Day-759 | Daily MCQs | UPSC Prelims | ECONOMY

Answer. (D)
Explanation:
● Statutory Liquidity Ratio (SLR) is the amount of reserves that the scheduled commercial banks are required to maintain with themselves on a daily basis in safe and liquid assets such as government securities, unencumbered securities, gold and cash with respect to their NDTL is called SLR. Excess CRR balances are also treated as liquid assets for the purpose of SLR, i.e., SLR can be maintained as cash balance with RBI. Scheduled Commercial Banks are required to maintain SLR as per the Banking Regulation Act 1949. The ceiling on SLR is 40%.
● Treasury bills dated securities issued under market borrowing programmes and market stabilization schemes (MSS), etc., also form part of the SLR.

Answer. (C)
Explanation:
● The repo rate is the rate at which the central Bank of a country (Reserve Bank of India in the case of India) lends money to commercial banks in the event of any shortfall of funds.
● Statement C is correct: The repo rate is used by monetary authorities to control Inflation. For example, In the event of Inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from the Central Bank. This ultimately reduces the money supply in the economy and thus helps to arrest Inflation.
● The central Bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.

Answer. (A)
Explanation:
The Reserve Bank of India is the central Bank of the country. Central banks are a relatively recent innovation and most central banks, as we know them today, were established
around the early twentieth century.
● Statement 1 is correct: The Reserve Bank of India was set up based on the recommendations of the Hilton Young Commission.
● Statement 2 is incorrect: The Reserve Bank of India Act, 1934, provides the statutory basis of the functioning of the Bank, which commenced operations on April 1, 1935.
Additional Information:
● The Bank began its operations by taking over from the Government the functions so far being performed by the Controller of Currency and from the Imperial Bank of India, the management of Government accounts and public Debt. The Reserve Bank, which was originally set up as a shareholder’s/private Bank, was nationalized in 1949.
● An interesting feature of the Reserve Bank of India was that at its very inception, the Reserve Bank was seen as playing a special role in the context of development, especially in agriculture. When India commenced its plan endeavours, the development role of the Reserve Bank came into focus, especially in the sixties when the Reserve Bank, in many ways, pioneered the concept and practise of using finance to catalyze development.
● The Reserve Bank was also instrumental in institutional development and helped set up institutions like the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the Industrial Development Bank of India, the National Bank of Agriculture and Rural Development, the Discount and Finance House of India etc. to build the financial infrastructure of the country.

Answer. (A)
Explanation:
Open Market Operations (OMO): The sale or purchase of government securities by RBI in the open market (secondary market) to banks/financial institutions for absorption and injection of durable liquidity in the economy is called open market operations. If the Inflation in the economy is high, then to control the Inflation, RBI reduces the money supply by selling government securities. And suppose RBI wants to increase the money supply. In that case, it buys government securities from the banks/financial institutions and pays them money in exchange for government securities, which ultimately increases the money supply in the economy.
There are two types of Open Market Operations (OMOs).
● Statements 1 and 2 are correct: Outright OMOs: They are permanent in nature. When the central Bank buys/sells these securities, it does not promise to sell/buy them later.
● LAF OMOs: This is a type of operation in which when the central Bank buys/sells the securities, the agreement also has specifications about the date and price of resale/repurchase of this security. This type of agreement is called a repurchase agreement or repo.

