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1
THE MONEY SUPPLY

Wc nornally iIinl of noncy as coins or noics. TIcsc arc financial
insiruncnis iIai wc usc io nalc ayncnis for in ccIangc for goods
and scrviccs. Econonisis agrcc iIai coins and noics arc noncy lui
suggcsi iIai oiIcr financial insiruncnis sucI as a cIcquc drawn on a
savings dcosiis in a lanl arc also accciallc in ccIangc for goods and
scrviccs and arc io lc includcd in iIc dcfiniiion of noncy. Moncy is lcsi
undcrsiood ly iIc iIrcc rolcs ii lays in an cconony.

1} Mcdiun of ccIangc TIis funciion of noncy rcsulis fron
colc accciing noncy in rciurn for iIc salc of a good or scrvicc and
luycrs ariing wiiI noncy wIcn iIcy urcIasc a good or scrvicc.
WiiIoui noncy colc would Iavc io ccIangc goods and scrviccs
dirccily. TIis is a laricr sysicn iIai is incfficicni lccausc in a laricr an
ccIangc would involvc irading a iangillc good or scrvicc in rciurn for a
good or scrvicc. TIis could lc quiic cosily or inconvcnicni as ii rcquircs
individuals io scarcI for oiIcrs wIo arc willing io ccIangc iIc goods
cacI oiIcr currcnily osscsscs. Considcr for insiancc iIai you arc a
young IT rofcssional wIo can offcr sofiwarc scrviccs and you wisI io
urcIasc izzas. You would nccd io iracl down a izza vcndor wIo is ai
iIai noncni in nccd of iIc sofiwarc scrviccs you can dclivcr on. Ii could
ialc a long iinc lcforc you and iIc izza vcndor siunllc on cacI oiIcr
and ly iIai iinc you could lc vcry Iungry indccd. If you could lc frccd
fron wIai is callcd iIc doullc coincidcncc of wanis your willingncss io
suly a scrvicc (sofiwarc} so as io saiisfy your dcnand for a good
(izza}, - i.c., naicIing iIc suly of iIc izza and dcnand for sofiwarc
ly diffcrcni agcnis in iIc cconony your lifc would lc considcrally
inrovcd. Moncy docs jusi iIai ly roviding iIc ncdiun of ccIangc so
iIai you can scll your scrvicc io wIocvcr wanis ii (noi jusi izza vcndors}
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and usc iIc noncy you gci fron iIis iransaciion io urcIasc iIc izza
you wani. Moncy's unduncntu oc is as a ncdiun of ccIangc.

(2} Siorc of valuc TIis rocriy of noncy ncans ii can lc ui
asidc uniil a iinc arrivcs wIcn you rcquirc io nalc a iransaciion. An
assci sucI as noncy nusi lc sonciIing wc can draw uon for fuiurc
urcIascs as oiIcrwisc izza vcndors will noi lc willing io accci your
noncy in ccIangc for sclling you izza. TIc vcndor acccis your noncy
lccausc in iurn Ic is conicnlaiing using iIai noncy say a wccl laicr io
nalc ayncnis io Iis sulicrs in ccIangc for ingrcdicnis sucI as
izza dougI. Many asscis can lc uscd as siorcs of valuc. For insiancc
you nay Iold sIarcs in a firn or gold jcwclry iIai could lc sold io
acquirc iIc noncy rcquircd io nalc ayncnis iIai arc duc io an
ccIangc iransaciion you Iavc cnicrcd inio. Unlilc sIarcs and jcwclry,
Iowcvcr, noncy as a siorc of valuc is iIc nosi liquid assci in iIai ii is
inncdiaicly usallc in naling an ccIangc for a good or scrvicc.

(3} Unii of accouni Hcrc noncy lays iIc rolc of ncasuring iIc
valuc of goods, scrviccs, and asscis in an cconony. A unii of accouni
rovidcs yardsiicl for casy conarisons of iIc valuc of ccononic goods,
scrviccs and asscis. For insiancc, grain is ncasurcd in lusIcls and
cirol in liircs, and in ordcr io judgc wIciIcr a lusIcl of grain is norc or
lcss valuallc iIan a liirc of oil wc gain if iIcir valuc is crcsscd in
noncy icrns. In iIis way iIc usc of noncy as a unii of accouni is rclaicd
closcly io iis usc as a ncdiun of ccIangc as noncy is uscd io luy and
scll iIings ii is scnsillc io Iavc iIc riccs of all ccononic iIings
crcsscd in noncy icrns.

Ii is inoriani io also disiinguisI noncy fron inconc. WIcn wc as
laycrsons say iIai sonconc nalcs a loi of noncy ccononisis inicrrci
iIai as a siaicncni iIai a crson Ias a IigI inconc. Inconc is a flow
Comment [e1]: MaiginaIia - A
nediun of exchange is sonelhing
lhal is used lo pay foi goods and
seivices.
Comment [e2]: MaiginaIia - A
sloie of vaIue is lhe piopeily of an
assel vheiely il has puichasing
povei ovei line.
Comment [e3]: MaiginaIia - A unil
of accounl is anylhing lhal is used lo
neasuie vaIue in an econony.
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variallc a ncasurc dcfincd cr unii of iinc. Moncy on iIc oiIcr Iand is
a siocl variallc a ncasurc dcfincd ai a oini in iinc. TIc disiinciion
lciwccn iIc iwo is clcar if wc considcr a crson carning a IigI inconc
ovcr a ycar. SucI a crson nay noi Iold a largc siocl of noncy if Ic is a
scndiIrifi wIo on rccciving Iis inconc scnds ii on goods and scrviccs
Ic Ias a IigI inconc ovcr iIc unii of iinc dcfincd as a ycar lui Ic Ias
liiilc noncy as ncasurcd ai a oini in iinc. Moncy iIcn is iIc siocl of a
iyc of assci wIicI is iIc rinary ncdiun of ccIangc and disiinci fron
iIc flow of inconc ovcr a criod of iinc. Ii is iruc iIai if you arc
cnloycd as a nanagcr your salary is aid ai iIc cnd of iIc noniI norc
oficn iIan noi in iIc forn of noncy. Dui iIis is lccausc noncy is iIc
unii of accouni and iIc ncdiun of ccIangc for iIc nanagcrial scrviccs
you rcndcr io iIc firn ovcr iIc noniI. As iIc iransaciion cosi of
accouniing for and aying for cacI ninuic of scrviccs rcndcrcd is IigI
iIc convcniion is io ay ai iIc cnd of a largcr iinc inicrval sucI as a
noniI. During iIai iinc inicrval your rcndcring of scrviccs io iIc firn is
concnsaicd for in iIc forn of inconc and accounicd for in iIc unii of
accouni or noncy. You rcccivc an inconc cqual io your coniriluiion io
iIc ouiui of iIc firn as inconc cquals ouiui. DoiI iIc inconc and iIc
ouiui arc ncasurcd in uniis of noncy
1
.

Onc cononcni of noncy wc usc as a ncdiun of ccIangc is
currcncy iIai is issucd ly ccniral lanls. CIcqucs drawn on our
accounis Icld wiiI conncrcial lanls also scrvc as a ncdiun of
ccIangc. Ii is naiural iIcn iIai noncy suly is iIc rcsuli of iIc
inicraciions lciwccn ccniral lanls, conncrcial lanls, and iIc ullic.

1
Suppose the only asset held is money so that all savings can only be in the Iorm oI money and
income
t
Y over the period ( ) t t , 1 is paid at time t . Think oI 1 t as the beginning oI the month
and t as the end oI the month. Then, the individual`s income (ignoring direct taxes) is equal to
consumption
t
C plus savings which is ( ) ( )
1 1
, or ,

+ =
t t t t t t
M M C Y M M . The change in
the stock oI money which is not spent during ( ) t t , 1 is the Ilow oI income.
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In India iIc ccniral lanl is iIc Fcscrvc Danl of India wIicI dcicrnincs
Iow nucI currcncy sIould lc in circulaiion. A ccniral lanl of a couniry
Ias iwo nain rcsonsililiiics. Firsi, ii dcicrnincs Iow nucI noncy
circulaics in iIc cconony and iIc suly of noncy affccis
nacroccononic variallcs sucI as inicrcsi raics, ccIangc raics,
uncnloyncni, and inflaiion. Sccond, ccniral lanls arc also rcsonsillc
for iIc rcgulaiion of financial narlcis and Iavc a largc rolc io lay
during criods of financial crisis.

To undcrsiand iIc noncy suly roccss ii ays us io lcgin ly
looling ai iIc lalancc sIccis of iIc ccniral lanl and conncrcial lanls
iIcir Ioldings of asscis and lialiliiics. A lanl's lalancc sIcci is iIc lisi
of iis sourccs of lanl funds iis lialiliiics and iIc uscs io wIicI iIc
funds arc ui iis asscis. TIis lisi of sourccs and uscs of funds nusi
lalancc so iIai ioial asscis ioial lialiliiics.
















Tallc 2.2. Ccniral Danl Dalancc SIcci
ASSETS LIADILITIES
Crcdii io conncrcial lanls
Crcdii io govcrnncni
Holdings of govcrnncni
dcli (incl. loans io govi.}
css govcrnncni dcosiis
Dcosiis Icld ly conn-
crcial lanls
(a} Fcquircd rcscrvcs
(l} Worling Fund
rcscrvcs
Nci Non Monciary Lialiliiics
of Ccniral Danl
Currcncy in Circulaiion
Currcncy wiiI ullic (C
P
}
+
Currcncy wiiI lanls
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior
F
E
S
E
F
V
E
S
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TIc nain sourccs of funds or iIc lialiliiics of a ccniral lanl arc
currcncy in circulaiion and dcosiis Icld ly conncrcial lanls wiiI iIc
FDI (Tallc 2.2}. TIc nain uscs of funds or iIc asscis arc in iIc forn of
crcdiis advanccd io iIc govcrnncni, iIc conncrcial lanls and iIc
rivaic sccior.

TIc currcncy in circulaiion and dcosiis Icld ly conncrcial lanls
conrisc wIai is lnown as iIc nonciary lialiliiics of iIc FDI as
cIangcs in iIcsc lialiliiics lcad io cIangcs in iIc noncy suly. TIc
nonciary lialiliiics of iIc ccniral lanl arc also rcfcrrcd io as lasc
noncy, IigI owcrcd noncy, or rcscrvcs (Tallc 2.2}. As iIc non-
nonciary lialiliiics and asscis of iIc FDI do noi inaci on iIc noncy
suly iIcy arc cnicrcd on iIc lalancc sIcci as iIc diffcrcncc lciwccn
non-nonciary lialiliiics and asscis or nci non-nonciary lialiliiics.

2.3.1. Lialiliiics of a ccniral lanl

TIc lialiliiics of iIc ccniral lanl arc sul-dividcd inio iwo
caicgorics currcncy in circulaiion in iIc Iands of iIc ullic (C
P
}, and
rcscrvcs (F}. TIougI currcncy wiiI lanls is ari of iIc currcncy in
circulaiion ii is counicd as a ari of rcscrvcs. TIis disiinciion is nadc
lccing in nind iIc counicrariy io iIcsc lialiliiics of iIc ccniral lanl.
All lialiliiics of iIc ccniral lanl iIai arc corrcsonding asscis of
conncrcial lanls arc ircaicd as rcscrvcs. TIc currcncy in iIc Iands of
iIc ullic ly conirasi is a lialiliiy of iIc ccniral lanl and a
corrcsonding assci Icld ly iIc non-lanl ullic.

