A bank, the only one in an economy, has reserves of Rs 200, deposits of Rs 1,000 and loans of Rs 800, with a Cash Reserve Ratio of 20 per cent. The RBI raises the CRR to 25 per cent. Reserves stay at Rs 200, every loan comes back as a deposit, and the public holds no currency. By how much must the bank’s loans fall?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Rs 200
Given:
Reserves = Rs 200
Old deposits = Rs 1,000
Old loans = Rs 800
Old CRR = 20 per cent
New CRR = 25 per cent
With fixed reserves, the deposits a bank can hold are reserves ÷ CRR. Loans are the rest of its assets: loans = deposits − reserves.
\( \displaystyle \text{New deposits} = \frac{200}{0.25} = 800 \)
\( \displaystyle \text{New loans} = 800 - 200 = 600 \)
\( \displaystyle \text{Fall in loans} = 800 - 600 = 200 \)
The bank must call back Rs 200 of loans, and money supply falls from Rs 1,000 to Rs 800.
NCERT (2026-27): “3.4 Policy Tools to Control Money Supply … It should be evident by now that if the Central bank changes the reserve ratio, this would lead to changes in lending by the banks which, in turn, would impact the deposits and hence, the money supply. In the previously discussed example, what would the money multiplier be if the RBI increases the reserve ratio to 25 per cent? Notice that in the previous case, Rs 100 in reserves could support deposits of Rs 400. 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. …” |