4=8
Ans: Cash Reserve: The liquid asset of bank is called cash reserve of bank. It is to be kept by the bank in order to meet the demands of the customers. Liquidity depends on the availability of liquid assets. Liquid assets are those assets which can be easily converted into cash without loss. More the liquid assets, greater will be the liquidity and vice versa. The liquid assets of a bank are composed of the following:
a)      Cash in hand.
b)      Cash balance with RBI.
c)       Cash balance with other banks.
d)      Money at call and short notice.
e)      Investments.
f)       Advances.
These cash reserves are also called the first line of defence, to indicate their significant role in defending the solvency, regulation and goodwill of the bank. The demand of the customer is immediately met by the bank with the cash reserves with itself or the balances which are within its immediate command.
The banker has to very cautions, prudent and far sighted in determining the Quantum of cash to be maintained in the above manner. In case he keeps cash reserves much above his actual needs, his losses interest on that portion. If the cash reserves fall short of his requirements, he may find himself in an embarrassing position. Hence determination of the adequate size of cash balances is an important task faced by a banker. He has to abide by the legal requirements and is to be guided by the conventions followed by the banking community is this regard.
Cash Credit: Cash Credit is a type of advance wherein a banker permits his customer to borrow money upto a particular limit by a bond of credit with one or more securities. The advantage associated with this system is that a customer can withdrawn money as and when required. The bank will charge interest only on the actual amount withdrawn by the customer. Many industrial concerns and business houses borrow money in this form. Cash credit limits are fixed once a year. Hence it gives rise to the tendency of fixing a higher limit than the amount of funds required by the customer throughout the year. In times of credit shortage the customer may misutilise the normally unutilized credit gap.
Discuss the principles of sound investments followed by commercial banks.      8
Ans: Principles of Sound Investment: Banks are one of the genuine investors in the securities market. Banks invest in the market in the hope of earning some return. Since, banks deals in borrowed funds, therefore a banker must select the securities very carefully and follow the following principles of sound investments:
1)      Safety of principal: A banker deals in borrowed funds and therefore his main consideration is safety of principal invested in securities. The banker has to ensure that the principal amount invested by him remain safe. The safety of investments depend on the solvency and ability of the issuing authorities to honour their commitment made to the investors. The government and semi-government securities are the safest securities because they are guaranteed by the government.
2)      Price stability: The price of security selected by the banker should remain stable. The safety of investments depends on the stability in the prices of securities. Banker should prefer those securities whose prices remain fairly stable over a period of time. The Prices of government securities remain stable and do not fluctuate.
3)      Marketability or liquidity: The primary objective of buying securities by the banker is to earn income and at the same time maintain his liquidity position. Thus, the banker should see that the security in which he can be sold in the market without loss of time and money. Marketability of securities ensures liquidity of investments. Government and semi-government securities are highly liquid as they have a ready market.
4)      Profitability or yield: After ensuring the safety of the principal money invested in securities, the banker should consider the returns from the investments. The banker should not give undue importance to higher yields at the cost of safety. The banker should not expect windfall profit, because high profit may bear the germ of loss.
5)      Diversification of Investment: The banker should diversify the risk involved in investment by investing in wide variety of securities issued by wide variety of business enterprises belonging to different trade and industry.
6)      Refinance: To ensure the liquidity of his investments the banker has to see that the security is eligible to obtain refinance from the Central Bank and other refinancing institutions.
In conclusion, it may be said that for a banker the government and semi-government securities are most ideal for investment of funds. Government securities with virtually no risks, have a ready market, are eligible for refinance and bring reasonably good return.
22. Discuss briefly the functions of State Bank of India.        8
Ans: The State Bank of India was established under the State Bank of India Act, 1955, by nationalizing the Imperial bank of India with the object of extending banking facilities in rural areas. I came into existence on 1st July 1955. Though Imperial Bank was important banking institution in 16th April 1955, SBI bill was passed on 8th May 1955 by the Government of India. SBI was organized depending on the recommendation of All India Rural Credit Survey Committee (AIRCSC) which was appointed by RBI in 1951.
SBI is managed by Central Board of directors. In this Board, there is one chairman, one vice-chairman two managing directors and sixteen directors (Total 20 members). The head quarter of SBI is located at Mumbai and its local offices at Kolkata, Mumbai, Chennai, New Delhi, Lucknow, Ahmadabad, Hyderabad, Bhubaneswar, Bangalore, Guwahati etc. It performed all the functions performed by commercial banks. Besides it, SBI performed as an agent of RBI where there is no branch of RBI
As an agent of RBI, the SBI also performs certain Central Banking functions such as:
1.       Bankers to Government : As an agent of the RBI, SBI acts as banker to the Central and State Government as a bankers as a adviser as a agent into there capacities :
a)      As a bankers.
b)      As an agent.
c)       As an advisor.
As a Government banker the SBI performs the following functions:
a)      It maintains and operates deposit account of the central and state governments.
b)      It receives and collects payment on behalf of the Central and state governments.
c)       It makes payments on behalf of the central and state governments.
d)      It provides short term advances to government for which are called ways and means advances etc.
As a Government agent the SBI perform the followings functions:
1)      Collect tax and other payments on behalf of the government.
2)      Raise loan from the public and thus manages public debts.
3)      Transfer funds and provide remittances facilities to the government etc.
a)      Bankers Bank: As an agent of the RBI, SBI acts as a banker to all the other banks.
b)      Custodian of cash reserve of the bank: As an agent of the RBI, SBI acts as the custodian of cash reserve of the banks.
c)       Clearing agent: In India the central clearing functions is managed by the RBI or the SBI is authorized to manage clearing house functions every day. Each commercial bank receives a number of cheques for collection from other banks on account of their customers.
Other functions of the SBI as General Banks act
A) Primary functions:
a)      Acceptance of deposits: It is the most important function of a bank. Under this function, bank accept deposits from individuals and organizations and finances the temporary needs of firms.
b)      Making loans and advances: The second important function of banks is advancing loan. The commercial bank earns interest by lending money.
c)       Investments of Funds: Besides loans and advances, banks also invest apart of its funds in securities to earn extra income.
d)      Credit Creations: The Bank creates credit by opening an account in the name of the borrower while making advances. The borrower is allowed to withdraw money by cheque whenever he needs.
B) Secondary functions of a bank: This function is divided into two parts
1)      Agency functions: These functions are performed by the banker for its own customer. For these bank changes certain commission from its customers. These functions are:
a)      Remittance of Funds: Banks help their customers in transferring funds from one place to another through cheques, drafts etc.
b)      Collection and payment of Credit Instruments: Banks collects and pays various credit instruments like cheques, bill of exchange, promissory notes etc.
c)       Purchasing and Sale of securities: Banks undertake purchase and sale of various securities like shares, stocks, bonds, debentures etc. on behalf of their customers.

d)      Income Tax Consultancy: Sometimes bankers also employ income tax experts not only to prepare income tax returns for their customer but to help them to get refund of income tax in appropriate cases.