Q.Read the following passage carefully : Any institution which accepts deposits from the public and advances loans is a bank. Banks are broadly categorised into : • Commercial Banks, and • Central Bank. Commercial banks accept deposits from public and use these deposits for giving loans. Banks keep a fraction of deposits as reserves. Generally, all depositors do not demand their money at the same time. The Central Bank of a country is responsible for controlling credit creation. The Reserve Bank of India (RBI) regulates the money supply in India through its monetary policy. On the basis of the above passage and common understanding, answer the following questions :

1. Meaning of a Bank A bank is any institution that accepts deposits from the public and advances loans. This dual function — mobilising savings from depositors and channelling them as credit to borrowers — defines the core activity of banking. Banks act as financial intermediaries, bridging the gap between those who have surplus funds and those who need them.
2. Two traits distinguishing Central Bank from Commercial Banks

The Central Bank (RBI in India) is a regulatory and policy institution, whereas commercial banks are profit-driven entities serving households and firms.

(iii) Justification of Open Market Operations as a tool to regulate money supply …

Functions of Commercial Banks

(i) Meaning of a Bank

The passage gives us the functional definition: any institution which accepts deposits from the public and advances loans is a bank. This captures the essence of banking—intermediation between savers and borrowers. Banks mobilise idle savings from households and firms, then channel those funds to productive uses through lending. The dual role of deposit-taking and loan-making distinguishes a bank from other financial institutions like insurance companies or mutual funds, which may pool money but do not create credit in the same way.

(ii) Two Traits Distinguishing the Central Bank from Commercial Banks

Commercial banks and the central bank operate in fundamentally different spheres, even though both are part of the monetary system.

Currency issuance

The central bank has the monopoly right to issue currency notes. In India, the Reserve Bank of India issues all notes except the one-rupee note and coin (which the Ministry of Finance issues). Commercial banks cannot print money; they can only create credit through the deposit-multiplier process. This power to issue legal tender makes the central bank the ultimate source of high-powered money in the economy.

Banker to the government

The central bank acts as the banker, agent, and financial adviser to the government. It manages the government's accounts, receives revenues, makes payments on behalf of the government, and handles the public debt. Commercial banks, by contrast, serve private individuals, firms, and other entities—they do not perform sovereign banking functions. The RBI, for instance, conducts government securities auctions and maintains the government's cash balances.

(iii) Open Market Operations as a Tool to Regulate Money Supply

Open market operations (OMO) are the purchase and sale of government securities in the open market by the central bank. This is one of the most flexible and frequently used instruments of monetary policy, and the statement is entirely justified.

How OMO works: the mechanism

When the RBI wants to increase the money supply—say, to stimulate economic activity during a slowdown—it buys government securities from commercial banks and the public. Payment for these securities is made by crediting the sellers' accounts, which increases the reserves of commercial banks. With higher reserves, banks can extend more loans. Because banks operate on a fractional reserve system (they keep only a fraction of deposits as reserves and lend out the rest), an injection of reserves sets off a multiplier process: each rupee of new reserves supports several rupees of deposit creation across the banking system. The money supply expands.

Conversely, when the RBI wants to reduce the money supply—perhaps to combat inflation—it sells government securities. Banks and the public pay for these securities, and that money flows out of the banking system into the RBI's account. Reserves fall, the capacity to lend contracts, and the money multiplier works in reverse. Credit creation slows, and the money supply shrinks.

Why OMO is effective …