Currcncy issucd ly iIc ccniral lanl arc an IOU fron ii. TIc icrn
IOU is a coniraciion of I owc you" and rcfcrs io a wriiicn cvidcncc of a
dcli signcd ly iIc dclior. In iIc casc of a currcncy noic ii is a ronisc
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io ay lacl iIc Ioldcr of iIc noic iIc anouni of currcncy dcnoicd on iIc
noic. For insiancc if you Iold a Iundrcd rucc noic you will scc a signcd
siaicncni ly iIc Covcrnor of iIc FDI on ii siaiing I ronisc io ay iIc
lcarcr iIc sun of onc Iundrcd ruccs". TIc ccniral lanl of a couniry is
a sccial iyc of IOU dclior in iIai an IOU is aid lacl wiiI oiIcr IOUs.
So if you sulnii a Iundrcd rucc noic io iIc FDI and dcnand ayncni
you will rcccivc iwo fifiy rucc noics or icn icn rucc noics or sonc
conlinaiion of noics iIai sun io a Iundrcd ruccs. TIcsc noics arc
Icld willingly ly iIc ullic as iIcy arc acccicd as a ncans of ayncni
in an ccononic ccIangc.

Moncy is willingly Icld ly iIc ullic lccausc of iIc ccciaiion
iIai ii will lc accciallc in ccIangc. TIc currcncy and coins wc Iold
arc also callcd fiai noncy. TIc world fiai concs fron iIc Laiin lci ii lc
donc" and a lcgal auiIoriiy docs sonciIing ly fiai wIcn ii dcclarcs
sonciIing io lc so. TIus a currcncy noic is noncy lccausc iIc ccniral
lanl dcclarcs ii io lc noncy. Your currcncy noic iIcrcforc Ias iIc
dcclaraiion rinicd on ii iIai ii is Cuaraniccd ly iIc Ccniral
Covcrnncni". TIis dcclaraiion worls lccausc colc arc in agrccncni
iIai iIc currcncy noic Ias valuc and arc iIcrcforc willing io accci ii as
a ncdiun of ccIangc. If colc sio agrccing iIai iIc currcncy noic Ias
valuc as wIcn iIcy losc confidcncc in iIc valuc of iIcir noncy (as occurs
during IigI inflaiions}, iIcn, iIc ncdiun of ccIangc funciion of iIc
noncy issucd ly iIc ccniral lanl gcis inaircd.

TIc oiIcr cononcnis of nonciary lialiliiics arc rcscrvcs. Fcscrvcs
consisi of conncrcial lanl dcosiis Icld wiiI iIc ccniral lanl and iIc
currcncy wiiI iIc lanls. Danls Iold dcosiis ai iIc ccniral lanl nainly
for iwo rcasons onc is for nainiaining wIai is callcd as iIc casI
rcscrvc raiio, and iIc oiIcr is as worling funds for ncciing ayncni
rcquircncnis. TIc casI rcscrvc raiio is wIai is oiIcrwisc callcd as
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rcquircd rcscrvcs. A ccniral lanl rcquircs iIai for cvcry Iundrcd ruccs
of dcosiis ai a lanl a ccriain fraciion callcd iIc rcquircd rcscrvc raiio
or casI rcscrvc raiio nusi lc Icld as rcscrvcs. Any addiiional rcscrvcs
alovc iIis iIai lanls Iold arc worling fund rcscrvcs. TIcsc worling
fund rcscrvcs arc Icld ai iIc ccniral lanl lccausc iIc ccniral lanl
ocraics as a lanlcr's lanl. An inoriani daily ocraiion of iIc ccniral
lanl is iIc usc of dcosiis nadc ly conncrcial lanls ai iIc ccniral
lanl io clcar cIcqucs drawn on onc lanl and dcosiicd in anoiIcr.
WIcn a cIcquc is drawn on a lanl ii gocs io a clcaringIousc sci u ly
iIc ccniral lanl. TIc conncrcial lanl's accouni ai iIc ccniral lanl is
iIcn dcliicd ly iIc anouni of iIc cIcquc. TIc lanl wIicI dcosiicd iIc
cIcquc ai iIc clcaringIousc will Iavc iis accouni ai iIc ccniral lanl
crcdiicd wiiI iIc funds. TIcsc dcosiis of a conncrcial lanl can also lc
uscd io nalc ayncnis io iIc ccniral lanl in ccIangc for currcncy
wIcncvcr a conncrcial lanl is in nccd of currcncy or vauli casI (so
callcd lccausc currcncy is siorcd ly lanls in lanl vaulis}.

TIc non-nonciary lialiliiics of iIc ccniral lanl includc a nunlcr
of cononcnis sucI as iis aid-u caiial and oiIcr lialiliiics. TIc aid
u caiial is iIc anouni iIc FDI rcccivcd fron iIc govcrnncni. TIc aid
u caiial ly iIc govcrnncni in iIc FDI is INF 50 nillion. TIc FDI
siricily scaling is noi owncd ly iIc govcrnncni and is noi a rofii-
naling insiiiuiion. Ii is an indccndcni cniiiy wiiIin iIc govcrnncni
wIicI Iowcvcr docs rcccivc all of iIc FDI's surlus aficr csiallisIncni,
inicrcsi rcni, riniing and siaiioncry cic. Iavc lccn aid for INF 250
lillion in 2008-09. TIc govcrnncni docs ccrcisc sonc conirol Iowcvcr
on iIis indccndcni cniiiy ly aoiniing iis IigIcsi lcvcl cnloyccs sucI
as iIc Covcrnor and Dcuiy Covcrnors and sciiing iIcir salarics. TIc
oiIcr lialiliiics includc iicns sucI as a coniingcncy rcscrvc iIc FDI
nainiains io cnallc ii io alsorl uncccicd and unforcsccn
coniingcncics. A Currcncy and Cold Fcvaluaiion Accouni is also ari of
Comment [e4]: MaiginaIia -
Requiied ieseives oi lhe cash ieseive
ialio is lhe fiaclion of deposils lhal a
cenliaI lank iequiies lo le kepl as
funds in an accounl vilh lhe cenliaI
lank.
Comment [e5]: MaiginaIia - Iaid
up capilaI is lhal anounl of lhe
aulhoiized shaie hoIdei slock lhal a
conpany has issued and ieceived
paynenl foi. Heie il is lhe anounl
lhe RI has ieceived fion lhe
goveinnenl foi leing lhe lankei lo
lhe goveinnenl.
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iis oiIcr lialiliiics. In iIis accouni for insiancc gains or losscs on iIc
valuaiion of forcign currcncy asscis and gold arising fron novcncnis in
iIc ccIangc raic and ricc of gold arc rccordcd. TIc incrcasc in iIc
valuc of forcign currcncy asscis and gold wiiI iIc FDI in 2008-09 for
insiancc was INF 356.3 lillion. Fron iIcsc non-nonciary lialiliiics if wc
nci oui iIc valuc of iicns sucI as ficd asscis (iIc Iysical asscis sucI
as lanl luildings, conuicrs and cquincni owncd ly iIc lanl} wc
oliain iIc nci non-nonciary lialiliiics of iIc lanl. In 2008-09 iIis was
INF 387.9 lillion. Monciary lialiliiics on iIc oiIcr Iand wcrc norc iIan
25 iincs iIis ai INF 9880 lillion.

2.3.2. Asscis of iIc ccniral lanl

TIc iwo najor nonciary asscis on iIc ccniral lanl's lalancc sIcci
arc iIc crcdii ii givcs io govcrnncni and io conncrcial lanls.

TIc ccniral lanl's crcdii io govcrnncni is iIc diffcrcncc lciwccn
iis invcsincni in govcrnncni sccuriiics and iIc dcosiis Icld ly iIc
govcrnncni wiiI iIc ccniral lanl. Firsi lci us undcrsiand Iow iIc valuc
of iis invcsincni in govcrnncni sccuriiics is arrivcd ai. Conncrcial
lanls iIai arc icnorarily sIori of liquidiiy aroacI iIc inicr lanl
narlci wiiI a dcnand for funds and lanls wiiI surlus liquidiiy suly
sucI funds. TIc FDI aiicnis io influcncc iIc inicrcsi raic in iIis
narlci ly undcrialing icnorary iransaciions callcd rcvcrsc rcurcIasc
agrccncnis (rcvcrsc rcos} and rcurcIasc agrccncnis (rcos}. In a
rcvcrsc rco iIc FDI sclls govcrnncni sccuriiics and iIc luycr agrccs io
scll iIcn lacl io iIc FDI in a sIori criod of iinc (say wiiIin 15 days}.
In a rco iIc FDI urcIascs govcrnncni sccuriiics wiiI an agrccncni
iIai iIc scllcr will rcurcIasc iIcn in iIc ncar fuiurc. SucI aciions
icnorarily affcci iIc availaliliiy of liquidiiy and iIrougI iIai influcncc
Comment [e6]: MaiginaIia - A
ieveise iepo is lhe puichase of a
secuiily ly a luyei vilh an
agieenenl lo ieseII il al a highei piice
al a specific fuluie dale.
Comment [e7]: MaiginaIia - A iepo
is a conliacl in vhich lhe seIIei of a
secuiily agiees lo luy il lack al a
specified line and piice. Il is aIso
caIIed a luylack.
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iIc sIori-icrn inicr-lanl inicrcsi raic. In 2008-09 for insiancc iIc FDI
uscd iIis nccIanisn io injcci liquidiiy iIrougI rco ocraiions on 158
days and ii uscd rcvcrsc rcos io alsorl liquidiiy on 169 days. Ai iIc
cnd of iIc accouniing ycar iIc ouisianding sccuriiics sold (rcvcrsc rcos}
arc ircaicd as a rcduciion in Invcsincni in Covcrnncni Sccuriiics or a
rcduciion in asscis Icld ly iIc FDI. In a sinilar vcin sccuriiics
urcIascd (rcos} arc counicd as an addiiion io iIc FDI's Invcsincni in
Covcrnncni Sccuriiics. TIc diffcrcncc lciwccn iIc addiiion io iIc
invcsincni in govcrnncni sccuriiics (rcos} and iIc rcduciion in Iolding
of govcrnncni sccuriiics (rcvcrsc rcos} is addcd io iIc valuc of iIc
cisiing Iolding of govcrnncni sccuriiics ly iIc FDI and is rcoricd on
iIc asscis sidc of iIc lalancc sIcci as Invcsincnis in govcrnncni
sccuriiics.
As iIc FDI is iIc fiscal agcni of iIc Trcasury dcarincni, iIc
govcrnncni Iolds a dcosiis accouni ai iIc FDI wIicI is aciually a
lialiliiy of iIc FDI. In nucI iIc sanc way as individuals lcc an
accouni ai a lanl, iIc govcrnncni also lccs a cIccling accouni wiiI
iIc FDI iIrougI wIicI inconing ia dcosiis and ouigoing govcrnncni
ayncnis arc Iandlcd. Ta ayncnis arc collccicd in iIc govcrnncni's
accounis ai a conncrcial lanl. TIc govcrnncni iIcn draws oui funds
fron iIcsc accounis in iIc conncrcial lanling sysicn and iransfcrs
iIcn io iis dcosii accouni ai iIc FDI. TIis rclcnisIcs iIc lalancc in
iis dcosii accouni ai iIc FDI and allows ii io nalc ayncnis. In iIc
roccss iIcrc is a dcclinc in iIc govcrnncni's dcosii accouni ai iIc FDI
wIcn ii nalcs a ayncni lui a corrcsonding incrcasc in iIc dcosii of
a conncrcial lanl iIai rcccivcs iIc govcrnncni's ayncni ordcr in iIc
forn of a cIcquc. Convcrscly wIcn iIc ia rcccii in iIc conncrcial
lanl accouni is iransfcrrcd io iIc FDI, iIcrc is a rcduciion in iIc
dcosiis of conncrcial lanls lui an incrcasc in iIc govcrnncni's
dcosii ai iIc FDI.

