Arrange the following steps of money creation by a bank in the order in which they take place, when the Cash Reserve Ratio is 20 per cent:
(A) The bank keeps 20 per cent of the deposit as reserves.
(B) A person deposits money in the bank.
(C) The bank lends out the part of the deposit that it is not required to keep as reserves.
(D) The loan shows up as a new deposit with the bank in the next round.
(E) The process stops when the required reserves become equal to the total reserves of the bank.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (B), (A), (C), (D), (E)
The bank needs a deposit first, and it can lend only what is left after keeping the required reserves.
(B) A person deposits money in the bank. — Nothing can be kept or lent before this.
(A) The bank keeps 20 per cent of the deposit as reserves. — The Cash Reserve Ratio is a legal requirement, so this part is set aside first.
(C) The bank lends out the part of the deposit that it is not required to keep as reserves. — Only the remaining amount of the deposit can be given as loans.
(D) The loan shows up as a new deposit with the bank in the next round. — The loan is deposited back, so the bank can lend again.
(E) The process stops when the required reserves become equal to the total reserves of the bank. — With Rs 100 of reserves and a CRR of 20 per cent, lending stops when deposits reach Rs 500.
NCERT (2026-27): “3.3.2 Limits to Credit Creation and Money Multiplier … In our fictional example, suppose CRR = 20 per cent, then with deposits of Rs 100, our bank will need to keep Rs 20 (20 per cent of 100) as cash reserves. Only the remaining amount of deposits, i.e., Rs 80 (100 – 20 = 80) can be used to give loans. The statutory requirement of the reserve ratio acts as a limit to the amount of credit that banks can create. We can understand this by going back to our fictional example of an economy with one bank. Let us assume that our bank starts with a deposit of Rs 100 made by Leela. The reserve ratio is 20 per cent. Thus our bank has Rs 80 (100 – 20) to lend and the bank lends out Rs 80 to Jaspal Kaur, which shows up in the bank’s deposits in the next round as liabilities, making a total of Rs 180 as deposits. Now our bank is required to keep 20 per cent of 180 i.e. Rs 36 as cash reserves. … The process keeps repeating itself till all the required reserves become Rs 100. The required reserves will be Rs 100 only when the total deposits become Rs 500.” |