Mr Rao deposits Rs 500 of fresh cash in a bank. Every loan comes back to the banking system as a deposit, and the public holds no currency. By how much more can total deposits finally grow if the Cash Reserve Ratio is 10 per cent instead of 20 per cent?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Rs 2,500
Given:
Fresh deposit (reserves) = Rs 500
CRR = 20 per cent or 10 per cent
Total deposits = fresh reserves × money multiplier, and the money multiplier is 1 ÷ CRR.
\( \displaystyle \text{At 20\%: } 500 \times \frac{1}{0.2} = 500 \times 5 = 2{,}500 \)
\( \displaystyle \text{At 10\%: } 500 \times \frac{1}{0.1} = 500 \times 10 = 5{,}000 \)
\( \displaystyle \text{Difference} = 5{,}000 - 2{,}500 = 2{,}500 \)
Deposits can grow by Rs 2,500 more. Rs 5,000 is the total at 10 per cent, not the extra amount.
NCERT (2026-27): “3.3 Money Creation by Banking System 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. M1 = Currency + Deposits = 0 + 500 = 500 Thus, money supply increases from Rs 100 to Rs 500. Given a CRR of 20 per cent, the bank cannot give a loan beyond Rs 400. Hence, requirement of reserves acts as a limit to money creation.” “… Thus, reserves of Rs 100 create deposits of Rs (5 × 100)=Rs 500.” |