CAIIB · CB

FUNCTIONS OF CENTRAL BANKS

Chapter notes, video classes, MCQ practice tests and quick-revision one-liners for Central Banking (Elective) — CAIIB.

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One-liners from this chapter

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What does Bagehot's principle prescribe regarding the rate of interest at which a central bank should lend during a banking panic?

Bagehot's principle prescribes that the central bank should lend at a high (penal) rate of interest, not a concessional rate, to minimize moral hazard.

What is the primary distinction between a central bank and a commercial bank in terms of profit motive?

Central banks are not profit-driven; commercial banks are.

Why does Bagehot's doctrine require a central bank to charge a penal rate when acting as Lender of Last Resort?

A penal rate deters banks from taking excessive risks, since they know that emergency central bank assistance will be costly, thereby minimizing moral hazard.

Who authored the foundational 1873 text that articulated the Lender of Last Resort principle?

Walter Bagehot authored 'Lombard Street' in 1873.

If the money multiplier is 2.5 and the central bank injects ₹4,000 crore of Reserve Money through Open Market Operations, what is the increase in total Money Supply?

The increase in Money Supply is ₹10,000 crore, calculated as MS = Money Multiplier × Base Money = 2.5 × ₹4,000 crore.

What is the primary goal of the Lender of Last Resort function during a systemic crisis?

To avert systemic crisis and prevent bank runs.

What is the formula linking Money Supply (MS), the Money Multiplier (MM), and Base Money (BM)?

The formula is MS = MM × BM; for example, if MM is 1.8 and BM increases by ₹2,000 crore, MS increases by ₹3,600 crore.

What type of banks can a central bank bail out according to the Bagehot doctrine?

Illiquid but solvent banks only.

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