CH 2 : MONEY AND BANKING

CHAPTER 2
MONEY AND BANKING

and facilitates trade.

SUMMARY (ii) Unit of account : This means that money acts
as a common measure of value. It acts as a
standard unit for quoting the value of goods
1. MONEY
and services called as price. This has made
Money is anything which is generally accepted as possible the keeping of business accounts.
a medium of exchange, measure of value, store
Secondary Functions :
of value and as means of standard of deferred
payment. (i) Standard of deferred payments : Deferred
payments are those payments which are to be
2. BARTER EXCHANGE made in future. This has facilitated borrowing
and lending activities. It has also led to the
Barter is a system of exchange where goods or
creation of financial institutions.
services are directly exchanged for other goods
(ii) Store of value : This means that the money
or services without using a medium of exchange.
can be stored for use in future as it does not
Difficulties of barter system:
lose value. This is possible because money
(i) Lack of double coincidence of wants : Double
comes in convenient denominations, is easily
coincidence of wants means finding a person
portable and economical to store and has
who is willing to buy a good or service
general acceptability.
being offered and also possesses the good or
service which the former wants. Such double 4. MONEY SUPPLY (MS)
coincidence was a difficult probability.
(ii) Lack of common measure of value : This It refers to the total volume of money held by
problem related to the rate of exchange public at a particular point of time in an economy.
between different commodities. The price of It is a stock variable.
each commodity had to be quoted in terms of 5. COMPONENTS OF MONEY SUPPLY
every other commodity.
(iii) Problem of deferred payments : Transactions (i) Currency with the public. This includes coins
regarding future payments could not take and currency notes in circulation.
place with ease, This was because the quality (ii) Demand deposits: A deposit on which a
of good could deteriorate over time. cheque can be written.
(iv) Lack of store of value : For storing purpose, Measures of money supply:
good must be portable, non-perishable, MS = C + DD + OD
require less space and acceptable for exchange ...where [C = Currency held by the public; DD
anytime. = Demand deposits with banks; OD = Other
deposits with RBI
3. FUNCTIONS OF MONEY
Functions of money can be classified into primary 6. BANK MONEY
and secondary. It refers to the demand deposits with the banks.
Primary or Basic Functions :
6.1 Legal Tender Money
(i) Medium of exchange : It means that money
can be used to make payments for exchange Money which has legal sanction behind it and is
of goods and services. This function solves accepted as a means of payment is called legal
the problem of double coincidence of wants tender money.

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 87

6.2 High Powered Money

Further 640 152 128
It consists of currency held by the public and cash deposit
reserves of banks.
h h h h
7. FIAT MONEY Total 5,000 4,000 1,000
It refers to money which under law must be
Money Multiplier = 1 - 1 =5
accepted for all debts, i.e., currency. LRR 20%
8. LEGAL RESERVE RATIO (LRR) Total Demand Deposits

It is that fraction of deposits with the commercial = Money Multiplier × Cash Reserves
banks which is legally compulsory for the banks = 5 # 1, 000 = `5, 000
to keep in the form of cash and liquid assets as
reserves. 13. CENTRAL BANK
It is an apex body that controls, operates,
9. STATUTORY LIQUIDITY RATIO (SLR)
regulates and directs the entire banking and
The fraction of deposits which banks are required monetary structure of the country.
to keep in the form of liquid assets, including cash
within the bank itself. 13.1 Currency Authority or Bank of Issue
It has the sole authority to issue currency in the
10. CASH RESERVE RATIO (CRR)
country. The advantages of this function are:
The fraction of deposits the banks are required to (i) It gives uniformity in issue of currency and
keep with the Central Bank. note circulation.
(ii) t gives power to central bank to control
11. COMMERCIAL BANK
money supply.
It is a financial institution which accepts deposits (iii) It stabilises the internal and external value of
from the public and gives loans for purposes of currency.
consumption and investment.
13.2 Banker to the Government
12. MONEY CREATION/DEPOSIT CREATION/CREDIT
As a banker it carries out all banking business
CREATION BY COMMERCIAL BANKS
of the government and maintains current account
Let us understand this process with the help of for keeping cash balances of the government. It
an example: accepts receipts and makes payments and also
Suppose, there is an initial deposit of `1,000 and gives loans and advances to the government. It
legal reserve ratio (LRR) is 20%, i.e., the bank manages the public debt and also acts as the
has to keep `200 and lend the rest `800. It is financial advisor to the government.
assumed that all the transactions are routed
through banks. The borrower withdraws his `800 13.3 Banker’s Bank and Supervisor
for making payments which are routed through It acts as a banker to other banks in the country
banks in the form of deposit accounts. and performs the following functions:
The bank receives `800 as deposit and keeps 20% (i) Custodian of cash reserves : Commercial
of it, i.e., `160 as reserve and lends `640. Again banks must keep a proportion of their net
the borrower uses this for payment which flows total deposits with the central bank as cash
back into the banks thereby increasing the flow reserves.
of deposits. (ii) Lender of last resort : When commercial
banks face financial crisis, they approach to
the central bank which gives them loans and
Round Deposits(`) Loan (`) LRR(20%) advances.
(iii) Clearing house function : Since the central
Initial 1,000 800 200 bank holds the cash reserves of commercial
deposit banks, it also acts as the clearing house for
Further 800 640 160 these banks.
deposit (iv) Supervisor : The central bank supervises the

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CH 2 : MONEY AND BANKING

functioning of commercial banks. It makes 14.4 Open Market Operations

rules regarding licensing, management, It refers to the buying and selling of securities
branch expansion, liquidation etc. by the central bank from/to the public and
commercial banks. It sells government securities
13.4 Custodian of Foreign Exchange Reserves
during excess demand and buys securities during
It acts as a custodian of country’s stocks of gold deficient demand.
and foreign exchange reserves and thus helps in
stabilizing the external value of money. 14.5 Legal Reserve Ratio (LRR)
Central bank can influence the credit creation
13.5 Controller of Money Supply and Credit
power of commercial banks by making changes in
During economic fluctuations, the Central CRR and SLR.
Bank influences money supply and credit in 1. Cash Reserve Ratio (CRR) : It refers to
the economy by controlling the lending power the minimum percentage of net demand
of the commercial banks. This, it does through and time deposits which commercial banks
qualitative and quantitative instruments. The are required to keep with the central bank.
former refers to direction of credit whereas the During inflation, when money supply has
latter refers to the volume of credit. to be reduced, central bank increases CRR
and decreases it during deflation or deficient
14. QUANTITATIVE INSTRUMENTS
demand.
Quantitative instruments are tools used by the 2. Statutory Liquidity Ratio (SLR) : It refers to
central bank to control the overall supply of money the minimum percentage of net demand and
and credit in the economy. These measures focus time deposits which the commercial banks
on maintaining price stability and influencing are required to keep with itself in the form
aggregate demand during different phases of the of cash reserves. By changing the SLR, the
economic cycle. amount of credit and hence money supply can
be greatly affected. It increased during excess
14.1 Bank Rate Policy demand and vice-versa.
It refers to the rate at which the central bank lends
money to commercial banks as a lender of the 15. QUALITATIVE INSTRUMENTS
last resort. During inflation (excess demand) the Qualitative instruments are tools used by the
central bank increases the bank rate and reduces central bank to regulate credit flow and influence
the same in times of deflation (deficient demand). the allocation of resources in the economy. These
measures are designed to address specific sectors
14.2 Repo Rate or purposes rather than the overall money supply.
It may be defined as the rate at which the central
bank lends money to the commercial banks in the 15.1 Margin Requirements
event of any shortfall of funds in the short-run. It is the difference between the amount of loan
Increase in repo rate discourages commercial and market value of the security offered by the
banks to borrow from central bank and thus borrower against the loan. Margin requirements
reduces money supply in the economy whereas are increased during inflation and decreased
decrease in repo rate encourages borrowings by during deflation.
commercial banks and thus increases money
supply in the economy. 15.2 Selective Credit Controls
Central bank gives directions to other banks to
14.3 Reverse Repo Rate
give or not to give credit for certain purposes to
It is the rate at which the central bank of a particular sectors.
country borrows money from commercial banks.
Increase in repo rate encourages commercial 15.3 Moral Suasion
banks to deposit funds with the central bank It is a combination of persuasion and pressure
reducing availability of funds with it. This, thus that central bank applies on other banks in order
helps in curtailing money supply in the economy to get them to act in accordance with its policies.
and vice-versa.

