Under the minimum fiduciary system, the minimum reserves of gold against note issue that the authority is required to maintain are fixed by law. Against these minimum reserves, the monetary authority can issue as much paper currency as is considered necessary for the economy.
There is no upper limit fixed for the issue of currency. Minimum fiduciary system is based upon two considerations:
(a) The central bank feels that there should not be any restriction on the note issue, especially when the demand for currency is fast increasing,
(b) In the modern age, when bank deposits assume greater significance as an important constituent of money supply, the convertibility of notes into gold need not be bothered about.
ADVERTISEMENTS:
The minimum fiduciary system, if ably managed, can prove very useful for developing countries. It can make available enormous resources for financing developmental schemes. Similarly, during inflation, the monetary authority can control the money supply.
This system has been in force in India since 1957. The Reserve Bank of India is required to keep minimum reserves of Rs. 200 crores of which not less than Rs.115 crores must be kept in the form of gold.
Merits
The minimum reserve system has the following advantages:
ADVERTISEMENTS:
(i) The system is economical because the entire note issue need not be backed by metallic reserves. Only a minimum reserve is to be maintained.
(ii) It renders elasticity to the monetary system. After maintaining the minimum reserves, the monetary authority can issue any amount of currency that it feels necessary.
Demerits
The minimum reserve system has the following drawbacks:
ADVERTISEMENTS:
(i) Since, under this system, no additional reserves arc required for increasing the supply of currency, there is always a tendency towards the over-issue of currency, and hence an inherent danger of inflationary pressures.
(ii) Since the system provides no convertibility of currency notes into gold, it lacks public confidence.