1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
1O
Suliraciing iIc valuc of iIc govcrnncni's dcosii ai iIc FDI fron
iIc Invcsincni in govcrnncni sccuriiics ly iIc FDI givcs us iIc ccniral
lanl or FDI's crcdii advanccd io iIc govcrnncni. TIc FDI could also
nalc dircci loans io iIc govcrnncni a rarc Icnoncnon wiiI nodcrn
day ccniral lanls and wIcn iIis Iacns crcdii io iIc govcrnncni
would incrcasc on iIc asscis sidc of iIc FDI's lalancc sIcci.

TIc nain assci of iIc FDI in a closcd cconony is iIc crcdii givcn
io conncrcial lanls. TIis Iacns iIrougI iwo cIanncls ocn narlci
ocraiions and discouni lcnding. TIc urcIasc of cisiing govcrnncni
sccuriiics ly iIc FDI is callcd an ocn narlci urcIasc and iIc salc of
govcrnncni sccuriiics ly iIc FDI is callcd an ocn narlci salc.
Ccncrally, iIc FDI nalcs urcIascs of govcrnncni sccuriiics fron
conncrcial lanls. Ii ays for iIis urcIasc ly crcdiiing iIc lanl's
accouni (a corrcsonding incrcasc in lialiliiy} ly iIc anouni of iIc
urcIasc. Ii nalcs funds availallc io iIc conncrcial lanl's accouni ai
iIc FDI ly issuing a cIcquc and sinly dcclaring iIai iIc crcdii in iIis
accouni is now IigIcr. How docs ii do iIis? Fccall iIai currcncy in
circulaiion was fiai noncy, iIc valuc of wIicI dccndcd on iIc
govcrnncni's dcclaraiion iIai iIis is noncy. In a sinilar way iIc funds
of a conncrcial lanl iIai arc dcosiicd wiiI iIc FDI arc dcclarcd io lc
IigIcr wIcn iIc FDI ays for iIc govcrnncni sccuriiics wiiI a cIcquc. If
wc lisi only iIc cIangcs iIai occur in iIc lalancc sIcci of iIc lanling
sysicn duc io an ocn narlci urcIasc of govcrnncni sccuriiics ly iIc
FDI ii would lool sonciIing lilc iIis.
TabIe 2.3 A: RBI's BaIance Sbeet
ASSETS LIABILITIES
PurcIasc of govcrnncni
sccuriiics

+ INF
Dcosiis Icld ly
conncrcial lanl

+ INF

Comment [eS]: MaiginaIia - The
luying and seIIing of goveinnenl
secuiilies ly a cenliaI lank in lhe
open naikel in oidei lo conlioI lhe
noney suppIy is an open naikel
opeialion.
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
11
TabIe2.3 B: CommercIaI Bank's BaIance Sbeet
ASSETS LIABILITIES

Salc of govcrnncni sccuriiics

- INF


Dcosiis Icld ai ccniral lanl + INF


In iIc Tallc 2.3A iIc FDI urcIascs INF of govcrnncni sccuriiics fron
a conncrcial lanl and ays for ii wiiI a cIcquc iIai is dcosiicd ly iIc
conncrcial lanl wiiI iIc FDI as iIc conncrcial lanl wisIcs io
incrcasc iIc worling funds ai iIc FDI iIai can lc uscd for ayncnis
uroscs. TIc conncrcial lanl iIcn corrcsondingly sccs a rcduciion in
iis Ioldings of govcrnncni sccuriiics Tallc 2.3D - and a corrcsonding
incrcasc on iis asscis sidc in iIc forn of an incrcasc in crcdii availallc in
iis dcosii accouni wiiI iIc FDI.

AnoiIcr oiion for iIc conncrcial lanl wIicI is sonciincs
rcsoricd io is io casI in iIc cIuic of iIc FDI for currcncy. TIc FDI will
iIcn wiiIdraw currcncy fron iis vaulis and Iand ii ovcr io iIc
conncrcial lanl. TIc currcncy in iIc vauli of iIc FDI is noi currcncy in
circulaiion iIc anouni in iIc Iands of iIc ullic or wiiI lanls. As ii
is noi in iIc Iands of iIc ullic or lanls io lc uscd as a ncdiun of
ccIangc ii is noi a lialiliiy of iIc FDI or an assci of any agcni in iIc
cconony. For iIis rcason sucI currcncy is noi ircaicd as ari of iIc
nonciary lialiliiics of iIc FDI. TIc noncni ii concs inio circulaiion,
Iowcvcr, ii lcconcs iIc lialiliiy of iIc FDI and iIc assci of iIc
conncrcial lanl. TIc cIangcs in iIc lalancc sIcci of iIc lanling
sysicn would iIcn lc dcicicd as follows in Tallc 2.4


1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
12
TabIe 2.4 A: RBI's BaIance Sbeet
ASSETS LIABILITIES
PurcIasc of govcrnncni
sccuriiics

+ INF

Currcncy wiiI lanls

+ INF

TabIe 2.4 B: CommercIaI Bank's BaIance Sbeet
ASSETS LIABILITIES

Salc of govcrnncni sccuriiics

- INF


Currcncy wiiI lanls
(Vauli casI}

+ INF



TIc cIangcs in lalancc sIccis for an ocn narlci urcIasc of
govcrnncni sccuriiics ly iIc ccniral lanl arc sinilar (you arc
cncouragcd io wriic oui iIc lalancc sIcci osiiions for sucI a
iransaciion ai iIis junciurc so as io lc alsoluicly faniliar wiiI ocn
narlci iransaciions ly iIc ccniral lanl}.

A sccond way in wIicI ccniral lanls lcnd io conncrcial lanls is
iIrougI iIc discouni window. Hcrc conncrcial lanls in sound financial
condiiion arc allowcd io lorrow all iIcy wani ai vcry sIori naiuriiics
(usually ovcrnigIi}. Conncrcial lanls arc suoscd io iurn io iIis
lcnding faciliiy fron iIc ccniral lanl only as a lacl u sourcc wIcn
iIcy facc a sIoriagc of funds in iIc inicrlanl narlci. TIcy rarcly rcsori
io using iIis discouni faciliiy as ii can iriggcr grcaicr sucrvision fron
iIc ccniral lanl ovcr iIc ocraiions of iIc conncrcial lanl. TIc
discouni raic is sci alovc iIc usual lcvcl of sIori icrn narlci inicrcsi
raics so as io discouragc conncrcial lanls fron rcqucsiing for funds
iIrougI iIis rouic. TIis iyc of discouni lcnding faciliiy was crcaicd so
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
13
iIai a ccniral lanl can lc a lcndcr of lasi rcsori and rcvcni lanl
failurcs duc io icnorary sIoriagcs of liquidiiy fron sinning oui of
conirol. Dy roviding liquidiiy wIcn ii was unavailallc clscwIcrc iIc
ccniral lanl can rcvcni lanling and financial anics. TIc discouni
raic in India is lnown as iIc Danl Faic and Ias rcnaincd uncIangcd ai
6 cr ccni sincc Aril 2003. TIc cffcci on iIc lalancc sIccis of iIc
ccniral lanl and conncrcial lanl wIcn a discouni loan of INF is
nadc is dcicicd in iIc following Tallc2.5

TabIe 2.S A: RBI's BaIance Sbeet
ASSETS LIABILITIES
Crcdii io conncrcial lanls
(Discouni Loans}

+ INF
Dcosiis Icld ly
conncrcial lanl wiiI
FDI

+ INF

TabIe 2.S B: CommercIaI Bank's BaIance Sbeet
ASSETS LIABILITIES
Dcosiis Icld ai ccniral lanl + INF Loan fron ccniral
lanl
+ INF


Finally, iIc ccniral lanl rovidcs crcdii io iIc rivaic sccior as
wcll. For insiancc ii nalcs loans io rinary dcalcrs in iIc govcrnncni
sccuriiics narlci. A rinary dcalcr is a lanl or a sccuriiics lrolcr
wIicI is rcquircd io nalc lids or offcrs wIcn iIc ccniral lanl conducis
ocn narlci ocraiions or iIc govcrnncni auciions govcrnncni
sccuriiics. Danl rinary dcalcrs in India includc Danl of Daroda,
Ciiilanl, Danl of Ancrica, cic. and siand alonc rinary dcalcrs includc
ICICI Sccuriiics Prinary DcalcrsIi Lid., SDI Discouni and Financc
Housc of India Lid., Morgan Sianlcy India Prinary Dcalcr Pvi. Lid., cic.
TIc FDI also rovidcs crcdii io insiiiuiions sucI as iIc Naiional Danl for
Agriculiurc and Fural Dcvcloncni (NADAFD} wIicI rovidcs crcdii io
Comment [e9]: MaiginaIia - The
Iendei of Iasl iesoil is a funclion of a
cenliaI lank in vhich il Iends noney
lo a lank vhich is facing unusuaIIy
heavy vilhdiavaIs and no one eIse is
viIIing lo piovide iesouices lo il.
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
14
agriculiurc and snall scalc indusirics in rural arcas. SucI loans sIow
u on iis lalancc sIcci as a crcdii io iIc rivaic conncrcial sccior.