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 89

MULTIPLE CHOICE QUESTION (b) The fraction of deposits banks keep with the
central bank
CRR is the mandatory proportion of total deposits
1. Which of the following represents a primary that commercial banks must maintain with the
function of money, essential for its role in central bank, impacting their ability to lend and
facilitating trade and providing a common create money by restricting or freeing up funds.
measure of value for goods and services in an
economy? 4. How does the central bank use the repo rate as
(a) Medium of exchange and store of value a monetary policy tool to influence borrowing
(b) Standard of deferred payments and unit of costs for commercial banks and regulate the
account money supply in the economy during inflationary
(c) Medium of exchange and unit of account periods?
(d) Store of value and standard of deferred (a) By reducing the money supply during
payments deflation
(b) By encouraging borrowing to reduce money
Ans : SQP 2024 supply
(c) Medium of exchange and unit of account (c) By increasing borrowing costs to reduce
The primary functions of money include acting money supply
as a medium of exchange to facilitate the buying (d) By eliminating inflation directly
and selling of goods and services and serving as a Ans : OD 2008
unit of account to provide a standard measure for
quoting their value. (c) By increasing borrowing costs to reduce
money supply
2. In the context of the total money available within The central bank raises the repo rate to make
an economy, which of the following best defines borrowing more expensive for commercial banks,
the term “money supply,” considering the public’s discouraging loans and reducing the overall money
holdings at a given point in time? supply to curb inflation.
(a) Total volume of currency and deposits held
by the central bank 5. How do qualitative instruments of monetary
(b) Total volume of money held by the public at policy, such as margin requirements and moral
a particular point in time suasion, differ from quantitative instruments like
(c) Total deposits in commercial banks only CRR and SLR in addressing credit allocation and
(d) Currency in circulation within banks only money supply?
(a) Quantitative instruments target inflation;
Ans : COMP 2006 qualitative instruments target GDP.
(b) Total volume of money held by the public at (b) Qualitative instruments regulate credit
a particular point in time flow to specific sectors, while quantitative
Money supply refers to the aggregate amount of instruments influence overall credit supply.
currency held by the public, demand deposits, (c) Quantitative instruments focus on subsidies;
and other deposits with the RBI, indicating the qualitative instruments focus on taxes.
liquidity available in the economy at a specific (d) Qualitative instruments are used only during
time. inflation.
Ans : SQP 2013
3. What is the Cash Reserve Ratio (CRR), and how
does it influence the banking system’s capacity to (b) Qualitative instruments regulate credit
extend loans and create credit in the economy? flow to specific sectors, while quantitative
(a) The fraction of deposits banks keep with instruments influence overall credit supply.
themselves Qualitative instruments, such as margin
(b) The fraction of deposits banks keep with the requirements and selective credit controls, address
central bank specific sectoral credit needs, while quantitative
(c) The percentage of deposits invested in tools, including CRR and repo rate, affect the
government securities overall money supply and economic demand.
(d) The percentage of deposits available for loans
Ans : DELHI 2007

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CH 2 : MONEY AND BANKING

17. The rate at which Commercial Banks borrow Ans : SQP 2022

from Central Bank is called _____. (d) Net time deposits with banks
(a) Bank rate
(b) Legal reserve ratio 23. The short term borrowing rate at which Reserve
(c) Reverse repo rate Bank of India borrows money from Commercial
(d) Cash reserve ratio Banks is called _____.
(a) Bank rate
Ans : COMP 2015
(b) Discount rate
(a) Bank rate (c) Repo rate
(d) Reverse repo rate
18. _____ is the main source of money supply in
an economy. Ans : DELHI 2014

(a) Central Bank (d) Reverse repo rate

(b) Commercial Banks
(c) Government 24. What would be the total money creation in the
(d) Both (a) and (b) economy, If initial fresh deposits with banks =
`50,000 and LRR = 20%
Ans : FOREIGN 2020
(a) `2,50,000
(d) Both (a) and (b) (b) `5,00,000
(c) `10,00,000
19. Measuring the value of goods and services refers (d) `12,00,000
to which of the following functions of money?
(a) Store of value Ans : OD 2017

(b) Unit of value (a) `2,50,000

(c) Standard of deferred payments
(d) Medium of exchange 25. Which Bank is authorised to issue currency?
(a) Central Bank
Ans : SQP 2015
(b) Commercial Bank
(b) Unit of value (c) Cooperative Bank
(d) Scheduled Bank
20. Which of the following functions of money
simplifies the process of borrowing and lending? Ans : COMP 2002

(a) Store of value (a) Central Bank

(b) Medium of exchange
(c) Standard of deferred payments 26. Which one of the following is a qualitative measure
(d) Unit of value of credit control by the Central Bank?
(a) Bank rate
Ans : COMP 2018
(b) Open market operations
(c) Standard of deferred payments (c) Marginal requirements
(d) Cash reserve ratio
21. Which of the following is not included in money
supply? Ans : MAIN 2006

(a) Currency held by public (c) Marginal requirements

(b) Inter-bank-deposits
(c) Demand deposits in Banks 27. _____ refers to the proportion of total deposits
(d) Saving deposits with post office banks. which Banks are required to keep in the form of
reserves with themselves.
Ans : MAIN 2019
(a) Cash deposit ratio
(b) Inter-bank-deposits (b) Statutory liquidity ratio
(c) Bank rate
22. M1 of money supply does not include. (d) Reserve deposit ratio
(a) Currency held by public
(b) Other deposits in RBI Ans : SQP 2007

(c) Demand deposits with the Commercial Banks (d) Reserve deposit ratio
(d) Net time deposits with banks

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 91

(c) By selling government securities to reduce (c) Fiat money is backed by gold reserves held by
money supply the central bank.
During inflation, the central bank sells government (d) Legal tender money is freely exchangeable for
securities to absorb excess money from the foreign currency.
economy, reducing demand and controlling price
levels. Ans : FOREIGN 2000

(a) Fiat money derives value from the

12. What is the significance of Statutory Liquidity government’s declaration of its acceptance.
Ratio (SLR), and how does it help regulate the Fiat money has value because the government
credit creation power of commercial banks? mandates its acceptance for debts, making it a
(a) It ensures all deposits are converted into critical element of the modern economy despite
liquid assets for immediate withdrawal. lacking intrinsic value.
(b) It mandates banks to keep a percentage of
deposits in cash or approved securities. 15. What is the primary purpose of the central bank
(c) It determines the maximum interest rate acting as the “lender of last resort” for commercial
banks can offer on loans. banks?
(d) It restricts banks from lending beyond a fixed (a) To ensure the government’s financial stability
percentage of their total deposits. during fiscal crises
Ans : COMP 2011
(b) To provide short-term liquidity support to
commercial banks in distress
(b) It mandates banks to keep a percentage of
(c) To guarantee repayment of loans to
deposits in cash or approved securities.
international investors
SLR requires banks to maintain a fraction of their
(d) To facilitate long-term investments in
deposits in liquid assets like cash or approved
infrastructure
securities, controlling their lending power and
influencing money supply. Ans : SQP 2003

13. Why is the Legal Reserve Ratio (LRR) critical for (b) To provide short-term liquidity support to
the central bank’s ability to influence the overall commercial banks in distress
credit availability in the economy? The central bank acts as the lender of last resort
(a) It ensures commercial banks meet their loan by providing financial assistance to commercial
obligations to the government. banks facing liquidity crises, ensuring the stability
(b) It regulates the minimum reserves banks must of the banking system.
hold to create credit.
16. Which statement best defines high-powered
(c) It directs commercial banks to invest a
money and its role in the monetary system?
portion of deposits in foreign reserves.
(a) It includes the total deposits with commercial
(d) It limits banks’ ability to invest in long-term
banks used for lending.
securities.
(b) It refers to currency held by the public and
Ans : DELHI 2012 reserves with commercial banks.
(b) It regulates the minimum reserves banks must (c) It is the value of government securities issued
hold to create credit. by the central bank.
LRR, including CRR and SLR, determines the (d) It denotes the total money supply in the
proportion of deposits commercial banks must economy during a financial year.
maintain, thereby controlling their ability to
Ans : OD 2004
extend loans and influence credit supply.
(b) It refers to currency held by the public and
14. How do legal tender money and fiat money differ, reserves with commercial banks.
and what characteristic makes fiat money an High-powered money comprises currency held by
essential part of the modern monetary system? the public and cash reserves of banks, forming the
(a) Fiat money derives value from the base for the creation of credit in the economy.
government’s declaration of its acceptance.
(b) Legal tender money is used only for
international transactions.

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CH 2 : MONEY AND BANKING

6. What is the primary objective of Open Market 9. How does the Cash Reserve Ratio (CRR) serve
Operations conducted by the central bank, and as a tool for monetary policy, and what impact
how does it impact the overall credit availability does its alteration have on the commercial banks’
and economic stability? lending capacity?
(a) To increase government revenue through (a) CRR helps the government increase taxes on
taxation banking institutions.
(b) To manage the supply of credit in the economy (b) CRR determines the liquidity banks must
(c) To influence the allocation of credit to specific hold with themselves for emergencies.
sectors (c) CRR is the proportion of deposits banks keep
(d) To reduce inflation by controlling imports with the central bank, impacting lending.
(d) CRR limits the percentage of profits banks
Ans : FOREIGN 2010
can retain for reinvestment.
(b) To manage the supply of credit in the economy
Through Open Market Operations, the central Ans : DELHI 2021

bank buys or sells government securities to (c) CRR is the proportion of deposits banks keep
regulate the availability of credit, ensuring with the central bank, impacting lending.
economic stability by controlling inflation or By adjusting the CRR, the central bank can
deflation. increase or decrease the funds available for
commercial banks to lend, influencing credit
7. Which of the following best describes the concept creation and money supply.
of “money supply,” highlighting its significance
in representing the total liquidity available to 10. What role does the repo rate play in regulating
the public at a specific point in time within an inflation, and how does an increase in this rate
economy? affect the borrowing behavior of commercial
(a) The volume of currency held exclusively by banks?
the central bank (a) It increases borrowing costs, discouraging
(b) Total money held by the public, including loans and reducing money supply.
demand deposits and currency (b) It decreases borrowing costs, encouraging
(c) Deposits with banks that can be accessed banks to lend more.
through loans (c) It has no direct impact on inflation but
(d) The amount of cash reserves kept by regulates international trade.
commercial banks with the central bank (d) It directly impacts public borrowing from the
Ans : COMP 2016 government.