Answer. (A)
Explanation:
● Statement 1 is correct: A license is required from RBI to commence banking operations, opening new bank branches and closing existing branches or changing the location of existing branches.
● RBI regulates amalgamation, merger and winding up of banks. (For shifting, merger and closure of urban branches, no approval is required.) RBI issues various guidelines for bank directors and also has the power to appoint additional directors to the board of a banking company.
● Statement 2 is incorrect: Commercial Banks (except PSBs) need prior approval of RBI for appointment/re-appointment/termination of Chairman, Whole-time Directors, Managing Director and CEO. RBI can appoint additional directors in commercial banks (except PSBs). RBI, in consultation with the Central Government, can supersede the Board of Directors of Commercial Banks (except PSBs).
● Statement 3 is incorrect: Commercial Banks are regulated under the provision of the Banking Regulation Act of 1949.
RBI’s powers are curtailed regarding PSBs, where RBI cannot remove directors and management, cannot supersede bank boards and does not have the power to force a merger or trigger liquidation. Also, PSB banking activity does not require a license from RBI, and hence, RBI cannot revoke the license of PSBs.
Additional information about Banks Board Bureau-
It was set up in February 2016 as an autonomous body– based on the recommendations of the RBI-appointed Nayak Committee.
● It was part of the Indradhanush Plan.
● It will make recommendations for appointment of whole-time directors as well as non-executive chairpersons of Public Sector Banks (PSBs) and state-owned financial institutions.
● The Ministry of Finance takes the final decision on the appointments in consultation with the Prime Minister’s Office.
Composition:
Banks Board Bureau comprises the Chairman, three ex-officio members i.e Secretary, Department of Public Enterprises, Secretary of the Department of Financial Services and Deputy Governor of the Reserve Bank of India, and five expert members, two of which are from the private sector.

Answer. (B)
Explanation:
● Statement B is correct: Bank Run is a situation that occurs when everybody wants to take money out of one’s bank account before the Bank runs out of reserves. As more and more people withdraw their funds, the probability of default increases, thereby prompting more people to withdraw their deposits. The bank’s reserves might not be enough to cover the withdrawals in the worst-case scenarios. Panic frequently causes a bank run, which may ultimately result in default. In these circumstances, the RBI acts as a guarantor for commercial banks and makes loans to ensure the banks’ solvency. To remain solvent, a company must be able to pay its long-term debts. This guaranteed mechanism gives each account holder peace of mind that, in the event of a crisis, their banks will be able to reimburse them for their money. This prevents panicking and bank runs. ‘Lender of last resort’ is another name for this function of the RBI.

Answer. (C)
Explanation:
Banking sector reforms were the most important reforms during the 1990s. The reasons for these reforms were:
● Statement 1 is incorrect: Lack of profitability due to populist measures taken by the Government,
● Statement 2 is correct: Higher CRR and SLR prior to the 1990s acted as a drag on the economic growth of the nation. A high CRR/SLR tends to discourage bank lending which causes subdued investments and also impacts the aggregate demand in the economy. The lower investments and demands are detrimental for economic growth.
CRR was around 15% and has been reduced to around 4%. The same is the case with SLR.
● Statement 3 is correct: The banking sector lacked competition, as private and foreign banks were not given due representation.
● Statement 4 is correct: Prior to the 1990s, concessional loans were provided for populist reasons, and credit discipline during that period was missing.
Reforms took place in banking sectors during 1990s:
● Liberalization of economy
● Mergers of banks
● Capital Adequacy
● Digitalization

Answer. (B)
Explanation:
The banking sector is considered the backbone of the Indian financial system. When the economy was facing a crisis during the 1980s, it played a major role in coping with such a crisis. Various committees made recommendations to deal with the crisis situation in the banking sector– major one was from Narasimham Committees I and II. Recommendations by Narasimham Committee I are–
● Statement 1 is incorrect: It recommended no more nationalization of banks as it would give a wrong message to private and foreign banking sector investors. In line with the structure of the banking system, there would seem to be scope for one or more of the large banks,
● Statement 2 is correct: In addition to the SBI, to have operations abroad in major International financial centres and in regions with strong Indian ethnic presence.
● Statement 3 is incorrect: It also emphasized reducing CRR and SLR limits to give banks more independence on the operational front; however, it was of the opinion to deregulate interest rates.
● Statement 4 is correct: Other recommendations included rationalization and better targeting of Priority sector lending.

