Read the passage carefully and answer the question based on the passage:

Role of Money

In modern economics, money plays a very crucial role as medium of exchange, unit of account, store of value and standard of deffered payment. The banking system, a cornerstone of financial markets, facilitates the creation and circulation of money.

Commercial banks accept deposits from the public and provide loans. A fraction of the deposits are kept by the commercial banks as reserves and the rest is lent out. This amplifies the money supply in the economy through the 'Multiplier Effect'. The RBI as central Bank regulates the money supply through monetary policy tools. These tools influence the credit availability and overall liquidity in the system, impacting inflation, growth and employment.

What is the process through which banks create money?

Credit creation.

The correct answer is Option (2) → Credit creation.

The process through which banks create money is primarily known as fractional reserve banking. This process inherently involves credit creation.

In modern economies, commercial banks operate under a system called fractional reserve banking. This means that banks are required to hold only a fraction of their customers' deposits as reserves (either in their vaults or with the central bank) and are allowed to lend out the remaining portion. When a bank lends money, it doesn't typically give out physical cash. Instead, it creates a new deposit in the borrower's account. This new deposit effectively adds to the money supply in the economy, even though no new physical currency has been printed. This act of making loans and creating new deposits is essentially credit creation.