(b) Total money held by the public, including Ans : OD 2023

demand deposits and currency (a) It increases borrowing costs, discouraging

Money supply includes the total currency held by loans and reducing money supply.
the public, demand deposits, and other deposits, An increase in the repo rate makes borrowing
reflecting the overall liquidity in the economy. from the central bank more expensive, reducing
the money supply and helping control inflation.
8. Which of the following is an example of a
qualitative instrument of monetary policy aimed 11. In what way does Open Market Operations
at regulating credit allocation to specific sectors (OMO) contribute to the central bank’s efforts
of the economy? in stabilizing the economy, particularly during
(a) Open Market Operations inflationary pressures?
(b) Repo Rate Adjustments (a) By increasing direct taxes on commercial
(c) Margin Requirements banks
(d) Cash Reserve Ratio (b) By buying government securities to inject
Ans : FOREIGN 2001 money into the economy
(c) By selling government securities to reduce
(c) Margin Requirements
money supply
Margin requirements are qualitative tools used by
(d) By lowering interest rates for long-term
the central bank to influence credit allocation by
borrowing
setting the difference between the loan amount
and the value of securities offered by borrowers. Ans : SQP 2009

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 93

28. Which one of the following is a quantitative tool Ans : SQP 2023

of credit control used by RBI? (b) Price stability

(a) Bank rate policy
(b) Marginal requirements 34. Who regulates money supply?
(c) Moral suasion (a) Government of India
(d) Direct action (b) Reserve Bank of India
(c) Commercial Banks
Ans : COMP 2008
(d) Planning Commission
(a) Bank rate policy
Ans : COMP 2001

29. The ratio of total deposits that a commercial (b) Reserve Bank of India
Banks has to keep with Reserve Bank of India is
called 35. _____ is not related with banking system.
(a) Deposit ratio (a) Bank rate
(b) Cash reserve ratio (b) Fiscal deficit
(c) Legal reserve ratio (c) Credit creation
(d) Statutory liquidity ratio (d) Cash Reserve Ratio

Ans : MAIN 2010 Ans : DELHI 2021

(b) Cash reserve ratio (b) Fiscal deficit

30. Which of the following is not a problem of barter 36. Central Bank as _____ manages public debt of
system of exchange? the government.
(a) store of value (a) Custodian of Foreign Exchange
(b) double coincidence of wants (b) Agent
(c) unit of account (c) Financial Advisor
(d) Unemployment (d) Supervisor

Ans : SQP 2013 Ans : OD 2021

(d) Unemployment (b) Agent

31. Money supply includes _____. 37. Statutory Liquidity Ratio implies to that
(a) all deposits in banks percentage of _____.
(b) only demand deposits in banks (a) total deposits of the commercial banks which
(c) only time deposits in banks must be kept in the current account, with the
(d) currency with the banks Reserve Bank of India.
(b) total deposits of the commercial banks which
Ans : COMP 2016
must be kept in the form of liquid assets, with
(b) only demand deposits in banks the Reserve Bank of India.
(c) net time and demand deposit liabilities of the
32. Demand deposits include _____. commercial banks which must be kept in the
(a) Saving account deposits and fixed deposits form of cash, with the Reserve Bank of India.
(b) Saving account deposits and current account (d) net time and demand deposit liabilities of the
deposits commercial banks which must be kept with
(c) Current account deposits and fixed deposits themselves in the form of liquid assets.
(d) All types of deposits
Ans : SQP 2009
Ans : MAIN 2021
(d) net time and demand deposit liabilities of
(b) Saving account deposits and current account the commercial banks which must be kept with
deposits themselves in the form of liquid assets.
33. Which of the following is not a function of money? 38. If the Legal Reserve Ratio is 20% and Initial
(a) Medium of exchange deposit is `2,000, then value of money multiplier
(b) Price stability and total money creation will be _____ and
(c) Store of value _____.
(d) Unit of account

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CH 2 : MONEY AND BANKING
Ans : DELHI 2023
(a) Both Assertion and Reason are true and
(a) Both Assertion and Reason are true and Reason is the correct explanation of Assertion.
Reason is the correct explanation of Assertion. (b) Both Assertion and Reason are true and
Reason is not the correct explanation of
56. Assertion : Coins are limited legal tender money. Assertion.
Reason : Coins represent money which is accepted (c) Assertion is true but Reason is false.
by the people to an unlimited extent. (d) Assertion is false but Reason is true.
(a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion. Ans : FOREIGN 2009

(b) Both Assertion and Reason are true and (c) Assertion is true but Reason is false.
Reason is not the correct explanation of
Assertion. 60. Assertion : The Central Bank is also known as the
(c) Assertion is true but Reason is false. bank of issue.
(d) Assertion is false but Reason is true. Reason : The Central Bank enjoys the sole
monopoly of issuing currency to ensure control
Ans : COMP 2021
over volume of currency and money supply.
(c) Assertion is true but Reason is false (a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion.
57. Assertion : LRR represents the minimum reserve (b) Both Assertion and Reason are true and
ratio essential to be maintained by banks. Reason is not the correct explanation of
Reason : Banks create deposits in the process of Assertion.
making loans to their customers. (c) Assertion is true but Reason is false.
(a) Both Assertion and Reason are true and (d) Assertion is false but Reason is true.
Reason is the correct explanation of Assertion.
(b) Both Assertion and Reason are true and Ans : COMP 2012

Reason is not the correct explanation of (a) Both Assertion and Reason are true and
Assertion. Reason is the correct explanation of Assertion.
(c) Assertion is true but Reason is false.
(d) Assertion is false but Reason is true. 61. Assertion : Demand deposits are created by
commercial banks.
Ans : OD 2001
Reason : Demand deposits form a significant part
(b) Both Assertion and Reason are true and of the total money supply in the economy.
Reason is not the correct explanation of Assertion. (a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion.
58. Assertion : Bank rate is decreased when credit is (b) Both Assertion and Reason are true and
to be expanded. Reason is not the correct explanation of
Reason : Selective credit control involves specifying Assertion.
the amount and purpose for which credit is to be (c) Assertion is true but Reason is false.
given. (d) Assertion is false but Reason is true.
(a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion. Ans : DELHI 2004

(b) Both Assertion and Reason are true and (b) Both Assertion and Reason are true and
Reason is not the correct explanation of Reason is not the correct explanation of Assertion.
Assertion.
(c) Assertion is true but Reason is false. 62. Assertion : Credit creation is inversely related to
(d) Assertion is false but Reason is true. the Legal Reserve Ratio.
Reason : LRR is fixed by the market forces of
Ans : SQP 2011
demand and supply.
(b) Both Assertion and Reason are true and (a) Both Assertion and Reason are true and
Reason is not the correct explanation of Assertion. Reason is the correct explanation of Assertion.
(b) Both Assertion and Reason are true and
59. Assertion : Open market operations are used to Reason is not the correct explanation of
influence money supply in the economy. Assertion.
Reason : Central bank sells government securities (c) Assertion is true but Reason is false.
to increase the flow of credit in the economy. (d) Assertion is false but Reason is true.

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 95

47. In the Indian economy, _____ are issued by the Ans : DELHI 2020

Reserve Bank of India and acts as legal tender (a) increasing, bank rate
money.
(i) Coins of all denomination 52. Under the _____ Exchange Rate System, the
(ii) Currency notes of various denominations, Central Bank can control the rise/fall of foreign
except one rupee note exchange rate in a range bound manners.
(iii) Demand deposits (a) fixed
(a) Only (i) (b) flexible
(b) Only (ii) (c) managed floating
(c) Only (iii) (d) gold standard
(d) (i) and (ii) Ans : OD 2017

Ans : OD 2023 (c) managed floating

(b) Only (ii)
53. If in an economy the initial deposits are `4,000
48. _____ formulates the Monetary Policy in the crore and Reserve Ratio (RR) is 10%. The value
economy. of total deposit created would be ` _____ crore.
(a) Commercial Banks (a) 4,000
(b) International Monetary Fund (b) 40,000
(c) Central Bank (c) 2,000
(d) Central Government (d) 20,000

Ans : FOREIGN 2023 Ans : FOREIGN 2008

(c) Central Bank (b) 40,000

49. ‘Money is an asset which can be stored for use in

future.’
In the light of given statement, identify the ASSERTION AND REASON
function of money.
(a) A measure of value
(b) A standard of deferred payment 54. Assertion : Supply of money is a flow variable.
(c) A store of value Reason : It is measured at a point of time.
(d) A medium of Exchange (a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion.
Ans : SQP 2023
(b) Both Assertion and Reason are true and
(c) A store of value Reason is not the correct explanation of
Assertion.
50. “Mr. Sahotra borrowed funds from bank for
(c) Assertion is true but Reason is false.
purchasing a new house”.
(d) Assertion is false but Reason is true.
From the above statement, identify the indicated
function of money: Ans : SQP 2016
(a) Medium of exchange (d) Assertion is false but Reason is true.
(b) Store of value
(c) Unit of account 55. Assertion : Demand deposits are also called bank
(d) Standard of deferred payments money.
Reason : Demand deposits are created by
Ans : COMP 2012
commercial banks.
(d) Standard of deferred payments (a) Both Assertion and Reason are true and
Reason is the correct explanation of Assertion.
51. The Central Bank can reduce the Money Supply
(b) Both Assertion and Reason are true and
in the economy by _____ the _____.
Reason is not the correct explanation of
(a) increasing, bank rate
Assertion.
(b) decreasing, cash reserve ratio
(c) Assertion is true but Reason is false.
(c) decreasing, bank rate
(d) Assertion is false but Reason is true.
(d) buying, government securities

