If you are appearing for IBPS exams you must be aware that you need to have a firm grasp over banking awareness. IBPSExamAdda.org.in is here with its modules to help you improve with the latest banking awareness 2015 material and banking awareness PDF downloads available! Read on to know more about cash reserves and how the government decides on the amount to be kept as reserve!
Banking awareness: What are cash reserves?
Imagine a situation where the government keeps no money as reserves and at the time of a war there is no money with the country to spend on defense! It is indeed necessary for the government to maintain a part of money with themselves so that they can be used in emergency and for various other investments.
Cash reserves refer to the amount of money that the commercial banks are required to maintain with the central bank. The central bank of a country, RBI for India instructs the commercial banks to keep some reserves with them instead of lending them out. Every commercial bank must deposit some cash with the RBI. Cash reserves act as an important monetary tool for the government.
How government decides upon its cash reserves?
A significant question that comes to our mind while talking about cash reserves is that how does the government decide on how much money should be kept in reserves?
The amount of money that must be kept as reserves is decided by the government and the central bank depending upon the market conditions. The policy adapted to increase or decrease the money supply in the market is called monetary policy and cash reserves form an important component of the monetary policy. Cash reserves are also maintained so that the bank does not run out of money in case many people decide to call in their money at the same time!
The bank primary deals with accepting deposits from the general public and extending loans to the people who come to ask for it. In case the banks give more loans than they can afford it would be a difficult situation for the bank. This is the reason why banks are instructed to maintain a cash reserve with them so as to avoid such situations.
Cash reserves are maintained by the government also to regulate the money supply in the economy. The amount that must be kept as reserves is decided also according to the required money supply in the market. In case the economy needs more money, the money supply will have to be increased in the economy and the government will decrease its cash reserves by decreasing the cash reserve ratio which will enable the commercial banks to give out more money.
In case the government wishes to decrease the money supply in the market, it will increase the amount to be kept in reserves. Once the reserve amount is increased by an increase in the cash reserve ratio, the commercial banks will give out lesser money to the general public and the money supply in the economy will be reduced. Thus the maintenance of reserves and money supply needed in an economy are related to each other. Other factors that influence the decision of RBI to decide upon its cash reserves are GDP, CPI and inflation rate of the country.
RBI is the only institution that has the authority of issuing notes and therefore is the most prestigious financial institution. The current cash reserve ratio that the RBI instructs the bank to maintain is 4%.
We hope that we were able to be of service to you and could help you in understanding how the government maintains its cash reserves. Banking awareness is an important section of the IBPS exam and we seek to help our readers in the best way we can!