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Can You Explain The Concept Of Proportional Reserve System And Exchange Management?

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Muhammad Abdullah786 Profile
According to proportional reserve system or the percentage system, the central bank is required by law to keep a fixed percentage varying from 25 to 40 per cent against the note issue. The remainder of the notes is to be covered by trade bills and government securities.  The proportional reserve system was adopted in France keeping 30% and in Germany 40% of gold against the note issue. The federal reserve bank of U.S.A. Has also adopted this system with slight modifications.    The main advantage claimed for this system is that it makes the supple of money elastic. If the percentage is fixed at 25, the central bank can issue 100 notes for 25 gold coins. The defect with this system of note issue is that it locks away unnecessarily a large quantity of gold which is seldom used for conversion purpose. In case the gold reserves are falling, the supply of money shall have to be reduced according to the percentage already fixed and this can be dangerous to the economy.    Exchange management:  According to this system the central bank is required by law to keep the percentage required against the notes issue in the form of gold, foreign bills or cash at some foreign banks where gold standard prevails. This method is followed by Pakistan, India, and in many European countries.

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