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CH 2 : MONEY AND BANKING

(a) 5 and `10,000 (b) Banking facilities to public

(b) 4 and `8,000
(c) 6 and `2,000 43. Read the following dialogue between two people:
(d) 4 and `10,000 Sita: I want 1 kg of potatoes.
Rani: What will you give in exchange?
Ans : COMP 2011
Sita: I can give you 2 liters of milk in return for
(a) 5 and `10,000 the potatoes.
Money Multiplier = 1 = 1 = 100 = 5 Rani: I don’t need milk. I want a pair of shoes.
LRR 20% 20 Which of the following problem is being faced by
and Total Money Creation Sita and Rani in their exchange process?
= Initial Deposit × MM = `2,000 × 5 = `10,000 (a) Lack of double coincidence of wants
(b) Absence of common units of value
39. Process of credit creation by commercial banks
(c) Lack of store of value
comes to an end when _____.
(d) Lack of standard of deferred payment
(a) Fresh deposits with Banks become zero.
(b) Reserve Ratio becomes zero. Ans : FOREIGN 2019

(c) Money multiplier becomes zero. (a) Lack of double coincidence of wants
(d) Total money reserves become equal to initial
deposit. 44. The main aim of monetary policy is _____.
(a) to bring price stability in the economy
Ans : FOREIGN 2021
(b) employment generation in the country
(d) Total money reserves become equal to initial (c) to increase trade surplus
deposit. (d) to generate greater tax revenue
Ans : SQP 2020
40. Which of the following statements does not
support with the function of RBI as supervisor to (a) to bring price stability in the economy
the commercial banks?
(a) Regulates the expansion, merger, acquisition 45. To reduce credit availability in the economy, the
etc. of the banks. Central Bank may _____.
(b) Formulates all rules and regulations for (a) buy securities in the open market
commercial banks. (b) sell securities in the open market.
(c) Extend loans to the commercial bank. (c) reduce reserve ratio.
(d) Inspection of operations of banks. (d) reduce repo rate.
Ans : COMP 2020
Ans : DELHI 2021
(b) sell securities in the open market.
(a) Regulates the expansion, merger, acquisition
etc. of the banks. 46. Ms. lqra Ansari, a teacher, was explaining in her
class about various types of deposits with the
41. Credit creation by commercial banks is determined
commercial banks. She quoted that –
by:
“These deposits form a part of M1 measure of
(a) Cash Reserve Ratio (CRR)
money supply and are payable on demand by the
(b) Statutory Liquidity Ratio (SLR)
commercial banks.”
(c) Initial Deposits
Identify the type of deposits she was explaining
(d) All the above
about and choose the correct alternative:
Ans : DELHI 2018 (i) Demand Deposits
(d) All the above (ii) Time Deposits
(iii) Post Office Deposits
42. Which of the following is not the function of the Alternatives:
central bank? (a) Only (i)
(a) Banking facilities to government (b) Only (ii)
(b) Banking facilities to public (c) (i) and (ii)
(c) Lendings to government (d) (i), (ii) and (iii)
(d) Lendings to commercial banks Ans : DELHI 2023

Ans : OD 2019 (a) Only (i)

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 97
Ans : FOREIGN 2003
66. Which of the following statements about Repo
(c) Assertion is true but Reason is false. Rate is correct?
I. It is the rate at which the central bank lends
63. Assertion : Only net demand deposits held by money to commercial banks for short-term
commercial banks are taken as part of money needs.
supply. II. An increase in repo rate discourages borrowing
Reason : Only deposits of the public held by the by commercial banks.
banks are included in money supply. III. A decrease in repo rate reduces the money
(a) Both Assertion and Reason are true and supply in the economy.
Reason is the correct explanation of Assertion. IV. Repo rate is used to manage liquidity and
(b) Both Assertion and Reason are true and inflation in the economy.
Reason is not the correct explanation of (a) Only I, II, and IV are correct.
Assertion. (b) Only II and III are correct.
(c) Assertion is true but Reason is false. (c) All statements are correct.
(d) Assertion is false but Reason is true. (d) Only I and IV are correct.
Ans : OD 2000 Ans : OD 2004

(a) Both Assertion and Reason are true and (a) Only I, II, and IV are correct.
Reason is the correct explanation of Assertion. Repo rate impacts borrowing and liquidity. An
increase discourages borrowing, while a decrease
64. Assertion : Reserve Ratio and Credit creation
increases money supply. Statement III is incorrect
power of commercial bank are directly related.
as a decrease in repo rate increases money supply.
Reason : Credit Creation is the product of the
reciprocal of Reserve Ratio (RR) and Primary 67. Identify the correct statements about the
deposit. functions of money.
(a) Both Assertion and Reason are true and I. Money acts as a medium of exchange, solving
Reason is the correct explanation of Assertion. the problem of double coincidence of wants.
(b) Both Assertion and Reason are true and II. Money serves as a unit of account, providing
Reason is not the correct explanation of a common measure of value.
Assertion. III. Money cannot act as a store of value over
(c) Assertion is true but Reason is false. time due to inflation.
(d) Assertion is false but Reason is true. IV. Money facilitates deferred payments, enabling
Ans : OD 2021 borrowing and lending activities.
(a) Only II and III are correct.
(d) Assertion is false but Reason is true.
(b) Only I, II, and IV are correct.
(c) All statements are correct.
(d) Only I and IV are correct.

STATEMENT BASED QUESTIONS Ans : FOREIGN 2000

(b) Only I, II, and IV are correct.

Money acts as a medium of exchange, unit of
65. Statement 1: All the coins are issued by Finance account, and store of value. It also facilitates
Ministry in India. deferred payments. Statement III is incorrect
Statement 2: All the currency notes are issued by as money can store value despite inflation to an
Reserve Bank of India. extent.
(a) Statement 1 is true & Statement 2 is false.
(b) Statement 1 is false & Statement 2 is true. 68. Which of the following statements about Open
(c) Both statements 1 & 2 are true. Market Operations (OMO) is correct?
(d) Both statements 1 & 2 are false. I. OMO refers to the buying and selling of
Ans : SQP 2005
government securities by the central bank.
II. Selling securities reduces money supply in the
(a) Statement 1 is true & Statement 2 is false. economy during inflation.
III. Buying securities increases money supply in
the economy during deflation.

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CH 2 : MONEY AND BANKING

Moral suasion relies on persuasion rather than exceeding 15 days.

enforcement to encourage banks to follow
monetary policies. It does not involve penalties, 91. Loans offered by commercial banks _____
direct regulation of interest rates, or mandatory (increase/decrease) the money supply in the
controls. economy.
Ans : OD 2020

Increase

ONE MARK QUESTIONS 92. If ‘legal reserve ratio’ is 20%, what will be the
value of money multiplier?

84. What is barter? Ans : OD 2018

Money Multiplier = 1 = 1 =5
Ans : COMP 2014
LRR 0.2
Barter is an exchange system where goods and
services are traded directly for other goods and ...[Given: LRR = 20% = 20 = 0.20
100
services without using money.
93. What is meant by bank rate?
85. Give the meaning of Money. Ans : FOREIGN 2022

Ans : DELHI 2017 Bank rate is the interest rate at which a country’s
Money is anything widely accepted as a medium Central Bank lends money to commercial banks.
of exchange with general acceptability.
94. Define ‘Statutory Liquidity Ratio’.
86. Define Money supply. Ans : SQP 2002

Ans : OD 2020 SLR is the minimum percentage of net demand

Money supply refers to the total stock of money and time deposits that commercial banks must
in circulation, including currency held by the hold as cash, designated assets, or securities, as
public and demand deposits, at a specific time. directed by the central bank.

87. Two components of money supply are _____ 95. What is Reverse Repo rate?
and _____. Ans : COMP 2006

Ans : FOREIGN 2015 It is the interest rate at which the Central Bank
Two components of money supply are Currency accepts deposits from commercial banks.
with the public and Demand Deposits.
96. What are open market operations?
88. What is included in money supply? Ans : OD 2018

Ans : SQP 2018 Open market operations involve the Central

Money supply comprises currency (paper notes Bank buying and selling government securities
and coins) and people’s bank deposits with and bonds to regulate the money supply in the
commercial banks. economy.

89. What are demand deposits?

Ans : COMP 2019

Demand deposits are bank deposits that can be

TWO MARK QUESTIONS
withdrawn by depositors anytime.
97. Money has separated the acts of sale and purchase.
90. What are Time Deposits?
Explain.
Ans : DELHI 2022
Ans : DELHI 2007
Time deposits are bank deposits that cannot be
With the advent of money, individuals can
withdrawn before the stipulated period, typically
purchase or sell goods without engaging in

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 99

III. A lower repo rate reduces liquidity in the The Reverse Repo Rate is not higher than the
economy. Repo Rate, making option (d) incorrect.
(a) Only II and III are correct.
(b) All statements are correct. 75. The bar graph above illustrates the percentage
(c) Only I and III are correct. distribution of various components of the money
(d) Only I and II are correct. supply. Which of the following statements is
correct?
Ans : FOREIGN 2020

(d) Only I and II are correct.

Repo rate impacts borrowing by commercial
banks. A higher rate discourages borrowing,
reducing liquidity. A lower repo rate increases
liquidity, making statement III incorrect.

GRAPH BASED QUESTIONS

74. The bar graph below shows the rates of various

monetary policy instruments used by the central
bank. Based on the graph, which of the following
statements is correct?
(a) Demand Deposits constitute the largest share
of the money supply.
(b) Time Deposits have a smaller share than
Currency with Public.
(c) Other Deposits have the highest percentage
in the money supply.
(d) Currency with Public constitutes the smallest
share of the money supply.
Ans : COMP 2007

(a) Demand Deposits constitute the largest share

of the money supply.
From the graph:
Demand Deposits have the highest share at 40%,
making option (a) correct.
Time Deposits (35%) are higher than Currency
(a) The Cash Reserve Ratio (CRR) rate is higher
with Public (22%), making option (b) incorrect.
than the Reverse Repo Rate.
Other Deposits (3%) have the smallest share,
(b) The Repo Rate is the highest among all
making option (c) incorrect.
instruments.
Currency with Public is not the smallest, making
(c) The Statutory Liquidity Ratio (SLR) has the
option (d) incorrect.
lowest rate.
(d) The Reverse Repo Rate is higher than the
Repo Rate.
Ans : SQP 2024
76. The pie chart above depicts the percentage
(a) The Cash Reserve Ratio (CRR) rate is higher distribution of government expenditure across
than the Reverse Repo Rate. various sectors. Based on the chart, which of the
From the graph: CRR is 4.0%, which is higher following statements is correct?
than the Reverse Repo Rate at 3.35%.
The SLR is the highest at 18.0%, making option
(b) incorrect.