Fcscrvc noncy or iIc nonciary lialiliiics of iIc ccniral lanl nay
iIcn lc wriiicn as

Fcscrvc Moncy


Currcncy
in
Circulaiion

+
Dcosiis Icld ly conncrcial
lanls ai iIc ccniral lanl

TIc rcccni ircnd in rcscrvc noncy is sIown in Tallc 2.6. In icrns of iis
sourccs (or asscis sidc} wc nay wriic iIis as
Fcscrvc Moncy Crcdii io govcrnncni
+ Crcdii io conncrcial lanls
+ Crcdii io conncrcial rivaic sccior
- Nci Non-Monciary Lialiliiics

TalIe 2.6: Conponenls of Reseive Money (INR liIIion)
Maich 31,
2OO5
Maich 31,
2OO6
Maich 31,
2OO7
Maich 31,
2OO8
Maich 31,
2OO9
Currency in
Circulation

3,686.61

4,295.78

5,O4O.99

5,9O8.O1

6,911.53
Bankers' &
Other
deposits
with RBI


1,2O4.74


1,423.8O


2,O47.91


3,375.O1


2,968.48
Reserve
Money (M
0
)

4,891.35

5,719.58

7,O88.9O

9,283.O2

9,88O.O1
Souice: Reseive ank of India, AnnuaI Repoils

2.3.3. TIc Dalancc SIcci of Conncrcial Danls -
In a sinilar way wc can wriic oui iIc lalancc sIcci of a
conncrcial lanl in iIc following nanncr as dcicicd in Tallc 2.7.
Conncrcial lanls issuc dcosiis and lorrow funds wIicI arc iis
sourccs of funds or iis lialiliiics. TIc funds oliaincd in iIis nanncr arc
uscd io acquirc asscis sucI as govcrnncni sccuriiics (conncrcial lanl
crcdii io govcrnncni} and loans io iIc rivaic sccior.
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
15
















TIc dcosiis of conncrcial lanls arc lroadly classificd as dcnand
dcosiis and iinc dcosiis. A dcnand dcosii is a lanl accouni iIai
allows iIc owncr of iIc dcosii io wriic cIcqucs as ncans of final
sciilcncni of ducs wiiI rcscci io a iransaciion. SucI cIcclallc
dcosiis arc ayallc on dcnand and wiiI iIc rcscniaiion of iIc cIcquc
ai iIc lanl ii nusi ay oui iIc funds inncdiaicly. Dy conirasi iinc
dcosiis sucI as ficd dcosiis wIicI arc a najor sourcc of lanl funds
arc non-iransaciion dcosiis and cannoi lc uscd io sciilc ducs. SucI
dcosiis Iavc a naiuriiy ranging fron a fcw noniIs io scvcral ycars and
can only lc acccsscd ly iIc dcosiior on ayncni of a sulsianiial
cnaliy wIicI involvcs iIc forfciiurc of considcrallc inicrcsi for carly
wiiIdrawal. Dcnand dcosiis wcrc aroinaicly 15 cr ccni of lanl
dcosiis and iinc dcosiis wcrc 85 cr ccni of dcosiis in cnd MarcI of
2009. TIc najor sourcc of funds in Indian lanls arc dcosiis wIicI
accouni for ovcr 75 cr ccni of iIcir lialiliiics.
TabIe 2.?: CommercIaI Banks' BaIance Sbeet
ASSETS LIABILITIES
Conncrcial lanl crcdii io
govcrnncni (C
l/D
}
Dcosiis wiiI ccniral lanl
(a} Fcquircd rcscrvcs (F
r
}
(l} Worling Fund
rcscrvcs
Currcncy wiiI lanls
(Vauli casI}
Loans fron ccniral lanl
Nci Non Monciary Lialiliiics
of conncrcial lanls
(NML
CD
}
Dcosiis (D }
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior ( A
D
}
(F
o
}
Comment [e10]: MaiginaIia - A
denand deposil aIIovs lhe ovnei of
lhe accounl lo viile cheques lo lhiid
pailies.
Comment [e11]: MaiginaIia - A
line deposil is a nonliansaclion
deposil lhal cannol le used as a
nediun of exchange.
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
16
Danls also oliain non-dcosii funds ly lorrowing fron oiIcr
lanls and iIrougI lorrowings in iIc caiial narlci. If a lanl A lorrows
fron anoiIcr lanl D iIc lialiliiy of lanl A is iIc assci of lanl D. If wc
consolidaic iIc lalancc sIccis of all lanls in iIc cconony iIcn iIis
forn of inicr-lanl lorrowing will canccl oui and noi acar on iIc
consolidaicd lalancc sIcci. TIus, only lorrowings fron iIc non-lanl
rivaic sccior would sIow u on iIc consolidaicd lalancc sIcci of
conncrcial lanls. Dorrowings arc noi yci an inoriani sourcc of lanl
funds in India and anouni io aloui 7 cr ccni of lanl lialiliiics. In
advanccd narlci ccononics sucI lorrowings can accouni for ovcr 30
cr ccni of lanl lialiliiics. Sincc lanls lorrow fron iIc rivaic sccior
and also nalc oui loans io iIc rivaic sccior wc nci oui iIc lorrowings
(a lialiliiy} fron iIc Advanccs (crcdiis} io iIc Privaic Conncrcial sccior
on iIc assci sidc of iIc lalancc sIcci. TIus, iIc Advanccs io iIc Privaic
Conncrcial sccior arc in nci icrns, nci of lorrowings fron iIc rivaic
sccior.
In India a fraciion of crcdii advanccd io iIc rivaic sccior ly lanls
is nandaicd io lc io wIai is callcd iIc rioriiy sccior agriculiurc, nicro
and snall cnicrriscs, nicro crcdii, cducaiion and Iousing. TIc idca is
io cIannclizc crcdii io iIcsc vulncrallc scciors of iIc cconony wIicI
nay noi lc aiiraciivc for lanls fron iIc oini of vicw of rofiialiliiy lui
arc ncvcriIclcss inoriani for ccononic dcvcloncni. Doncsiic lanls
and forcign lanls Iavc io cicnd 40 cr ccni and 32 cr ccni
rcscciivcly of iIcir non-lanl crcdii io iIc rioriiy scciors. TIc
ircaincni of Advanccs io iIc rivaic sccior in nci icrns is cquivalcni io
iIc accouniing ircaincni for crcdii advanccd io govcrnncni wIicI lcing
iIc loans io govcrnncni lcss iIc dcosiis of govcrnncni wiiI conncrcial
lanls is also in nci icrns.
Conncrcial lanls in India arc nandaicd io Iold a ccriain fraciion
of iIcir dcosii lialiliiics in iIc forn of govcrnncni sccuriiics. TIis is
callcd iIc siaiuiory liquidiiy raiio or SLF wIicI is sci ai 25 cr ccni of
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
17
lanl dcosii (dcnand and iinc} lialiliiics. In iincs of unccriainiy lanls
Iold a grcaicr fraciion iIan 25 cr ccni as govcrnncni sccuriiics arc low
risl financial insiruncnis. SucI sccuriiics arc also vcry liquid in iIai
iIcy can lc iradcd and convcricd inio casI ai low iransaciion cosis if a
lanl rcquircs. In cnd MarcI 2009 conncrcial lanls invcsincnis in
sucI sccuriiics anounicd io 30.4 cr ccni of dcosii lialiliiics. SucI
invcsincnis arc advanccs ly conncrcial lanls io govcrnncni and if wc
suliraci fron iIis iIc dcosiis of govcrnncni in conncrcial lanls
iIrougI wIicI arc nanagcd iIc govcrnncni ia rccciis and ayncnis
wc oliain in nci icrns iIc conncrcial lanl crcdii io govcrnncni.
TIc oiIcr iicns on iIc lalancc sIcci arc ly now faniliar io you.
TIc nci-non nonciary lialiliiy of conncrcial lanls arc iIc valuc of
Iysical asscis owncd ly iIc lanl sucI as lanl luildings, furniiurc
and cquincni suliracicd fron iIc caiial of iIc lanl or iIc lanl's nci
woriI (iis lialiliiy in iIc forn of iIc valuc of iis aid u caiial and
rciaincd carnings}. As wc saw carlicr iIc conncrcial lanls lcc
dcosiis wiiI iIc ccniral lanl in iIc forn of nandaicd rcquircd rcscrvcs
and for worling fund uroscs io ncci iis olligaiions wIcn a cIcquc is
wriiicn on iis accouni. Danls also lcc a ccriain anouni of currcncy in
iIcir vaulis io Ionour wiiIdrawals nadc ly iIcir dcosiiors. Finally,
conncrcial lanls nay also ialc oui discouni loans fron iIc ccniral
lanl wIcn iIcrc arc acuic sIoriagcs of liquidiiy in iIc sIori-icrn noncy
narlcis.

2.3.4. Consolidaicd lanl lalancc sIcci

Wc now consolidaic iIc lalancc sIccis of iIc ccniral lanl and
conncrcial lanls io oliain iIc consolidaicd lalancc sIcci of iIc
lanling sysicn. Consolidaiion rcquircs iIai all clains and lialiliiics
lciwccn individual conncrcial lanls and lciwccn conncrcial lanls
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
18
and iIc ccniral lanl arc nciicd our. For insiancc, currcncy wiiI lanls
iIai is a nonciary lialiliiy of iIc ccniral lanl is ai iIc sanc iinc an
assci of iIc conncrcial lanls (scc Tallcs 2.8A and 2.8D}. TIc
consolidaicd lalancc sIcci of iIc lanling sysicn will iIcrcforc noi
dcici iIis iicn as iIc sourccs of funds for onc cniiiy Ias a counicrari
in iIc uscs of funds ly anoiIcr cniiiy of iIc lanling sysicn. TIc asscis
of iIc lalancc sIcci of iIc consolidaicd lanling sysicn iIcn includc iwo
cnirics. Onc is lanl crcdii io govcrnncni (Cl} wIicI is iIc sun of crcdii
io govcrnncni ly iIc ccniral lanl (Cl/CD} and crcdii io govcrnncni ly
conncrcial lanls (Cl/D}. TIc oiIcr is advanccs or crcdii givcn io iIc
rivaic sccior (A} wIicI is iIc sun of advanccs givcn ly iIc ccniral lanl
io iIc rivaic sccior (ACD} and advanccs ly conncrcial lanls io iIc
rivaic sccior (AD}. TIc lialiliiics of iIc lanling sysicn conrisc iIrcc
cononcnis. TIcsc arc iIc currcncy in circulaiion wiiI iIc ullic (C
P
},
dcosiis ai conncrcial lanls (D}, and nci non-nonciary lialiliiics of iIc
ccniral lanl and conncrcial lanls (NML}.















Tallc 2.8 A . Ccniral Danl Dalancc SIcci
ASSETS LIADILITIES
Crcdii io conncrcial lanls
Crcdii io govcrnncni
Holdings of govcrnncni
dcli (incl. loans io govi.}
css govcrnncni dcosii
(C
l/CD
}
Dcosiis Icld ly conn-
crcial lanls
(a} Fcquircd rcscrvcs
(l} Worling Fund
rcscrvcs
Nci Non Monciary Lialiliiics
of Ccniral Danl (NML
CD
}
Currcncy in Circulaiion
Currcncy wiiI ullic (C
P
}
+
Currcncy wiiI lanls
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior (A
CD
}
F
E
S
E
F
V
E
S
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
19


































So far wc Iavc lccn canining iIc lalancc sIcci of iIc lanling
sysicn on iIc rcsuniion iIai iIc cconony is closcd io nonciary
iransaciions wiiI agcnis alroad. Wc now rcla iIis assuniion and
Tallc 2.8 D . Conncrcial Danls' Dalancc SIcci
ASSETS LIADILITIES
Conncrcial lanl crcdii io
govcrnncni (C
l/D
}
Dcosiis wiiI ccniral lanl
(a} Fcquircd rcscrvcs (F
r
}
(l} Worling Fund
rcscrvcs
Currcncy wiiI lanls
(Vauli casI}
Loans fron ccniral lanl
Nci Non Monciary Lialiliiics
of conncrcial lanls
(NML
CD
}
Dcosiis (D }
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior ( A
D
}
(F
o
}
TabIe 2.S C : ConsoIIdated BaIance Sbeet oI BankIng System
ASSETS LIABILITIES
Danl Crcdii io govcrnncni
C
l
(C
l/CD
+ C
l/D
}
Nci Non Monciary Lialiliiics
NML (NML
CD
+ NML
D
}
Currcncy in circulaiion
wiiI ullic (C
P
}
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior
A (A
CD
+ A
D
}
Dcosiis (D }
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
2O
caninc iIc cIangc in iIc lalancc sIcci wIcn iIc cconony is ocn io
inicrnaiional iransaciions. In iIai casc iIc ccniral lanl Ias an
addiiional assci forcign ccIangc asscis iIai includc Ioldings of gold
(FECD} as dcicicd in Tallc 2.9A. Cold coin and lullion occasionally is
Icld ly ccniral lanls ouisidc iIc couniry. In India ii is Icld cniircly
wiiIin iIc couniry. Ii is only as a naiicr of accouniing convcnicncc iIai
gold is counicd as an assci along wiiI forcign ccIangc asscis. For
conncrcial lanls inicrnaiional iransaciions involvc iwo asscis and onc
lialiliiy (Tallc 2.9D}. TIc asscis arc iIc nci forcign ccIangc asscis of
lanls (FED}, and iIc advanccs or crcdii givcn ly conncrcial lanls io
non-rcsidcnis (AFE}. TIc addiiional lialiliiics of conncrcial lanls arc iIc
dcosiis of non rcsidcnis (DFE}.
TIc addiiional iicns on iIc consolidaicd lalancc sIcci of iIc
lanling sysicn (Tallc 2.9C} iIcn is an addiiional assci iIc forcign
ccIangc asscis (nci} of iIc lanling sccior (FE}. In iIis consolidaicd
lalancc sIcci iIc Iolding of forcign currcncy dcosiis (DFE} Iavc lccn
nciicd oui fron forcign currcncy advanccs (AFE}.








