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.

Banks create money through the process of credit creation. When banks accept deposits, they keep only a fraction as reserves and lend the remaining amount to borrowers. The loan amount again gets deposited into banks, allowing further lending. In this way, deposits multiply in the banking system and money is created.

• Fractional Reserve Banking (Option 1): This is the system or the framework that allows money creation to happen, but the specific process through which the money is generated is called credit creation. [The concept of Fractional Reserve is not mentioned in NCERT]

• Monetary Policy (Option 3): This refers to the actions taken by a Central Bank (like the RBI or the Fed) to manage the money supply and interest rates. It regulates credit creation but isn't the process itself.

• Reserve Management (Option 4): This is the internal practice of a bank ensuring it has enough liquid assets to meet its obligations; it is a constraint on money creation, not the process of it.