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CH 2 : MONEY AND BANKING

IV. OMO is only used for long-term economic (c) Only I, II, and III are correct.
adjustments. LRR includes CRR and SLR, which are tools to
(a) Only I, II, and III are correct. regulate credit creation. CRR is maintained with
(b) Only II and IV are correct. the central bank, and SLR with the bank itself.
(c) All statements are correct. LRR is a quantitative measure, not qualitative,
(d) Only I and IV are correct. making IV incorrect.
Ans : SQP 2003
71. Which of the following statements about Central
(a) Only I, II, and III are correct. Bank functions is correct?
OMO involves the buying and selling of government I. The central bank is the sole authority to issue
securities to regulate money supply. It is used for currency in the country.
short- and medium-term adjustments. Statement II. It acts as a banker to the government by
IV is incorrect. managing its accounts and loans.
III. The central bank directly provides loans to
69. Which of the following statements about Cash the public for investments.
Reserve Ratio (CRR) and Statutory Liquidity (a) Only I and II are correct.
Ratio (SLR) is correct? (b) Only II and III are correct.
I. CRR is the fraction of deposits that (c) All statements are correct.
commercial banks must keep with the central (d) Only I and III are correct.
bank.
II. SLR is the fraction of deposits that banks Ans : DELHI 2014

are required to maintain in the form of liquid (a) Only I and II are correct.
assets. The central bank issues currency and acts as a
III. Both CRR and SLR are used to influence banker to the government. It does not directly
credit creation by commercial banks. provide loans to the public, which is done by
IV. CRR reduces money supply directly, while commercial banks.
SLR impacts money supply indirectly.
(a) Only I and II are correct. 72. Which of the following statements about Money
(b) Only II, III, and IV are correct. Supply is correct?
(c) All statements are correct. I. Money supply refers to the total volume of
(d) Only III and IV are correct. money held by the public at a particular
point of time.
Ans : DELHI 2012
II. It includes currency with the public, demand
(c) All statements are correct. deposits, and other deposits with the RBI.
CRR is maintained with the central bank, and III. Money supply measures the flow of money
SLR is maintained in liquid assets by commercial over a period of time.
banks. Both tools regulate credit creation and (a) Only I and II are correct.
money supply, with CRR having a direct effect (b) Only II and III are correct.
and SLR an indirect one. (c) All statements are correct.
(d) Only I and III are correct.
70. Which of the following statements about Legal
Reserve Ratio (LRR) is correct? Ans : OD 2017

I. LRR includes both CRR and SLR. (a) Only I and II are correct.
II. CRR is kept with the central bank, while Money supply is a stock variable, measured at a
SLR is maintained by the bank itself. specific time. It includes currency with the public
III. Increasing CRR and SLR reduces the credit and deposits but does not measure the flow of
creation ability of commercial banks. money over time.
IV. LRR is a qualitative measure to control
credit. 73. Which of the following statements about Repo
(a) Only II and IV are correct. Rate is correct?
(b) All statements are correct. I. Repo rate is the rate at which the central
(c) Only I, II, and III are correct. bank lends money to commercial banks.
(d) Only I and III are correct. II. A higher repo rate discourages borrowing by
commercial banks.
Ans : COMP 2005

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 101

25%, which is significantly lower than Services, do not fit the purpose of CRR adjustment.
making option (a) incorrect. The Industry
sector contributes 20%, which is less than 81. Open Market Operations (OMO) involve the
Services, making option (c) incorrect. Lastly, buying and selling of government securities by
Trade contributes only 10%, which is lower than the central bank to regulate money supply. Selling
Agriculture’s 25%, making option (d) incorrect. securities reduces money supply, while buying
Thus, the correct answer is that the Services securities increases liquidity in the economy.
sector accounts for the largest share in GDP. How does selling government securities during
inflation affect the economy?
(a) It reduces money supply.
(b) It increases money supply.
PASSAGE BASED QUESTION (c) It encourages lending by banks.
(d) It stabilizes market prices.
Ans : DELHI 2019
79. Repo rate is the rate at which the central bank
(a) It reduces money supply.
lends money to commercial banks for short-term
Selling securities absorbs liquidity from the
needs. An increase in the repo rate discourages
market, reducing money supply, which is necessary
borrowing by commercial banks, reducing
to control inflation. The other options do not
liquidity in the economy. Conversely, a decrease
describe the effect of selling securities.
in the repo rate encourages borrowing, increasing
the money supply. 82. Statutory Liquidity Ratio (SLR) is a percentage
What happens when the central bank increases of a bank’s deposits that must be kept in liquid
the repo rate? assets like cash, gold, or government-approved
(a) Borrowing by commercial banks is encouraged. securities. It is used to control credit creation by
(b) Liquidity in the economy increases. banks.
(c) Borrowing by commercial banks is discouraged. What is the impact of decreasing SLR during
(d) Money supply remains unchanged. deflation?
Ans : SQP 2015 (a) Reduces the lending capacity of banks.
(b) Increases the lending capacity of banks.
(c) Borrowing by commercial banks is discouraged.
(c) Stabilizes money supply in the economy.
A higher repo rate increases the cost of borrowing
(d) Decreases liquidity in the market.
for commercial banks, discouraging borrowing
and reducing liquidity. The other options do not Ans : OD 2022
align with the repo rate’s function. (b) Increases the lending capacity of banks.
A lower SLR leaves more funds with banks,
80. Cash Reserve Ratio (CRR) is the percentage of
enabling them to lend more, which helps increase
a commercial bank’s total deposits that must be
money supply during deflation. Other options are
kept with the central bank as reserves. During
incorrect based on SLR’s function.
inflation, the central bank increases CRR to
reduce money supply, while it decreases CRR 83. Moral suasion is a qualitative monetary policy
during deflation to enhance money supply. tool used by the central bank to influence and
What is the purpose of increasing CRR during persuade commercial banks to follow its directives
inflation? without any strict enforcement.
(a) To enhance credit creation. What is the primary objective of moral suasion by
(b) To reduce money supply in the economy. the central bank?
(c) To encourage borrowing by commercial (a) To enforce penalties on non-compliant banks.
banks. (b) To persuade banks to align with central bank
(d) To stabilize the banking system. policies.
Ans : COMP 2018 (c) To regulate the interest rates directly.
(d) To mandate strict credit controls.
(b) To reduce money supply in the economy.
Increasing CRR reduces the amount of money Ans : FOREIGN 2002
available with banks for lending, thereby reducing (b) To persuade banks to align with central bank
money supply during inflation. The other options policies.

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CH 2 : MONEY AND BANKING

(a) Agriculture accounts for the largest share of

GDP at 45%.
(b) Services sector contributes the largest share
of GDP at 45%.
(c) Trade contributes the same percentage as
Agriculture.
(d) Industry is the smallest contributor to GDP.
Ans : OD 2010

(b) Services sector contributes the largest share

of GDP at 45%.
From the pie chart, the Services sector has the
highest contribution of 45% to GDP, making
(a) Education receives the highest share of option (b) correct. Agriculture contributes
government expenditure at 30%. 25%, not 45%, so option (a) is incorrect. Trade
(b) Healthcare and Defense receive equal shares contributes 10%, which is significantly less than
of government expenditure. Agriculture’s 25%, making option (c) incorrect.
(c) Infrastructure receives the smallest share of Industry contributes 20%, which is higher than
government expenditure. Trade’s 10%, so option (d) is incorrect. Thus, the
(d) Defense has the largest allocation among all Services sector is the largest contributor to GDP.
sectors.
78. The bar graph below shows the percentage
Ans : FOREIGN 2013
contribution of various sectors to GDP. Which of
(a) Education receives the highest share of the following statements is correct?
government expenditure at 30%.
From the pie chart, Education has the largest share
at 30%, making option (a) correct. Healthcare
and Defense each receive 25%, which are equal
but not the largest, making option (b) incorrect.
Infrastructure receives 20%, which is the smallest
share, making option (c) incorrect. Defense’s
25% allocation is not the largest, making option
(d) incorrect. Thus, Education has the highest
allocation.

77. The pie chart below illustrates the percentage

contribution of various sectors to GDP. Based on
the chart, which of the following statements is
correct?