Tallc 2.9 A. Addiiional Iicns on Ccniral Danl Dalancc
SIcci in an Ocn Econony
ASSETS LIADILITIES
Forcign EcIangc Asscis
(including gold Iolding}
(FE
CD
}
Tallc 2.9 D. Addiiional Iicns on Conncrcial Danl Dalancc
SIcci in an Ocn Econony
ASSETS LIADILITIES
Advanccs (Crcdii} in forcign
currcncy
(A
FE
}
Nci Forcign Currcncy Asscis
of Danls (FE
D
}
Dcosiis (clains on lanls}
in forcign currcncy
(D
FE
}
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
21







TIc nci forcign ccIangc asscis of iIc lanling sysicn so dcfincd
is iIcn addcd io iIc oiIcr asscis of iIc consolidaicd lanling sysicn io
oliain iIc consolidaicd lalancc sIcci of iIc lanling sysicn in an ocn
cconony Tallc 2.10.















In icrns of an idcniiiy iIc consolidaicd lalancc sIcci of iIc lanling
nay lc wriiicn as

TabIe 2. .C: AddItIonaI Items on ConsoIIdated Bank
BaIance Sbeet In an Open Economy
ASSETS LIADILITIES
Forcign EcIangc Asscis
(Nci} of Danling Sccior
(FE}
FE FE
CD
+ FE
D
+ (A
FE
D
FE
}
TabIe 2.10 : ConsoIIdated BaIance Sbeet oI BankIng System
In an Open Economy
ASSETS LIABILITIES
Danl Crcdii io govcrnncni
C
l
(C
l/CD
+ C
l/D
}
Nci Non Monciary Lialiliiics
NML (NML
CD
+ NML
D
}
Currcncy in circulaiion
wiiI ullic (C
P
}
Advanccs (Crcdiis} io
Conncrcial Privaic
Sccior
A (A
CD
+ A
D
}
Forcign EcIangc Asscis
(Nci} of lanling sccior
Dcosiis (D }
FE FE
CD
+ FE
D
+ (A
FE
D
FE
}
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
22
C
P
+ D Cl + A+ FE - NML

Noi surrisingly iIis is also iIc dcfiniiion of iIc noncy suly (M
S
}. TIc
noncy suly iIcn is givcn ly

M
S
C
P
+ D Cl+ A + FE - NML

TIc various cononcnis in icrns of iIc sourccs of iIc noncy
suly in India arc sIown in Tallc 2.11. TIc dcfiniiion of iIc noncy
suly nalcs aarcni iIc nonciary inaci of caiial flows inio an
cconony. WIcn forcigncrs crcss a dcnand for Iolding iIc asscis of an
cconony ciiIcr sIarcs of a conany as in iIc casc of forcign
insiiiuiional (or orifolio} invcsiors or ly sciiing u a lusincss unii as in
iIc casc of forcign dircci invcsincni iIcy firsi ccIangc forcign
currcncy for doncsiic currcncy. TIc forcign ccIangc asscis of iIc
lanling sysicn (FE} iIcn incrcasc and iIc dircci inaci of iIis,
TalIe 2.11: Souices of Money Slock (INR liIIion)
Maich 31,
2OO5
Maich 31,
2OO6
Maich 31,
2OO7
Maich 31,
2OO8
Maich 31,
2OO9
Net Bank
Credit to
Government
(G
b
)

7,524.36

(33.5)

7,594.16

(27.9)

8,276.26

(25.O)

8,995.18

(22.4)

12,771.99

(26.8)
Net Bank
Credit to
Commercial
Sector (A)

12,759.12

(56.8)

16,886.81

(62.1)

21,288.62

(64.3)

25,789.9O

(64.2)

3O,133.37

(63.3)
Net Foreign
-Exchange
Assets (FE)

6,492.55
(28.9)

7,261.94
(26.7)

9,131.79
(27.6)

12,951.31
(32.2)

13,521.84
(28.4)
Net Non-
Monetary
Liabilities
(NML)
*


4,319.26



4,547.72



5,595.99



7,557.56



8,787.O1


Money
Supply

22,456.77

27,195.19

33,1OO.68

4O,178.83

47,64O.19
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
23
*
Coveinnenls cuiiency IialiIilies lo lhe pulIic have leen nelled oul of lhese
figuies.
N..: Iiguies in paienlheses aie peicenlages lo lolaI noney suppIy
Souice: Reseive ank of India, AnnuaI Repoils


wIcn oiIcr iicns on iIc lalancc sIcci rcnain uncIangcd, is an
cquivalcni incrcasc in iIc noncy suly (M
S
}. If iIc Ccniral lanls wanis
io ncgaic iIc inaci of caiial flows on iIc noncy suly say lccausc ii
finds iIc incrcascd noncy suly io lc inflaiionary, iIcn, ii can
undcrialc io offsci iIis iIrougI a roccss lnown as sicrilizaiion.
Sicrilizaiion involvcs a rcduciion in ccniral lanl crcdii io govcrnncni
(Cl/CD} in rcsonsc io an incrcasc in forcign ccIangc asscis. A conlcic
offsciiing of iIc incrcascd caiial inflow (FE} ly sicrilizaiion so iIai
iIcrc is no inaci on iIc noncy suly would rcquirc iIc rcduciion in
ccniral lanl crcdii io govcrnncni (Cl/CD} io lc of sucI a nagniiudc
iIai FE -Cl/CD. TIc rcccni suri of caiial flows io India sincc 2003
rcquircd iIc Fcscrvc Danl of India io sicrilizc iIc caiial inflows io iIc
cconony io a considcrallc cicni. In MarcI 1991, for insiancc, ccniral
lanl lcnding io govcrnncni (Cl/CD} was 33.4 cr ccni of iIc noncy
suly and iIc nci forcign ccIangc asscis of iIc lanling sccior (FE}
was 5 cr ccni of iIc noncy suly. Dy 2009 iIcrc was a drasiic
rcvcrsal. In 2009 iIc ccniral lanl lcnding io govcrnncni was a nucI
rcduccd 1.3 cr ccni of iIc noncy suly as iIc ccniral lanl sougIi io
sicrilizc iIc inaci of caiial inflows wIicI rcsulicd in iIc nci forcign
ccIangc asscis of iIc lanling sccior consiiiuiing 28.4 cr ccni of iIc
noncy suly.

TIc noncy suly in India as rcad oui of iIc lalancc sIccis of iIc
lanling sysicn is rcfcrrcd io as lroad noncy or M3. A narrowcr
dcfiniiion of noncy is M1 or narrow noncy. TIis includcs only iIc
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
24
dcnand dcosiis of iIc lanling sysicn in iIc dcfiniiion of noncy and
lcavcs oui iinc dcosiis. A dcnand dcosii is norc currcncy lilc iIan a
iinc dcosii. Unlilc a iinc dcosii, a dcnand dcosii can lc iransfcrrcd
inio currcncy ai a vcry low iransaciion cosi indccd dcnand dcosiis
arc dcfincd as iIosc dcosiis iIai wc nalc wiiI lanls iIai allow us io
gci our noncy lacl on dcnand. Droadcr dcfiniiions of noncy includc
cononcnis iIai arc lcss closc or crfcci sulsiiiuics io currcncy in
circulaiion. M2, for insiancc, is M1 lus iinc dcosiis wiiI a naiuriiy of
lcss iIan a ycar osi officc savings lanl dcosiis. M3 includcs all iinc
dcosiis rcgardlcss of iIcir naiuriiy. And io conlcic iIc naning
ccrcnony, M0 is iIc synlolic nanc for IigI owcrcd noncy or iIc
nonciary lasc. To sun u.

Moncy Siocl Mcasurcs
M0 Currcncy in Circulaiion + Dcosiis Icld ly conncrcial lanls
ai iIc ccniral lanl
M1 Currcncy in Circulaiion wiiI iIc Pullic + Dcnand Dcosiis
M2 M1 + Tinc Dcosiis wiiI naiuriiy of lcss iIan a ycar (Posi officc
savings lanl dcosiis}
M3 M2 + Tinc Dcosiis wiiI naiuriiy of 1 ycar and norc


Droad noncy or M3 is iIc nonciary aggrcgaic iIai is ialcn io lc iIc
rcfcrcncc for iIc noncy siocl in India. TIc cononcnis of iIc noncy
siocl in icrns of iis uscs (or lialiliiics} arc givcn in iIc Tallc 2.12







1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
25
TalIe 2.12: AppIicalions of Money Slock (INR liIIion)
Maich
31, 2OO5
Maich
31, 2OO6
Maich
31, 2OO7
Maich
31, 2OO8
Maich
31,2OO9
Aveiage
Shaie
Cuiiency
vilh lhe
IulIic
(A) 3,563.14 4,121.24 4,828.54 5,684.1 6,663.64



14.57
Denand
Deposils
() 2,934.76 4,142.92 4,851.OO 5,874.26 5,868.2O


13.88
Tine
Deposils
(C) 15,958.87 18,931.O4 23,421.13 28,62O.46 35,1O8.35


71.55
Naiiov
Money
(M1) 6,497.9O 8,264.16 9,679.54 11,558.36 12,531.84

ioad
Money
(M3) 22,456.77 27,195.2 33,1OO.67 4O,178.82 47,64O.19

N..: Denand deposils is incIusive of Olhei deposils al lhe RI
M1 = (A) + ()
M3 = (A) + () + (C)
Souice: Reseive ank of India, AnnuaI Repoils


2.3.5. TIc lanling sysicn and iIc crcaiion of noncy

TIc analysis of iIc ccniral lanl's lalancc sIcci rcvcals iIai ii can
cIangc iIc nonciary lasc iIrougI ocraiing wiiI iIc following nonciary
olicy iools

(1} Reserve requIrements. TIc ccniral lanl can cIangc iIc
nandaicd rcscrvc rcquircncnis iIai all dcosii ialing financial
inicrncdiarics arc rcquircd io Iold as a crccniagc of iIcir dcosiis in a
rcscrvc accouni wiiI iIc ccniral lanl.

