A bank would like to lend the maximum possible, since it earns interest on loans. Yet it must balance its lending activities. Why?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → To ensure that sufficient funds are available to repay any depositor on demand
People keep money in a bank only if they are sure of getting it back whenever they ask. So a bank keeps back part of its funds and lends the rest. It must balance lending against the need to repay depositors on demand.
Option (1) To ensure that its net worth is recorded on the assets side — Incorrect. Net worth is shown on the liabilities side when assets exceed liabilities.
Option (2) To ensure that sufficient funds are available to repay any depositor on demand — Correct. Its survival depends on depositors’ trust.
Option (3) To ensure that the spread between its lending and deposit rates becomes zero — Incorrect. The spread is the bank’s profit; it does not try to make it zero.
Option (4) To ensure that it need not keep reserves with the RBI — Incorrect. Keeping reserves is a legal requirement set by the RBI.
NCERT (2026-27): “Commercial Banks … So the bank will typically retain a portion of the funds to repay depositors whenever they demand their funds back, and loan the rest. Since banks earn interest from loans they make, any bank would like to lend the maximum possible. However, being able to repay depositors on demand is crucial to the bank’s survival. Depositors would keep their funds in a bank only if they are fully confident of getting them back on demand. A bank must, therefore, balance its lending activities so as to ensure that sufficient funds are available to repay any depositor on demand.” “3.3 Money Creation by Banking System … The accounting rule states that both sides of the account must balance. Hence if assets are greater than liabilities, they are recorded on the right hand side as Net Worth.” |