Answer. (D)
Explanation:
NABARD does not give direct loans to individuals, but it extends refinance to:
● Commercial Banks
● Regional Rural Banks (RRBs)
● State Cooperative Banks & Land Development Banks
● Non-Banking Financial Companies (NBFCs) for further lending (refinance) to the agriculture and rural sectors.
● Small Finance Banks
● Scheduled Primary Urban Cooperative Banks
● North East Development Finance Corporation
● State Agricultural Development Finance Companies

Answer. (B)
Explanation:
● Pair 1 is incorrect: Subprime borrowers are considered to be high-risk borrowers who are unlikely to pay off their Debt and have poor credit ratings.
● Pair 2 is incorrect: Helicopter money is an unconventional monetary policy aimed at bringing the economy back on track. Here, the central bank increases the money supply, aiming to boost demand and Inflation in the economy.
It involves printing large sums of money and distributing it to the public. The term was coined by an American Economist Milton Friedman.
● Pair 3 is correct: Zombie lending is the evergreening of a loan when the borrower is on the verge of default. As per the economic survey 2021, Such transactions go undetected as banks are not required to disclose them.
The evergreening of loans is a term in which banks try to revive a loan that is on the verge of default by granting further loans to the same borrower.
● Pair 4 is correct: Over-leveraged borrowers are the ones who borrow money way beyond their capacity to repay; the debt-equity ratio of such borrowers is very high.

Answer. (D)
Explanation:
Priority sectors refer to those sectors of the economy that may need more timely and adequate credit in the absence of this special scheme.
Statement 1 is incorrect: Priority sector guidelines do not lay down any preferential rate of interest for priority sector loans. Typically, these are small-value loans to those sectors of the society/economy that impact large segments of the population and weaker sections and to the sectors which are employment-intensive, such as agriculture and small enterprises.
Statement 2 is incorrect: Scheduled Commercial Banks (SCBs) having any shortfall in lending to the priority sector are allocated amounts for contribution to the Rural Infrastructure Development Fund (RIDF) established with NABARD and other Funds with NABARD/NHB/SIDBI/ MUDRA Ltd. The following financial institutions are mandated to undertake priority sector lending:
o Commercial Banks including foreign banks: 40% of their total lending.
o Regional Rural Banks: 75% of their total lending.
o Small Finance Banks: 75% of their total lending.
● Urban (Primary) Cooperative Banks: 40% (will be increased to 75% by 2024 in a phased manner) of their total lending.

Payment banks are not required to follow the PSL provisions because they do not give credits.

Answer. (A)
Explanation:
The Lead Bank Scheme was introduced by the Reserve Bank of India in December 1969. The scheme aims at coordinating the activities of banks and other developmental agencies through various fora in order to achieve the objective of enhancing the flow of bank finance to the priority sector and other sectors and to promote banks’ role in the overall development of the rural sector. A particular bank is assigned the lead bank responsibility of the district for coordinating the activities in the district. The lead Bank is expected to assume a leadership role in coordinating the efforts of the credit institutions and government.
• Statement 1 is correct: The Scheme has been useful in achieving its original objectives of improvement in branch expansion, deposit mobilization and lending to the priority sectors, especially in rural/semi-urban areas.
o The genesis of the Lead Bank Scheme (LBS) can be traced to the Study Group headed by Prof. D. R. Gadgil (Gadgil Study Group) on the Organizational Framework for the Implementation of the Social Objectives, which submitted its report in October 1969. The Study Group drew attention to the fact that commercial banks did not have adequate presence in rural areas and also lacked the required rural orientation. The Study Group, therefore, recommended the adoption of an ‘Area Approach’ to evolve plans and programmes for the development of an adequate banking and credit structure in the rural areas.
o A Committee of Bankers on Branch Expansion Programme of Public Sector Banks appointed by the Reserve Bank of India under the Chairmanship of Shri F. K. F. Nariman (Nariman Committee) endorsed the idea of an ‘Area Approach’ in its report (November 1969), recommending that in order to enable the Public Sector Banks to discharge their social responsibilities, each bank should concentrate on certain districts where it should act as a ‘Lead Bank’.
• Statement 2 is incorrect: Envisaging a greater role for private sector banks, the lead banks were advised to ensure that private sector banks are more closely involved in the implementation of the Lead Bank Scheme. Private sector banks should involve themselves more actively by leveraging information technology and bringing in their expertise in strategic planning. They should also involve themselves in the preparation and implementation of the District Credit Plan.
• Statement 3 is incorrect: The Lead Bank Scheme has been administered by the RBI since 1969. RBI assigns lead bank responsibility to designated banks in every district following a detailed procedure formulated for this purpose. As of June 30, 2017, 25 public sector banks and one private sector bank have been assigned lead bank responsibility in 706 districts of the country.