1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
26
(2} Open Market OperatIons. Dy sclling or urcIasing govcrnncni
sccuriiics iIc ccniral lanl cIangcs iis lalancc sIcci. TIcrc is a cIangc
in iIc asscis ii Iolds in iIc forn of a cIangc in iis Ioldings of
govcrnncni sccuriiics or iis crcdii io govcrnncni and iis lialiliiics in iIc
forn of a cIangc in iIc Worling Fund rcscrvcs Icld ly conncrcial
lanls ai iIc ccniral lanl. Wc saw for insiancc Iow an ocn narlci
urcIasc of govcrnncni sccuriiics ly iIc ccniral lanl rcsulis in an
incrcasc in iIc ccniral lanl's asscis in iIc forn of govcrnncni sccuriiics
and an incrcasc in iis lialiliiics in iIc forn of dcosiis Icld ly
conncrcial lanls wiiI iIc ccniral lanl. A cIangc in iIc dcosiis Icld
ly conncrcial lanls ai iIc ccniral lanl anounis io a cIangc in iIc
nonciary lasc or M0.

(3} DIscount LendIng. TIis is iIc lorrowings ly lanls fron iIc
ccniral lanl wIcncvcr iIcy find iIc narlci for sIori icrn ovcrnigIi
funds io lc ccnsivc (as occurs wIcn iIc inicrcsi raic Icrc is IigIcr
iIan iIc discouni raic} or wIcn iIcy arc consiraincd in iIcir aliliiy io
lorrow in iIis narlci. In iIis casc, iIc ccniral lanls' asscis in iIc forn
of crcdii io conncrcial lanls cIangcs io iIc cicni of iIc discouni loan.
As iIc rocccds of iIc discouni loan is crcdiicd io iIc dcosii accouni of
iIc conncrcial lanl ai iIc ccniral lanl, iIc lialiliiics of iIc ccniral
lanl cIangc ly iIc sanc anouni as iIc cIangc in iis asscis. TIc
cIangc in iIc nonciary lasc cquals iIc cIangc in lialiliiics in iIc forn
of a cIangc in dcosiis Icld ly conncrcial lanls wiiI iIc ccniral lanl.
(Wriic oui iIc lalancc sIcci of iIc ccniral lanl wIicI rcflccis iIc
cIangc in nonciary lasc if discouni lcnding incrcascd ly INF 100 as an
ccrcisc}.

TIrougI iIcsc aciions a cIangc in ocn narlci ocraiions, iIc
rcquircd rcscrvc raiio, or a cIangc in iIc discouni raic iIc ccniral lanl
affccis iIc suly of noncy in iIc cconony. Fccall iIai in iIc lcginning
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
27
of iIis scciion wc cnIasizcd iIai iIc noncy suly rcsulis fron aciion
ialcn ly iIrcc laycrs ccniral lanls, conncrcial lanls, and iIc non-
lanl ullic wIicI ocraic a dcosii accouni wiiI lanls. Lci us caninc
iIc roccss of crcdii and dcosii crcaiion rcsuliing fron iIc usc of onc
nonciary iool ly iIc ccniral lanl iIc rcquircd rcscrvc raiio. To focus
on iIc csscniials lci us rc-wriic iIc lalancc sIcci of conncrcial lanls
in iIc following way. As conncrcial lanls' najor lialiliiy is iIc dcosiis
ii issucs lci us in wIai follows ignorc iIc loans ii ialcs fron iIc ccniral
lanl (discouni loans} and iis nci non-nonciary lialiliiics. Lci iIc iniiial
dcosiis lc of a valuc of INF 100 scc Tallc 2.13. On iIc asscis sidc of
iIc lalancc sIcci lci us clul iogciIcr iIc advanccs ii nalcs in iIc forn
of crcdii io govcrnncni and crcdii io iIc rivaic conncrcial sccior as
crcdii advanccd ly iIc conncrcial lanl, or, iis Advanccs. Lci iIc
advanccs ly conncrcial lanls lc INF 75. TIc conncrcial lanls
lalancc sIcci iIcn nay lc wriiicn as sIown in Tallc 2.13.













TIc conncrcial lanl rcccivcs funds in iIc forn of dcosiis ai iis
lrancIcs. TIc lanl lnows iIai ccci in iIc casc of a lanling anic,
dcosiiors arc noi lilcly all io sIow u ai iIc sanc iinc, dcnanding
TabIe 2. 13: CommercIaI Banks' BaIance Sbeet
ASSETS LIABILITIES
Dcosiis wiiI ccniral lanl
(a} Fcquircd rcscrvcs ---- 15
(l} Worling Fund
rcscrvcs
Currcncy wiiI lanls
(Vauli casI}
Dcosiis --------- 100
----- 10
Advanccs -------------- 75
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
28
iIcir funds in casI. Sonc dcosiiors will wiiIdraw funds in iIc forn of
currcncy for wIicI iIc lanl Iolds casI in iIc vaulis. Sonc ayncnis
will Iavc io lc nadc io clcar cIcqucs iIai dcosiiors nalc oui io agcnis
wIo Iold accounis wiiI oiIcr lanls io cnallc iIis, iIc conncrcial
lanls lccing worling funds on dcosii ai iIc ccniral lanl. Fron asi
ccricncc in our canlc in Tallc 2.13 iIc conncrcial lanl finds iIai
lccing 10 cr ccni of dcosiis as vauli casI or worling funds ai iIc
ccniral lanl is sufficicni liquidiiy io ialc carc of wiiIdrawals and
dcosiior ayncnis io crcdiiors iIrougI iIc wriiing of cIcqucs. Aari
fron cnsuring sufficicni liquidiiy for wiiIdrawal and dcosiior ayncnis
of funds iIc lanl also Ias a nandaic io Iold 15 cr ccni of iis dcosiis
as rcquircd rcscrvcs wiiI iIc ccniral lanl. Aficr cnsuring ii Ias funds
for rcquircd rcscrvcs and for ayncnis and wiiIdrawals iIc lanl can
usc iIc rcnaindcr of iIc dcosiis ii Iolds io oliain carnings. Ii docs so
ly naling oui loans or Advanccs in iIis casc of INF 75.

TIus for a Iundrcd rucc dcosii iIc lanl lccs 15 cr ccni
asidc as rcquircd rcscrvcs, 10 cr ccni in liquid forns io nanagc dcosii
ouiflows in iIc forn of wiiIdrawals and dcnand dcosii ayncnis, and
loans oui 75 cr ccni io oliain rofiis. TIc fundancnial iradcoff for a
lanl is io Iold sufficicni liquidiiy io Ionor dcosii ouiflows lui iIc cosi
of iIai is forgonc carnings on loans advanccd. Danls will iIcrcforc noi
Iold ioo nucI of cira liquidiiy lcyond iIai rcquircd for dcosiior
ouiflows and aiicni io givc oui cccss liquidiiy as loans.

Suosc now iIc ccniral lanl dccidcd io rcducc iIc rcquircd
rcscrvc raiio fron 15 cr ccni io 10 cr ccni of dcosiis. TIis lcavcs iIc
conncrcial lanl wiiI INF 5 of surlus liquidiiy in iIc forn of vauli casI
and dcosiis ai iIc ccniral lanl. WiiI iIis cIangc in ccniral lanl olicy
iIc lalancc sIcci of iIc conncrcial lanls will now lc alicrcd as in iIc
following Tallc 2.14 -
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
29














Conncrcial lanls now Iavc surlus liquidiiy iIcy ocraic wiiI a 10
cr ccni liquidiiy raiio iIai is sufficicni io nanagc dcosiior ouiflows.
TIc currcni liquidiiy raiio, Iowcvcr, is 15 cr ccni and iIc addiiional
liquidiiy of 5 cr ccni is siiiing on iIc lools of iIc lanls and iIc lanls
arc forgoing carnings. TIc lanls, iIcrcforc, lcnds iIis surlus liquidiiy
io iIc rivaic conncrcial sccior. TIc conncrcial lanls nalcs oui loans
of INF 5 io cusioncrs.
WiiIoui any loss of gcncraliiy lci us assunc iIcrc arc only iwo
lanls in iIc financial sysicn Danl ADC and Danl HIJ. For sinliciiy
suosc iIai loiI lanls arc synnciric and cacI lanl iIcrcforc finds
iIai iIc rcduciion in iIc rcquircd rcscrvcs of INF 5 in iIc financial
sysicn rcsulis in addiiional liquidiiy of INF 2.5 in iis Worling Fund
rcscrvc accouni. Lci us lcgin wiiI Danl ADC wIicI Iaving iIis surlus
liquidiiy nalcs oui a loan of INF 2.5 ly ocning a cIccling accouni for
iIc lorrowcr (if sIc docs noi alrcady Iavc onc} and uiiing iIc
sanciioncd loan anouni inio iIis dcosii accouni. Danl ADC incrcascs
iis lialiliiics wiiI INF 2.5 of dcosiis and iis asscis wiiI INF 2.5 of
TabIe 2.14 : CommercIaI Banks' BaIance Sbeet
ASSETS LIABILITIES
Dcosiis wiiI ccniral lanl
(a} Fcquircd rcscrvcs ---- (15-5}
(l} Worling Fund 10
rcscrvcs
Currcncy wiiI lanls
(Vauli casI}
Dcosiis --------- 100
----- (10+5}
15
Advanccs -------------- 75
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
3O
advanccs or loans. TIc cIangc in iIc lalancc sIcci of Danl ADC will lc
as dcicicd in Tallc 2.15.A

TabIe 2.1S. A: Bank ABC's BaIance Sbeet
ASSETS LIABILITIES
Fcquircd rcscrvcs -INF 2.5
Worling Fund rcscrvcs + INF 2.5
Advanccs + INF 2.5 Dcosiis + INF 2.5

TIc cusioncr wIo oliains iIc loan fron Danl ADC uscs iIc
anouni io nalc ayncnis for an inconc gcncraiing rojcci iIai was iIc
lasis for iIc sanciioning of iIc loan. WIcn iIc rcccivcr of iIc ayncni
Ias an accouni wiiI Danl HIJ iIc cIcquc wriiicn oui on Danl ADC will
lc dcosiicd ai Danl HIJ. Danl HIJ iIcn rcscnis iIc cIcquc for
ayncni ai iIc ccniral lanl. TIc ccniral lanl crcdiis Danl HIJ's
Worling Fund rcscrvcs wiiI an anouni of INF 2.5 and dcliis iIc
Worling Fund rcscrvcs of Danl ADC ly INF 2.5. WiiI iIis iransaciion
iIc anouni in iIc dcosii accouni of INF 2.5 Ias lccn iransfcrrcd io
Danl HIJ and Danl ADC's lalancc sIcci is as in Tallc 2.15.D.

TabIe 2.1S. B: Bank ABC's BaIance Sbeet
ASSETS LIABILITIES
Fcquircd rcscrvcs -INF 2.5
Advanccs + INF 2.5

Danl HIJ iIai goi aid INF 2.5 inio iis Worling Funds rcscrvc
accouni accordingly crcdiis iIc dcosii accouni of iis cusioncr wIo
lrougIi in iIc cIcquc fron Danl ADC. TIc cIangc in iIc lalancc sIcci
of Danl HIJ will lc as in Tallc 2.15.C.