(a) The Agriculture sector contributes the highest

percentage to GDP.
(b) The Services sector accounts for the largest
share in GDP.
(c) The Industry sector contributes more than
the Services sector.
(d) Trade contributes more than Agriculture.
Ans : DELHI 2008

(b) The Services sector accounts for the largest

share in GDP.
The Services sector has the highest contribution
to GDP at 45%, making it the largest contributor
among all sectors. Agriculture contributes

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 103

reciprocal exchanges. This innovation resolves the rise in primary deposits leads to more secondary
barter system’s challenge of requiring a double deposits and increased credit creation. Enhanced
coincidence of wants, thereby simplifying trade credit creation boosts economic growth by
and economic transactions. providing greater access to credit for investment
purposes.
98. Is the general price level in the economy influenced
by money supply? Explain. 103. Define Legal Reserve Ratio.
Ans : OD 2008 Ans : OD 2023

An increased money supply boosts aggregate The Legal Reserve Ratio (LRR) is the proportion
demand. Without a matching rise in aggregate of total deposits that commercial banks must
supply, this leads to an increase in the general legally reserve with the central bank. It consists
price level within the economy. of :
(i) Cash Reserve Ratio (CRR): The minimum
99. Intrinsic value refers to the material worth of funds commercial banks must deposit with
money, while face value is its nominal worth as the central bank.
currency. When these values diverge significantly, (ii) Statutory Liquidity Ratio (SLR): The reserve
it can lead to unusual economic behaviors. What of assets maintained by banks with the central
happens when the intrinsic value of money exceeds bank.
its face value?
104. State the role played by the central bank as the
Ans : FOREIGN 2010
“lender of last resort”.
Money functions as a commodity when its intrinsic
value, derived from the material it is made of, Ans : FOREIGN 2019

surpasses its face value, which is the value printed When commercial banks cannot fulfill their
on the currency or coin. financial needs from other sources, they turn to
the central bank, which acts as the lender of last
100. Do you consider a commercial bank “creator of resort, providing loans and advances.
money” in the economy?
105. State, whether the following statement is true or
Ans : SQP 2013
false:
Commercial banks significantly contribute to ‘All’ financial Institutions are banking institutions.
credit creation in the economy. They generate
credit through demand deposits linked to loans. Ans : SQP 2020

These demand deposits often exceed cash False; As a financial institution can be a banking
reserves. For instance, if cash reserves are `1,000 institution only when it performs both the
and demand deposits are `10,000, banks create functions of accepting deposits and advancing
credit ten times their reserves. loans.

101. Will credit creation by commercial banks during 106. State, whether the following statement is true or
an inflationary situation be beneficiary to the false:
economy or have a negative impact? ‘Margin requirement is raised by the Central
Bank to increase money supply.’
Ans : COMP 2016

Credit creation by commercial banks raises the Ans : COMP 2020

money supply, boosting aggregate demand. False; Central Bank reduces the margin
During inflation, this results in excess demand, requirements in order to increase money supply.
worsening the situation and driving prices higher,
thereby having a negative impact on the economy. 107. How can Reserve Bank of India help in bringing
down the foreign exchange rate which is very
102. How can improvement in banking habits of the high?
people accelerate the pace of economic growth?
Ans : DELHI 2001
Ans : DELHI 2021
The Reserve Bank of India can devalue the
Improved banking habits encourage people to Indian rupee to reduce the high exchange rate.
deposit cash in banks rather than holding it. This Alternatively, it can increase the supply of foreign

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CH 2 : MONEY AND BANKING

Consequently, banks prefer advancing loans, 132. Giving reasons, state whether the following
which boosts credit creation and increases the statements are true or false.
money supply in the economy. (i) CRR and SLR are complementary to each
other in controlling credit creation in the
130. Giving reasons, state whether the following economy.
changes by RBI will increase or decrease the (ii) Market rate of interest and bank rate share a
money supply. direct relationship.
(i) Decrease in bank rate. (iii) Currency created by the central bank is called
(ii) RBI increases the margin from 20% to 30%. bank money.
(iii) Purchase of securities in the open market.
Ans : FOREIGN 2021
Ans : OD 2016
(i) True: A rise in the Cash Reserve Ratio (CRR)
An increase in the money supply raises aggregate and Statutory Liquidity Ratio (SLR) reduces
demand, and if aggregate supply does not rise the funds available for commercial banks to
correspondingly, it leads to higher general price lend, thereby restricting their credit creation
levels. capacity.
(i) Decrease in Borrowing Costs: This increases (ii) True: An increase in the Bank Rate by the
the money supply as lower borrowing costs Central Bank raises the borrowing costs for
encourage people to take more loans, boosting commercial banks, leading them to raise their
credit and demand. market interest rates. Conversely, a decrease
(ii) Increase in Margin Requirements: This in the Bank Rate lowers these costs and
reduces the money supply, as higher margins market rates.
mean smaller loans relative to the security (iii) False: Money issued by the Central Bank
value. This discourages borrowing, reducing is referred to as high-powered money, not
credit creation. regular money supply.
(iii) Purchase of Securities by RBI: This raises
the money supply, as the RBI releases funds 133. Describe any two main functions of a Central
to purchase securities, increasing commercial Bank.
banks’ resources for lending, thereby
Ans : SQP 2023
expanding credit and money supply.
The Central Bank serves as the apex institution
131. As per the following news published in “The of a country’s monetary system and performs
Hindu” on 6th August, 2022: several key functions, including:
The Monetary Policy Committee (MPC) of the (i) Bank of Issue: This function refers to the
Reserve Bank of India raised the Repo Rate by Central Bank’s exclusive legal right to issue
50 basis points.” Identify and explain the likely currency, ensuring a monopoly on note
cause and consequences behind this type of action issuance. This monopoly brings uniformity to
taken by the Reserve Bank of India. currency circulation and grants the Central
Ans : COMP 2023
Bank the authority to influence the money
supply, as currency held by the public is a
The Repo Rate is the interest rate charged by the component of the money supply.
Central Bank on loans to commercial banks. (ii) Bankers’ Bank: The Central Bank acts
Effect During Excess Demand and Inflation: as a bank for other banks, maintaining a
The Central Bank raises the Repo Rate to relationship similar to the one commercial
discourage borrowing by commercial banks. banks have with their customers. It holds
Higher Repo Rates lead commercial banks to their required cash reserves, provides
increase their lending rates, making credit more financial securities, offers advice, discounts
expensive for borrowers. This reduces the demand bills and securities, and extends loans during
for loans and discourages investment. emergencies.
Additionally, reduced credit availability helps lower
aggregate demand, addressing the inflationary 134. Describe any two methods by which Reserve Bank
gap and controlling inflation effectively. of India can regulate money supply.
Ans : COMP 2001

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 105

The store of value function allows wealth to be 1. Medium of Exchange: Money acts as an
saved for future use. Money facilitates this by intermediary for exchanging goods and
enabling individuals to save earnings until they services, eliminating the need for a double
choose to spend them. Its convenience arises coincidence of wants and fostering trade
from: (i) availability in suitable denominations, among individuals and nations.
(ii) ease of portability and economical storage, 2. Measure of Value: It enables all goods
and (iii) general acceptability, allowing it to be and services to have prices, simplifying
exchanged for goods anytime. In contrast, the the comparison and measurement of their
barter system lacked suitable assets for storage, exchange values.
as goods needed to be non-perishable, portable, 3. Standard of Deferred Payment: Money’s stable
and acceptable for exchange—qualities fulfilled value, durability, and general acceptability
by money, overcoming this limitation. make it ideal for future payments, unlike
fluctuating commodities.
114. Explain the ‘Unit of Account’ function of money. 4. Store of Value: Money can be stored without
How has it solved the related problem created by losing value, unlike perishable goods, offering
barter? a convenient and durable way to preserve
Ans : OD 2003 wealth.
The unit of account function means measuring the 117. Currency is issued by the Central Bank, yet we
value of goods and services in monetary terms. say that commercial banks create money. Explain.
The barter system faced challenges in determining How is this money creation by commercial banks
exchange rates since, without a common value likely to affect the national income? Explain.
unit, each commodity’s price had to be expressed
relative to others, leading to complexity. The Ans : COMP 2017

introduction of money solved this issue by Money creation, or credit creation, is a crucial
providing a standard measure to compare prices. function of commercial banks, enabling them to
Money allows values to be expressed simply, like generate credit far exceeding the initial deposits.
`20 per meter or `10 per kilogram, standardizing The money supply has two components: currency
borrowing, lending, and business accounting, with the public, issued by the Central Bank, and
thereby facilitating trade. demand deposits, created by commercial banks.
When banks grant loans, they create equivalent
115. Explain the ‘standard of deferred payment’ deposits in the borrower’s name, adding to the
function of money. How has it solved the related money supply. This process promotes investment
problem created by barter? by providing funds to investors. An increased
Ans : FOREIGN 2005 money supply boosts aggregate demand, thereby
raising national income.
The standard of deferred payment refers to the
use of money for transactions settled in the 118. How do changes in bank rate affect money creation
future. In a modern economy, many payments by commercial banks? Explain.
are deferred and conveniently stated in monetary
terms due to money’s relatively stable value and Ans : DELHI 2020

general acceptability. In the barter system, future The Bank Rate is the interest rate at which the
payments were challenging due to fluctuations Central Bank provides funds to commercial banks
in commodity values and disagreements over the during emergencies, acting as the “lender of the
quality of goods. Money resolves these issues, last resort.” Adjusting the bank rate impacts
facilitating borrowing and lending, promoting borrowing costs for banks and, subsequently, the
trade, and enabling the establishment of financial economy:
institutions. 1. Increase in Bank Rate: Raising the bank
rate raises borrowing costs for commercial
116. How does money overcome the problems of barter banks, leading them to hike lending rates for
system? Explain briefly. the public and businesses. This discourages
Ans : SQP 2014 borrowing, reduces credit creation, and
decreases money supply in the economy.
Money addresses the limitations of the barter
2. Decrease in Bank Rate: Lowering the bank
system through the following functions:

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CH 2 : MONEY AND BANKING

exchange by selling from its reserves, thereby 1. CU (Currency with the Public): Includes
lowering its value. currency notes issued by the Reserve Bank of
India and coins in circulation.
2. DD (Demand Deposits at Banks): Refers to
the demand deposits held by the public in
THREE MARK QUESTIONS banks.
3. OD (Other Deposits): Comprises demand
deposits with the RBI from public financial
108. Explain the problem of double coincidence of institutions, foreign central banks, foreign
wants faced under barter system. How has money governments, and international financial
solved it? institutions like the IMF.
Ans : OD 2009
These components together define the money
supply in the economy.
The barter system involved direct exchange of
goods without using money. It required a “double 111. State the meaning and components of money
coincidence of wants,” meaning both parties supply.
needed to have goods that the other wanted.
Ans : SQP 2012
For instance, Ram needing cloth from Shyam
would only work if Shyam desired what Ram The supply of money refers to the total stock of
offered. Finding such matching needs was often money available with the public on a given day.
challenging, hindering trade. Money simplified It is expressed as:
transactions by acting as a universal medium of M = C + DD
exchange, allowing individuals to purchase goods 1. Currency with Public (C): This includes
or services they need without relying on reciprocal coins and currency notes held by the public,
needs. excluding any currency held by banks.
2. Demand Deposits (DD): These are bank
109. The barter system, based on the direct exchange
deposits on which cheques can be issued and
of goods and services, had inherent limitations
are payable on demand. They are considered
that made it inefficient for larger economies. One
equivalent to currency and form part of the
significant issue was related to the preservation
money supply.
of value over time. Explain “difficulty in storing
This measure reflects the money accessible for
wealth” problem faced in the barter system of
transactions in the economy.
exchange.
Ans : FOREIGN 2011 112. Explain the “medium of exchange” function of
money. How has it solved the related problem
Storing value refers to preserving purchasing power
created by barter?
for future use, which the barter system failed to
ensure. Goods like wheat and vegetables lacked Ans : COMP 2004

durability and degraded over time. Additionally, One key function of money is serving as a medium
storing goods required significant resources, of exchange, enabling payment for goods and
and bulky items were difficult to exchange services. Producers sell goods to wholesalers for
conveniently, often leading to losses during urgent money, and wholesalers, in turn, sell to consumers
trades. The introduction of money addressed in exchange for money. Similarly, individuals
these issues. Money is durable, involves lower sell their services for money and use it to buy
storage costs, and enjoys general acceptability, necessities. This role of money eliminates the
effectively connecting the present with the future double coincidence of wants inherent in the barter
and serving as a reliable store of value. system. Bank money also functions as a medium
of exchange when it gains general acceptability,
110. State the two components of M1, measure of
underscoring its value and utility in transactions.
Money Supply.
Ans : DELHI 2018 113. Explain the ‘Store of Value’ function of money.
How has it solved the related problem created by
The components of the measure of money supply
barter?
M1 are:
Ans : DELHI 2000

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 107
Ans : DELHI 2002
127. Explain the role of Repo Rate in reducing money
The Cash Reserve Ratio (CRR) is the mandated supply.
percentage of a bank’s total deposits that must Ans : SQP 2008
be kept as cash with the Central Bank. Changes
in CRR directly impact the lending capacity of The Repo Rate is the interest rate at which the
banks and the money supply. Central Bank (RBI) provides short-term loans to
Effect on Increasing Money Supply: When the commercial banks. It is a tool used to regulate
CRR is lowered, banks hold less cash with the money supply and credit creation.
Central Bank, freeing up more funds for lending. 1. Impact of Rising Repo Rate: Higher Repo
This increases credit creation and expands the Rates make borrowing costlier for commercial
money supply in the economy. Therefore, to boost banks, prompting them to increase lending
the flow of credit, the Central Bank reduces the rates for the public. This discourages
CRR. borrowing, reduces credit demand, and lowers
credit creation in the economy.
125. Explain the role of Statutory Liquidity Ratio in 2. Impact of Falling Repo Rate: Lower Repo
increasing money supply. Rates reduce borrowing costs for banks,
encouraging them to lend more. This increases
Ans : OD 2006
credit creation and expands the money supply
The Statutory Liquidity Ratio (SLR) is the in the economy.
percentage of a bank’s deposits that it must
maintain as reserves in the form of liquid assets 128. Explain the role of reverse repo rate in controlling
like cash, gold, or government-approved securities. money supply.
The Central Bank can modify the SLR to influence Ans : COMP 2010
credit and money supply.
Effect on Increasing Money Supply: When The Reverse Repo Rate is the interest rate
the Central Bank reduces the SLR, banks are the Central Bank pays commercial banks for
required to maintain a smaller portion of deposits depositing surplus funds with it.
as reserves. This allows banks to lend more, 1. Effect of Increasing Reverse Repo Rate: A
thereby increasing credit creation and expanding higher rate incentivizes commercial banks to
the money supply in the economy. deposit more funds with the Central Bank,
reducing their liquidity and lending capacity.
126. What is Legal Reserve Ratio? Explain its This curtails credit creation by commercial
components. banks.
2. Effect of Decreasing Reverse Repo Rate: A
Ans : FOREIGN 2007
lower rate discourages banks from depositing
The Legal Reserve Ratio is the legally mandated excess funds with the Central Bank,
minimum fraction of a bank’s deposits that must increasing their liquidity. This enhances their
be held as reserves, either in cash or liquid assets. lending capacity, boosting credit creation in
It has two components: the economy.
1. Cash Reserve Ratio (CRR): The portion of
deposits that commercial banks must keep as 129. Explain the role of Reverse Repo Rate in
reserves with the Central Bank. increasing money supply.
2. Statutory Liquidity Ratio (SLR): The portion Ans : DELHI 2013
of deposits that commercial banks must
maintain in cash, liquid assets, or approved The Reverse Repo Rate is the interest rate at
securities with themselves. which the RBI borrows funds from commercial
The Legal Reserve Ratio is the sum of CRR and banks for a short period. Banks use this facility
SLR, ensuring liquidity and financial stability in to park their surplus funds with the RBI and earn
the banking system. interest.
Role in Increasing Money Supply: To expand
credit or increase the money supply, the Central
Bank lowers the Reverse Repo Rate. This makes
lending to the public more profitable for banks
compared to depositing funds with the RBI.

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rate reduces borrowing costs for commercial 121. Explain the ‘bank of issue’ function of the Central
banks, enabling them to lower lending rates. Bank.
This encourages borrowing, increases credit
Ans : FOREIGN 2015
creation, and boosts money supply in the
economy. The Central Bank exclusively issues currency in
a country. In India, the Reserve Bank of India
119. Elaborate, how does a Central Bank stabilize (RBI) is authorized to issue paper currency,
money supply through ‘Bank Rate’. except one-rupee notes and coins, which are
Ans : SQP 2020
issued by the Ministry of Finance. This authority
ensures uniformity in note circulation and allows
Bank rate is the rate at which the central bank the Central Bank to directly regulate the money
of a country gives credit to the commercial banks supply. Centralized currency issuance enhances the
to meet their long-term needs. Through changes efficiency of the financial system and strengthens
in bank rate, the central bank affects the money monetary control.
supply in the economy.
Decrease in Bank Rate. When credit is to be 122. Explain the role of ‘Open market operations’ in
expanded or money supply is to be increased, reducing money supply.
the central bank reduces the bank rate. A low
Ans : SQP 2019
bank rate encourages the banks to keep a small
proportion of the deposits as reserves and use Open Market Operations involve the Central
a greater portion for giving out loans to the Bank buying or selling government securities to
borrowers or investors. Thus, money supply regulate the money supply.
increases. On the other hand, when money supply Effect on Reducing Money Supply: During
is to be reduced, Central Bank raises the bank inflation or excess demand, the Central Bank
rate. An increase in bank rate increases the cost sells government securities. Payments for these
of borrowings of commercial banks forcing them securities are made through banks, reducing the
to increase the lending rates which discourages cash reserves of commercial banks. This limits
the borrowers from taking loans. This decreases their ability to lend, decreasing credit creation and
money supply in the economy. the overall money supply. Since the money flows
back to the Central Bank and exits circulation,
120. Discuss the function of Central Bank as ‘Banker, aggregate demand in the economy falls, helping
Agent and Advisor’ to the Government. to control inflation.
or
Explain ‘Government’s Bank’ function of Central 123. Explain the role of Cash Reserve Ratio in
Bank. controlling credit creation.

Ans : OD 2020 Ans : COMP 2022

The Central Bank serves as a banker, agent, and The Cash Reserve Ratio (CRR) is the proportion
financial advisor to the government: of a commercial bank’s net demand and time
1. As a Banker: It performs all banking functions deposits that must be held as cash reserves with
for the government, including: the Central Bank.
(i) Maintaining a current account for 1. Increase in CRR: Banks must hold a higher
government cash balances. fraction of their deposits with the Central
(ii) Accepting receipts, making payments, Bank, reducing their ability to lend. This
and managing exchanges and remittances. decreases borrowings and limits the banks’
(iii) Providing short-term loans and advances credit creation capacity, leading to a decline
to the government. in the money supply.
2. As an Agent: It manages public debt on 2. Decrease in CRR: Banks hold a smaller
behalf of the government. fraction of deposits with the Central Bank,
3. As a Financial Advisor: It offers guidance on increasing their lending capacity. This boosts
economic, financial, and monetary matters to credit creation and raises the money supply
assist in policymaking. in the economy.

124. Explain the role of Cash Reserve Ratio in

increasing money supply.