Answer. (B)
Explanation:
• Statement 1 is correct: Central Bank Digital Currency (CBDC) or E-rupee is a legal tender issued by a central bank (RBI) in a digital form. It is similar to the fiat currency, is no different from cash, and is exchangeable one-to-one with the fiat currency (bank notes/cash) at par. Only its form is different, i.e., digital. RBI launched the e-rupee on a pilot basis for Wholesale and retail markets. RBI Act 1934 has been amended to include e-rupee in ‘bank note’, and now it’s a legal tender.
o E-rupee will not replace cash; rather, it will complement it. CBDC will be distributed in the same denominations as present coins and paper money.
o E-rupee will be distributed through intermediaries, i.e., banks, and it can be converted to other forms of money like deposits with banks.
o E-Rupee will be a bearer instrument, i.e., whoever is holding the e-Rupee will be assumed to be the owner at any given point of time.
● Statement 2 is incorrect: E-rupee will not earn any interest like cash.
● Statement 3 is correct: People will be able to make payments offline means being able to use a CBDC without being connected to the internet, either temporarily or because of coverage limitations.

Answer. (B)
Explanation:
Nachiket Mor, in 2013, recommended the formation of Payment banks in India.
The main objective of payment banks is to widen the spread of payment and financial services to small businesses, low-income households, and the migrant labour workforce in a secured, technology-driven environment.
A payments bank is like any other bank but operates on a smaller scale without involving any credit risk. In simple words, it can carry out most banking operations but can’t advance loans or issue credit cards.
• Statement 1 is incorrect: Payment banks will accept only demand deposits, i.e., only savings accounts and current account facilities will be available.
• Statement 2 is incorrect: Payment banks will not be allowed to lend and issue credit cards).
o It can accept demand deposits (up to Rs 1 lakh) and offer remittance services, mobile payments/transfers/purchases, and other banking services like ATM/debit cards, net banking, and thid-party fund transfers.
• Statement 3 is correct: Payment banks will be acting as add-ons to the already established banks rather than their competitors. The RBI has allowed the payment banks to act as the banking correspondents (BCs) of other banks. Under the BC arrangement and with the prior consent of their customers, payment banks will be allowed to transfer funds deposited by a customer into his/her account with another eligible bank.

Answer. (C)
Explanation:
The government’s fiscal policy has a big role in stabilizing the economy during business cycles. The two important phases of business cycles are boom and recession. A recession should not be allowed to grow into a deep recession. Similarly, a boom should not explode bigger. Amplifying the business cycle is dangerous (growing boom and deepening recession). Practically, fiscal policy responses using taxation and expenditure can go in two ways in response to the business cycle: Countercyclical and pro-cyclical.
o countercyclical fiscal policy refers to a government strategy to counter a boom or recession through fiscal measures. It works against the ongoing boom or recession trend, thus trying to stabilize the economy. Understandably, countercyclical fiscal policy works in two different ways during these two phases.
• Statement 1 is correct: During the boom phase, countercyclical fiscal policy tries to reduce aggregate demand by reducing government expenditure and increasing tax levels. During the recession phase, countercyclical fiscal policy raises aggregate demand by increasing expenditure and reducing tax levels. So, a counter-cyclical fiscal policy tends to cool down the economy when there is a boom and stimulate the economy when there is a slowdown.
• Statement 2 is correct:In countercyclical fiscal policy, the government increases spending and reduces tax levels to increase the aggregate demand in the economy.

