Consider the following statements, where banks hold reserves of Rs 100 and every loan returns to the banks as a deposit:
(A) At a Cash Reserve Ratio of 20 per cent, these reserves can support deposits of Rs 500.
(B) At a Cash Reserve Ratio of 25 per cent, these reserves can support deposits of Rs 400.
(C) When the ratio is raised from 20 to 25 per cent, banks have to call back some loans.
(D) At a Cash Reserve Ratio of 25 per cent, the money multiplier is 5.
(E) At a Cash Reserve Ratio of 20 per cent, the banks can give loans of up to Rs 500.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (B) and (C) only
Deposits = reserves × money multiplier, where the multiplier = 1 / CRR.
(A) At a Cash Reserve Ratio of 20 per cent, these reserves can support deposits of Rs 500. — Correct. 100 × (1/0.2) = 100 × 5 = Rs 500.
(B) At a Cash Reserve Ratio of 25 per cent, these reserves can support deposits of Rs 400. — Correct. 100 × (1/0.25) = 100 × 4 = Rs 400.
(C) When the ratio is raised from 20 to 25 per cent, banks have to call back some loans. — Correct. Deposits must fall from 500 to 400, so loans are called back.
(D) At a Cash Reserve Ratio of 25 per cent, the money multiplier is 5. — Incorrect. It is 1/0.25 = 4.
(E) At a Cash Reserve Ratio of 20 per cent, the banks can give loans of up to Rs 500. — Incorrect. Rs 100 of the Rs 500 is reserves, so loans are Rs 400.
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. Table 3.3 demonstrates its balance sheet. …”
“3.4 Policy Tools to Control Money Supply … In the previously discussed example, what would the money multiplier be if the RBI increases the reserve ratio to 25 per cent? … But the banking system would now be able to loan Rs 300 only. It would have to call back some loans to meet the increased reserve requirements. Hence, money supply would fall.” |
