The Reserve Bank of India (RBI) is the central bank of India. It controls the money supply of the country through various methods. Repo and reverse repo operations have now become the main tool of monetary policy of the RBI. Under a repo, the RBI buys securities with an agreement that also fixes the date and the price at which they will be sold back. The interest rate at which money is lent in this way is called the repo rate. Suppose the general price level in the economy has been rising fast for some months. At its policy meeting, the RBI decides to raise the repo rate. Commercial banks that borrow from the RBI in this way will now have to pay a higher rate of interest.
Suppose that, after the step described in the passage, the reserves of commercial banks fall by Rs 40 crore. The Cash Reserve Ratio is 20 per cent, the public holds no currency and all loans return to banks as deposits. By how much can total deposits fall at most?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Rs 200 crore
Given:
Fall in reserves = Rs 40 crore
CRR = 20 per cent
Change in deposits = change in reserves × money multiplier
Money multiplier = 1 ÷ 0.20 = 5
Fall in deposits = 40 × 5 = Rs 200 crore
Rs 160 crore is only the fall in loans (200 − 40).
NCERT (2026-27): “3.3.2 Limits to Credit Creation and Money Multiplier … Since the bank is only expected to keep 20 per cent of its deposits as reserves, thus, reserves of Rs 100 (20per cent of 500 = 100) can support the deposits of Rs 500. In other words, our bank can give a loan of Rs 400. …”
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