1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
31
TabIe 2.1S. C: Bank HIJ's BaIance Sbeet
ASSETS LIABILITIES
Worling Fund rcscrvcs + INF 2.5 Dcosiis + INF 2.5

Wc now consolidaic iIc lalancc sIccis of Danl ADC and Danl
HIJ. TIis involvcs adding u iIc cIangc in iIc lalancc sIccis of Danl
ADC and Danl HIJ as dcicicd in Tallcs 2.15.D and 2.15.C. WIilsi
adding u wc nusi lcc in nind iIai iIc lanls arc synnciric and iIai
iIc scqucncc of iransaciions iIai occurrcd on Danl ADC's lalancc sIcci
will also occur on Danl HIJ's lalancc sIcci. Sinilarly, iIc cIangc
dcicicd in Danl HIJ's lalancc sIcci (Tallc 2.15.C} will also sIow u on
Danl ADC's lalancc sIcci. WIcn consolidaiing iIcn wc nusi ialc carc
io doullc iIc dcnoninaiions of iIc iransaciions rcoricd in Tallc 2.15.D
and Tallc 2.15.C. TIc consolidaicd cIangc in iIc lalancc sIcci of
conncrcial lanls can iIcn lc wriiicn as in Tallc 2.15.D
2
.

TabIe 2.1S. D: ConsoIIdated Bank BaIance Sbeet
ASSETS LIABILITIES
Fcquircd rcscrvcs - INF 5
Worling Fund rcscrvcs + INF 5
Advanccs + INF 5 Dcosiis + INF 5

TIc lalancc sIccis of conncrcial lanls ai iIis siagc of iIc
dcosii crcaiion roccss aficr all iIcsc iransaciions Iavc occurrcd in iIc
lanling sysicn is now as sIown in Tallc 2.16.




2
As an exeicise you shouId viile oul lhe changes lo lhe consoIidaled laIance sheel (a) vhen lhe
lvo lanks aie nol synneliic, and (l) vhen lheie is a singIe lank. You viII find lhal lhe oulcone
in lolh cases is as shovn in TalIe 2.15.D.
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
32

Conncrcial lanls now find iIcy Iavc dcosiis of INF 105.
Fcquircd rcscrvcs iIai iIc ccniral lanl nandaics arc 10 cr ccni of
dcosiis. TIc lanls nusi iIcn Iold 10 cr ccni of 105 or INF 10.5 as
rcquircd rcscrvcs an incrcasc of INF 0.5. TIc lanls also ocraic wiiI a
liquidiiy raiio of 10 cr ccni io nanagc dcosii ouiflows. Worling Fund
rcscrvcs ai iIc ccniral lanl and vauli casI nusi iIcn also lc INF 10.5
so as io aiiain iIc dcsircd liquidiiy raiio. TIc lalancc sIcci ai iIis siagc
is as follows scc Tallc 2.17.

1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
33

Danls again find iIcy Iavc cccss rcscrvcs of INF 4 and would
wani io nalc loans of iIis anouni raiIcr iIan Iavc iIc noncy arlcd
on iIc lalancc sIcci wiiI no carnings dcrivcd fron ii. Again iIc
lorrowcr dcosiis iIc loan anouni in iIc lanl rcsuliing in iIc lalancc
sIcci as follows Tallc 2.18.


Yci anoiIcr round of lalancc sIcci adjusincnis is callcd for. For
dcosiis anouniing io INF 109 iIc rcquircd rcscrvcs ai 10 cr ccni is an
addiiional INF 0.4 io nalc ii INF 10.9. Sinilarly, iIc liquidiiy raiio of 10
cr ccni rcquircs cira rcscrvcs io lc lci ai INF 10.9 as wcll. TIc
lalancc sIcci now rcads as follows Tallc 2.19.


1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
34
Yci again iIcrc arc cccss rcscrvcs of INF 3.2. TIc conncrcial
lanls will again loan oui iIis anouni. Advanccs ly conncrcial lanls
arc now 84 + 3.2 or INF 87.2. TIcrc arc ncw dcosiis of INF 3.2 as iIc
loan anouni is ui inio a dcosii accouni (ialing iIc dcosiis io INF
112.2} and cccss rcscrvcs again of INF 2.56 iIai would again lc loancd
oui. TIc roccss will coniinuc uniil iIc lalancc sIcci cvcniually rcacIcs
iIc osiiion dcicicd in Tallc 2.20. Dcosiis iIai wcrc iniiially INF 100
Iavc now lcconc INF 125 and loans advanccd sinilarly Iavc incrcascd
fron an iniiial INF 75 io INF 100.



TIc roccss of incrcncnis io dcosiis, loans advanccd, and
rcscrvcs rcquircd rcscrvcs lus oiIcr rcscrvcs in iIc forn of worling
funds and vauli casI is dcicicd in iIc following Tallc 2.21.



1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
35
TabIe 2.21: Process oI deposIt creatIon wben requIred reserves are
decreased by S per cent

Increase In
Reserves beId
Increase In
Loans
Increase In
DeposIts
Siagc 1 .5 + .5 1 5 5
Siagc 2 .4 + .4 .8 4 4
Siagc 3 .32 + .32 .64 3.2 3.2
Siagc 4 .256 + .256 .512 2.56 2.56
Siagc 5 .2048 +.2048 .4096 2.048 2.048
. . .
. . .
. . .
. . .
TOTAL 2.5 + 2.5 5 25 25

2.3.6. Muliilc dcosii crcaiion roccss

WIcn lanls lcnd oui cccss rcscrvcs iIcrc arc sulscqucni
incrcncnis io dcosiis. Danls lcc rcscrvcs on Iand io fund dcosii
ouiflows. Eccss rcscrvcs alovc iIis anouni can lc safcly givcn oui as a
loan and incrcasc iIc carnings of a lanl. An incrcasc in a unii of
rcscrvcs duc io a cIangc in olicy ly iIc ccniral lanl (a rcduciion in
rcquircd rcscrvcs in our canlc} rcsulis in an incrcasc in loans and
dcosiis ly a nuliilc of iIis anouni a roccss rcfcrrcd io as nuliilc
dcosii crcaiion.

Wc can gcncralizc. TIc rcquircd rcscrvcs,

R arc a fraciion
1
x of
dcosiis D (10 cr ccni in our canlc} iIai conncrcial lanls nusi
Iold as a dcosii wiiI iIc ccniral lanl
D x R
r
1
=

1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
36
1
x is a olicy iool sci ly iIc ccniral lanl. TIc liquidiiy raiio for
nainiaining oiIcr rcscrvcs
o
R in iIc forns of worling funds and vauli
casI is a fraciion
2
x of dcosiis.

D x R
2
o
=

Lci
0
D rcrcscni iIc iniiial incrcasc in loans advanccd and ncw
dcosiis in conncrcial lanls as a rcsuli of iIc olicy cIangc. In our
canlc iIc rcduciion in iIc rcquircd rcscrvc raiio fron 15 cr ccni io
10 cr ccni rcsulicd in lanls naling an iniiial incrcasc in loans
advanccd ly INF 5. TIcn, in iIc canlc,
0
D 5. TIcn, iIc roccss of
dcosii crcaiion and loans advanccd will coniinuc uniil iIc cIangc in
ioial dcosiis in iIc lanling sysicn, D , is givcn ly


2 1
0
x x
D
D
+

=

In our canlc, wiiI
0
D 5,
1
x 0.1,
2
x 0.1, iIc roccss of dcosii
crcaiion ly lanls cnds wIcn dcosiis Iavc incrcascd ly

25
2 .
5
= = D
Indccd, iIc ioial cIangc in dcosiis and loans advanccd duc io iIc olicy
cIangc is sIown as INF 25 in iIc final lalancc sIcci osiiion of iIc
conncrcial lanls.

TIc nuliilc crcaiion of dcosiis is a dircci inlicaiion of a
fraciional rcscrvc lanling sysicn wIcrc only a fraciion of dcosiis nccd
io lc lci as rcscrvcs io nanagc dcosii ouiflows. If all lanls wcrc
rcquircd io lcc iIc cniirc dcosii as a rcscrvc, iIcn,
2 1
x x + 1. In iIai
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
37
casc iIc lanls would noi lc allc io loan oui any noncy as iIcy would
Iavc io lcc dcosiis as rcscrvcs iill iIc dcosiior wiiIdraws iIc noncy.
In a 100 cr ccni rcscrvc sysicn lanls can ncvcr nalc loans and will
ncvcr lc allc io carn rofiis ciiIcr. WiiI
2 1
x x + 1,


0
0
1
D
D
D =

=

and iIc incrcasc in dcosiis cacily cquals iIc iniiial incrcasc in
dcosiis.

2.3.7. TIc noncy nuliilicr

TIcrc is an addiiional conlicaiion iIai wc nccd io addrcss. WIai
if iIc crson wIo rcccivcs a loan dccidcs io wiiIdraw sonc of iIc
anouni fron Iis dcosii accouni as currcncy in ordcr io faciliiaic
iransaciions? In iIis casc a fraciion of iIc loan nadc lcavcs iIc
Conncrcial lanling sysicn iIrougI wiiIdrawals of casI. TIis is a
dcosii ouiflow iIai rcduccs iIc lcvcl of cccss rcscrvcs availallc wiiI
lanls iIai nay lc advanccd as loans. If for insiancc iIc iniiial INF 5
iIai was givcn oui as a loan was ialcn oui in iIc forn of currcncy and
noi dcosiicd, iIcn, iIcrc is no incrcasc in dcosiis and iIc nuliilc
dcosii crcaiion roccss ccascs. Ii is only dcosiis iIai can lc iIc sourcc
of nuliilc dcosii crcaiion and currcncy is incaallc of nuliilc dcosii
cansion. TIc cansion of noncy (dcfincd as currcncy wiiI iIc ullic
lus dcosiis} is dininisIcd as iIcrc is an incrcasc in iIc Iolding of
currcncy. Again lci us gcncralizc. Suosc a fraciion of noncy is Icld
as currcncy wiiI iIc ullic. TIcn, a fraciion of an incrcasc in noncy
suly duc io iIc advancing of a loan will lc wiiIdrawn. TIcn (1- } of a
ncw loan/dcosii rcnains wiiI iIc lanls wIicI can iIcn usc iIis
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
38
anouni io nalc oui anoiIcr loan aficr lccing asidc rcscrvcs for
liquidiiy uroscs u io iIc fraciion
2 1
x x + . Wc can iIcn sIow iIai iIc
lanls can crcaic ncw advanccs and dcosiis io an cicni givcn ly


( )( ) + +

=
1
2 1
0
x x
D
D

or,
( ) + +
=

) 1 (
1
`
2 1 0
x x D
D



0
D D is iIc raiio of iIc final incrcasc in dcosiis io iIc iniiial
incrcasc in dcosiis, or, iIc nuliilc incrcasc in dcosiis as a fraciion of
iIc iniiial incrcasc in dcosiis.
0
D D nusi lc grcaicr iIan uniiy as iIc
icrns in iIc dcnoninaior of iIc rigIi Iand sidc arc fraciions and lcss
iIan uniiy rcsuliing in iIc rigIi Iand sidc lcing grcaicr iIan uniiy.

Econonisis dcfinc iIc noncy nuliilicr, m, as iIc raiio of iIc
noncy suly M3 io iIc nonciary lasc M0.