Answer. (D)
Explanation:
• Statement 1 is incorrect: Capital adequacy ratio (CAR) is the ratio of a bank’s capital to risk-weighted asset ratio. The banks must maintain this capital so that they can sustain it in case of defaults. The RBI mandates how much CAR must be maintained by the banks.
• Statement 2 is incorrect: As per the RBI guidelines, the scheduled banks need to maintain CAR of 9% (while BASEL III norms propose CAR to 8%). The Public Sector Banks (PSBs) must adhere to maintenance of CAR of 12%.
• Basel I: In 1988, BCBS introduced a capital measurement system called Basel Capital Accord, also called Basel I. It focused almost entirely on credit risk (the risk that some of its borrowers may not repay the loan, and it varies from borrower to borrower). It defined capital and structure of risk weights for banks.
• Basel II: In June 2004, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of the Basel I accord. The guidelines were based on three parameters, which the committee calls pillars:
o Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
o Supervisory Review: According to this, banks need to develop and use better risk management techniques to monitor and manage all the three types of risks that a bank faces, viz., credit, market, and operational risks.
o Market Discipline: This needs increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc. to the Central Bank. Basel II norms in India and overseas are yet to be fully implemented.
• Basel III: In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008. A need was felt to strengthen the system further as banks in the developed economies were under-capitalized, over-leveraged (high debt) and had a greater reliance on short-term funding. Also, the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive.

Answer. (B)
Explanation:
If all the people of the economy increase the proportion of income they save, the total value of savings will not increase – it will either decline or remain unchanged. This result is known as the Paradox of Thrift, which states that as people become thriftier, they save less or the same as before.
• Statement B is correct: It states that individuals try to save more during an economic recession, leading to a fall in aggregate demand and economic growth. Such a situation is harmful to everybody as investments give lower returns than normal.

Answer. (B)
Explanation:
Section 8 of RBI Act 1934 deals with the appointment of Governor and Deputy Governor of RBI.
• Statement 1 is incorrect: According to the provisions of the Act, the Central government appoints the RBI governor and Deputy governor.
• Statement 2 is correct: The Governor and Deputy Governors shall devote their whole time to the affairs of the Bank and shall receive such salaries and allowances as may be determined by the Central Board, with the approval of the Central Government.
• Statement 3 is correct: RBI’s affairs are governed by a central board of directors appointed by GOI in accordance with the RBI act.
• Statement 4 is correct: Section 8 of the act also provides that the retiring director of RBI is eligible for re-appointment.

Answer. (D)
Explanation:
• When an economy is facing inflation, we require more money to buy a given quantity of goods and services because the purchasing power of the rupee decreases. In the case of inflation, generally, wage increases, but nothing can be said about the production or output.
• Statement D is correct: In inflation, more money is required to buy the same amount of goods and services. Hence, the purchasing power of money during inflation decreases.

Answer. (C)
Explanation:
Demand-pull Inflation means the demand for a commodity has increased, leading to an increase in the prices of that commodity. It occurs due to an increase in the level of demand for a particular product. Examples of demand-pull Inflation are–
• 1 is correct: An increase in people’s level of income leads to an increase in purchasing power.
• 2 is correct: Banks reducing interest rates means easy loans to people, which will increase the demand for loans and ultimately cause demand-pull inflation to occur.
• 3 is incorrect: Supply shock means the commodity supplied earlier will be reduced from its earlier level; hence, it is an example of cost-push inflation.
• 4 is incorrect: Increased cost of raw material will ultimately increase the cost of production and hence is an example of cost-push inflation.
• 5 is correct: The government’s expansionary fiscal policy will increase the money supply in the economy and the level of income of the people and hence is an example of demand-pull inflation.