Base Monetary
Supply Money
0
3
= =
M
M
m

TIc iniiial incrcasc in dcosiis in our canlc alovc occurrcd duc
io a cIangc in iIc nonciary lasc as iIc ccniral lanl rcduccd rcquircd
rcscrvcs. TIc nuliilc incrcasc in dcosiis was iIc rcsuliing incrcasc in
iIc noncy suly. Hcncc,


( )( )
0
3
2 1
1
1
M
M
x x
m =
+ +
=



1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
39
AnoiIcr way of wriiing iIis is io cross nuliily and wriic iIc alovc
crcssion as follows

Moncy Suly noncy nuliilicr nonciary lasc

or,
0
M m M
S
=

In iIc cnd of MarcI 2009,


0
M INF 9,880.01 lillion

S
M
3
M INF 47,640.19 lillion

TIc noncy nuliilicr in cnd MarcI 2009, iIcn, was

82 . 4
01 . 880 , 9
19 . 640 , 47
= = m

Alicrnaiivcly, iIc Fcscrvc Danl of India Iad sci rcquircd rcscrvcs as


1
x 0.05

Conncrcial lanls ocraicd wiiI a liquidiiy raiio for nainiaining
rcscrvcs in iIc forn of worling funds and vauli casI givcn ly


2
x 0.0285

TIc ullic Icld a fraciion of iIc noncy as currcncy givcn ly

=
S P
M C 0.1399
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
4O

TIcn, iIc noncy nuliilicr in cnd MarcI 2009 was


( )( ) ( )( )
82 . 4
1399 . 0 8601 . 0 0285 . 0 05 . 0
1
1
1
2 1
=
+ +
=
+ +
=
x x
m

TIc noncy nuliilicr iclls us ly Iow nucI iIc noncy suly will
cIangc for a givcn cIangc in iIc noncy suly will cIangc for a givcn
cIangc in iIc nonciary lasc or IigI owcrcd noncy. TIc ccniral lanl
influcnccs iIc nonciary lasc nainly iIrougI cIangcs in rcscrvc
rcquircncnis and ocn narlci ocraiions. An ocn narlci urcIasc of
govcrnncni sccuriiics for insiancc fron conncrcial lanls rcsulis in an
incrcasc in iIc Worling Fund rcscrvcs of conncrcial lanls Icld ai iIc
ccniral lanl. TIc ccniral lanl ays for urcIasing iIc sccuriiics ly
crcdiiing iIis accouni of conncrcial lanls. Conncrcial lanls would
find iIcnsclvcs Iolding cccss rcscrvcs and would advancc iIcsc funds
as loans. TIis rcsulis in iIc roccss of nuliilc dcosii crcaiion. WiiI a
noncy nuliilicr of 4.82 ii ncans iIai iIc ocn narlci urcIasc of
govcrnncni sccuriiics rcsulis in a 4.82 iincs incrcasc in loans and
dcosiis in iIc financial sysicn.

TIc noncy suly in iIc cconony is influcnccd noi only ly olicy
cIangcs undcrialcn ly iIc ccniral lanl. Conncrcial lanls and iIc
ullic could also influcncc iIc noncy suly wiiI a cIangc in iIcir
financial lcIaviour. For insiancc, if conncrcial lanls dccidc io incrcasc
iIc anouni of cccss rcscrvcs iIcy Iold raiIcr iIan lcnd ii oui as occurs
during iincs of unccriainiy, a sccd lrcalcr is crcaicd in iIc roccss of
nuliilc dcosii crcaiion and iIc noncy suly rcduccs. You can cIccl
iIai an incrcasc in iIc liquidiiy raiio wiiI wIicI conncrcial lanls
ocraic,
2
x , indccd rcduccs iIc noncy nuliilicr. Finally, if iIc ullic
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
41
dccidcs io Iold norc currcncy iIcn again iIcrc is a dcosii ouiflow iIai
rcduccs iIc roccss of nuliilc dcosii crcaiion. Again, an incrcasc in
currcncy wiiI iIc ullic an incrcasc in - rcduccs iIc valuc of iIc
noncy nuliilicr. TIc noncy suly iIcn is iIc rcsuli of dccisions ialcn
ly iIc ccniral lanl, conncrcial lanls, and dcosiiors.

TIc ccniral lanl is iIc crucial agcni, Iowcvcr, in iIc noncy
suly roccss in a fraciional rcscrvc lanling sysicn. WiiIoui a ccniral
lanl iIc cIancc of a lanl run incrcasc. A lanl run occurs wIcn
dcosiiors losc iIcir confidcncc in iIc lanl and aiicni io wiiIdraw
iIcir funds ai iIc sanc iinc. As iIc lanl Ias givcn oui iIosc funds as
loans iIai arc difficuli io call in ai a noncni's noiicc, iIc lanl is noi in
a osiiion io ay all iis dcosiiors wIo wani io wiiIdraw. Ii is Icrc iIai
iIc ccniral lanl ancIors iIc sialiliiy of iIc lanling sysicn ly scrving
as a lcndcr of lasi rcsori. As lanls can iurn io iIc ccniral lanl for funds
wIcn iIcrc is a wavc of dcosiior wiiIdrawals ii induccs a ccriainiy io
dcosiiors iIai iIc lanl can ncci iis olligaiions and nalcs iIcn lcss
liallc io run and wiiIdraw iIcir dcosiis. TIc ccniral lanl ly sciiing
rcquircd rcscrvcs also rcsiricis conncrcial lanls fron lcing rccllcss
and lcnding oui all iIcir dcosiis and noi Iaving funds on Iand io
Ionour dcosii ouiflows. Dcsidcs, ccniral lanls also roicci dcosiiors'
funds ly insisiing iIai lanls nainiain a ccriain fraciion of dcosiis in
iIc forn of cquiiy or nci woriI callcd caiial rcquircncnis. TIc noncy
ui in ly iIc owncrs of iIc firn in ccIangc for sIarcs in iIc owncrsIi
of iIc firn dcicrnincs iIc lanl caiial or iniiial nci woriI of iIc firn.
TIc IigIcr is iIis caiial ui u ly owncrs, iIc IigIcr is iIcir sialc in
iIc lanl and iIc norc carcful iIcy will lc wiiI Iow iIcy invcsi iIc
funds of dcosiiors as firsi loss is lornc ly iIc owncrs. TIus aari fron
influcncing iIc noncy suly iIc ccniral lanl also cnsurcs iIc safciy
and soundncss of conncrcial lanls.
Comment [e12]: MaiginaIia - A
lank iun oi a lank faiIuie occuis
vhen a lank cannol neel ils
olIigalions lo pay ils deposilois and
ciedilois.
Comment [e13]: MaiginaIia - The
nel voilh of a lank oi ils equily
capilaI is lhe diffeience lelveen ils
assels (vhal il is oved) and ils
IialiIilies (vhal il oves).
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
42

Acndi. Moncy nuliilicr for alicrnaiivc Iolding raiio

Sonciincs iIc noncy nuliilicr fornula is also wriiicn oui for an
alicrnaiivc casI Iolding raiio wIicI indicaics iIc rooriion of currcncy
Ioldings io dcosiis raiIcr iIan iIc noncy suly. In iIis casc iIc
currcncy io dcosii raiio is givcn ly iIc fraciion , wIcrc,

D C
P
=

In cnd MarcI 2009, 0.1626

TIc noncy nuliilicr as lcforc is givcn ly


o r
S
R R C
D C
M
M
m
+ +
+
= =

0


TIc noncy suly is iIc sun of iIc currcncy wiiI iIc ullic (C
P
} lus
dcosiis (D}. Fcscrvc noncy or iIc nonciary lasc in iIc sun of currcncy
in circulaiion lus dcosiis Icld ly conncrcial lanls ai iIc ccniral
lanl.
Currcncy in circulaiion Currcncy wiiI iIc
ullic (
P
C }
+ Currcncy wiiI lanls

Dcosiis wiiI ccniral lanl Fcquircd rcscrvcs
(
r
R }
+ Worling Fund
rcscrvcs


TIc sun of currcncy wiiI lanls (vauli casI} and Worling Fund rcscrvcs
rcrcscnis oiIcr rcscrvcs of conncrcial lanls or iis liquidiiy Ioldings.
TIcn,
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
43

Currcncy in circulaiion
+
Dcosiis wiiI ccniral
lanl





Currcncy wiiI iIc
ullic (
P
C }


+

Fcquircd rcscrvcs
(
r
R }
+
OiIcr rcscrvcs (
o
R }



Fcquircd rcscrvcs and iIc liquidiiy raiio for lccing oiIcr rcscrvcs arc
givcn ly

D x R
r
1
=
D x R
o
2
=

TIus,
( )D x x D
D D
R R C
D C
m
r P
P
2 1
0
+ +
+
=
+ +
+
=

( )
( ) { }
2 1
1
x x + +
+

WiiI rcquircd rcscrvcs sci ai
1
x 0.05 and iIc liquidiiy raiio of
lanls ai
2
x 0.0285, wc Iavc,


( )
82 . 4
0285 . 0 05 . 0 1626 . 0
1626 . 0 1
=
+ +
+
= m

TIis is iIc sanc valuc of iIc noncy nuliilicr as oliaincd carlicr.







1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
44
Acndi 2. TIc nuliilc dcosii crcaiion or noncy nuliilicr
fornula

Lci iIc iniiial ncw dcosii and loan advanccd as givcn ly a conncrcial
lanl lc
0
D . Of iIis a fraciion
1
x nusi lc sci asidc as rcquircd rcscrvcs
and fraciion
2
x nusi lc sci asidc for liquidiiy uroscs io ialc carc of
dcosii ouiflows. TIis lcavcs a surlus anouni of liquidiiy wiiI iIc lanl
as givcn ly


TIis surlus liquidiiy rcsulis in a ncw loan advanccd and a ncw
addiiional ncw dcosii as givcn ly


Again fron
1
D a fraciion
1
x nusi lc sci asidc as rcquircd rcscrvcs and
fraciion
2
x nusi lc sci asidc for liquidiiy uroscs io ialc carc of dcosii
ouiflows. TIis lcavcs a ncw anouni of surlus liquidiiy and sulscqucni
loan and dcosii wiiI iIc lanl as givcn ly


Howcvcr, ( ) [ ]
0 2 1 1
1 D x x D + = , and sulsiiiuiing in iIc alovc wc gci iIc
sulscqucni dcosii in icrns of iIc iniiial ncw dcosii as


Or,

TIc icrninal dcosii iIcn is givcn ly


Or,
( ) ( ) [ ]
0 2 1 0 2 1 0
1 D x x D x x D + = +
( ) [ ]
0 2 1 1
1 D x x D + =
( ) ( ) [ ]
1 2 1 1 2 1 1
1 D x x D x x D + = +
( ) [ ] ( ) [ ] ( ) [ ]
0 2 1 2 1 1 2 1
1 1 1 D x x x x D x x + + = +
( ) [ ]
0
2
2 1 2
1 D x x D + =
........
2 1 0
+ + + = D D D D
T
1o Iov:v,
To{c..o, 1.1.^. /nncvvvv
45






........
2 1 0
+ + + = D D D D
T
( ) [ ] ( ) [ ] ..... 1 1
0
2
2 1 0 2 1 0
+ + + + + = D x x D x x D
1
D
2
D
( ) [ ] ( ) [ ] { } .... 1 1 1
2
2 1 2 1 0
+ + + + + = x x x x D
( )

+
=
2 1
0
1
x x
D
as
a
a a

= + + +
1
1
... 1
2