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 109

The Central Bank regulates the money supply 136. Explain, using a numerical example, how an
and credit in the economy through the following increase in reserve deposit ratio affects the credit
measures: creation power of the banking system.
(i) Bank Rate Policy: This refers to the interest
Ans : SQP 2019
rate at which the Central Bank provides funds
to commercial banks during emergencies, The reserve deposit ratio refers to the minimum
acting as the lender of last resort. An increase reserves a bank must maintain at any given
in the bank rate raises the cost of borrowing time, typically expressed as a percentage. This
for commercial banks, prompting them to ratio, mandated by the central bank, represents
raise their lending rates. This discourages the portion of deposits that commercial banks
borrowing by the public, thereby reducing are required to hold. It is a key monetary policy
the volume of credit and money supply in the instrument, essential for regulating money
economy. supply. A higher reserve deposit ratio decreases
(ii) Open Market Operations: These involve the the lending capacity of banks. During inflation,
Central Bank buying or selling government central banks often raise the ratio to limit credit
securities in the open market. When the creation. For instance, if a bank holds `100 crore
Central Bank buys securities, payments in deposits and the reserve ratio is set at 6%, it
to sellers are deposited in commercial must maintain `6 crore as reserves. If the central
banks, increasing their cash reserves and bank raises the ratio to 10%, the required reserves
lending capacity, which expands the money increase to `10 crore. Consequently, the bank’s
supply. Conversely, selling securities reduces lending capacity reduces from `94 crore to `90
commercial banks’ cash reserves and lending crore due to the 4% increase in the reserve deposit
ability, thereby decreasing the money supply. ratio, demonstrating how a higher ratio curbs
lending power.

FOUR MARK QUESTIONS

NUMERICAL QUESTIONS
135. Explain any two functions of money.
137. Explain ‘Bankers’ Bank’ function of the Central
Ans : DELHI 2009
Bank.
Money serves four primary functions : or
1. Medium of Exchange: Money facilitates the Elaborate the ‘Banker’s Bank and Supervisor’
trade of goods and services by acting as a function of the Reserve Bank of India.
universally accepted medium. It overcomes
Ans : COMP 2024
the limitations of the barter system, enabling
easier transactions and offering individuals Being the apex bank, the Central Bank acts as
freedom to choose goods and negotiate better the banker to other banks, i.e., it has the same
deals. relationship with commercial banks as the latter
2. Standard of Deferred Payment: Money maintains with the general public.
is widely accepted for future payments, As the banker to banks, the Central Bank
supporting borrowing and lending, and functions in following capacities:
fostering financial institutions. (i) Custodian of Cash Reserves: It is the custodian
3. Unit of Account: Money provides a standard of their cash reserves. Banks of the country
measure for valuing goods and services, aiding are required to keep a certain percentage of
in price comparison, maintaining business their deposits with the Central Bank (known
records, and enabling the banking system. as Cash Reserve Ratio). In this way, Central
4. Store of Value: Money preserves value over Bank acts as a custodian of cash reserves of
time, is portable, and offers lower storage commercial banks.
costs, eliminating issues of perishability and (ii) Lender of the last Resort: When commercial
enabling future use. banks fail to meet their financial requirements
from other sources, they approach the Central
Bank to give loans and advances as lender of

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(ii) From the set of statements given in Column I Gross capital formation, representing total
and II, choose the correct pair or statements: investments in fixed capital, fell sharply. Savings
and current account deposits dropped by 8%
Column I Column II due to higher withdrawals, while the growth in
1. Bank money A. exchange of money currency notes held by the public exceeded bank
for goods deposits.
Although a rise in money supply often signals
2. Barter B. a component of
growth in consumption and business investments,
exchange money supply.
analysts noted that this increase was unlikely
3. Demand C. demand deposits to drive either. Instead, it reflected higher cash
deposits with created by withdrawals to meet needs during the lockdown
banks commercial banks until economic conditions stabilize.
4. Legal tender D. money which can (i) _______ (quantitative / qualitative)
be legally used to instruments of monetary policy affect the
make payment of direction of credit in the economy.
debts. (ii) Choose the correct pair of statements from
(a) 1-A the given statements in Column I and II:
(b) 2-B
(c) 3-C Column I Column II
(d) 4-D 1. LRR A. rate of interest
(iii) Who regulates money supply in India? at which Central
(a) Government of India Bank lends to
commercial banks
(b) Reserve Bank of India
for long term
(c) Commercial banks
(d) Planning Commission 2. Reverse Repo B. rate at which
Rate the RBI borrows
(iv) Which of the following is not a function of money from
The Reserve Bank of India? commercial banks
(a) It helps in barter exchange.
3. Bank Rate C. rate at which
(b) It issues the currency of the country.
Central Bank
(c) It acts as a bank of the banking system.
advances short
(d) It is the custodian of the foreign exchange
term loans to
reserves of the economy.
commercial banks
Ans :
4. Repo Rate D. minimum reserve
(i) (c) It includes term deposits with the banks. maintained by a
(ii) (d) 4-D commercial bank
(iii) (b) Reserve Bank of India (a) 1-A
(iv) (a) It helps in barter exchange. (b) 2-B
(c) 3-C
149. Read the para given below and answer the (d) 4-D
questions that follow:
The uncertainty caused by the COVID-19 (iii) Which of the following statements is true?
pandemic in India led to a sharp rise in currency (a) Money Multiplier is inversely related to
circulation as people hoarded cash or shifted LRR.
money to accessible deposits to guard against (b) Loans given by Commercial banks are
salary cuts or job losses. RBI data shows that equal to the amount of deposits they
India’s M3 money supply increased by 6.7% in receive.
the first five months of 2020 compared to 2019, (c) CRR is decreased to control inflation
marking the highest growth in seven years. (d) Demand deposits refer to the cash
Currency in circulation, including money with the reserves of Commercial Banks.
public and banks, also surged significantly.

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 111

Rounds Deposits Legal Loan The deposit creation process will be as follows: As
(`) Reserves (`) given in the question, the initial deposit is `10,000
(LRR = 20%) and LRR is 0.1 or 10%. In this case, banks keep
`1,000 as reserve and lend the remaining `9,000.
Initial 1000 200 800 The borrowed money is used to make payments
First Round 800 160 640 and the recipients of these payments deposit the
money back in the banks. In this way, banks
Second 640 128 512
receive new deposits of `9,000 of which 10%,
Round
i.e., `900 is kept as reserves and the remaining
h h h h amount (i.e., `8100) is given as loans. In this way,
Total 5,000 1,000 4,000 in every round, 90% of the loans are converted
into new deposits.
Commercial banks create money : They create
Given the amount of initial deposits and LRR,
demand deposits in the process of giving loans.
the total deposit creation is:
The money creation process can be explained
with the help of an example. = Initial deposit # 1
LRR
Suppose, initial deposit is `1,000 and LRR is 0.2
or 20%. In this case, banks keep 20%, i.e., `200 as = `10, 000 # 1 = `1, 00, 000
0.1
reserves and lend the remaining `800. Those who
borrow this money use it for making payments 143. If Legal Reserve Ratio is 0.2 and new deposits are
and those who receive payments put the money `5000, explain the process of money creation by
back into banks. In this way, banks receive new commercial banks.
deposits of `800. The banks again keep 20%,
Ans : DELHI 2003
i.e., `160 as cash and lend the rest, i.e., `640.
In this way, in every round, 80% of the loans are Process of Money Creation
converted into deposits.
Given the amount of initial deposits and LRR, Round Deposits Legal Loan
the total money creation is: (`) Reserves (`)
(LRR = 20%)
Total Demand Deposit = Initial deposit # 1
LRR Initial 5,000 1,000 4,000
= `1,000 × 1 = `5,000 First 4,000 800 3,200
0.2
Round
Since bank deposits are a part of money supply, it
is also called money creation. Second 3,200 640 2,560
Round
142. If Legal Reserve Ratio is 0.1 and new deposits are
h h h h
`10,000, explain the process of deposit creation
by the commercial banks. Total 25,000 5,000 20,000

Ans : COMP 2000 The money creation process will be as follows:

As given in the question, the initial deposit is
Process of Deposit Creation `5,000 and LRR is 0.2 or 20%. In this case, banks
Round Deposits Legal Loan keep `1,000 as reserve and lend the remaining
(`) Reserves (`) `4,000. The borrowed money is used to make
(LRR = 10%) payments and the people who have received these
payments again deposit the money in banks. In
Initial 1,000 1,000 9,000 this way, banks receive new deposit of `4,000 of
First 9,000 900 8,100 which 20% i.e., `800 is kept as reserve and the
Round remaining amount (i.e., `3,200) is given as loans.
In this manner, in every round, 80% of the loans
Second 8,100 810 7,290
advanced are converted into new deposits.
Round
Given the amount of initial deposit and LRR, the
h h h h total amount of money creation is:
Total 1,00,000 10,000 90,000 = Initial deposit # 1
LRR

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the last resort. The power of commercial banks which enables

(iii) Clearing House: It acts as a bank of central them to expand their deposits through loans is
clearance, settlements and transfers. As all called credit creation. Through this process,
commercial banks have their accounts with commercial banks are able to create credit, which
the Central Bank, it can easily settle claims of is in far excess of their cash reserves.
various commercial banks against each other This process is based on the following assumptions:
by making debit and credit entries in their (i) There is a single banking system in the
accounts. economy.
(iv) Act as a Supervisor: As a supervisor, the (ii) All transactions are routed through banks.
Central Bank regulates and controls the Numerical Example: Suppose, a customer
commercial banks by taking care of their deposits `10,000 in bank and the Legal Reserve
licensing, branch expansion, etc. Ratio (LRR) is 20%. Bank has to pay interest
on these deposits. Therefore, it further lends this
138. Explain the relationship between legal reserve money to people after retaining a part of this
ratio and money multiplier with a numerical amount to meet its customers’ obligations. Since
example. LRR is 20%, the bank will keep 20% of deposits
Ans : OD 2011 as reserve, i.e., `2,000 and will lend the remaining
80%, i.e., `8,000. Those who borrow will spend
Money Multiplier = 1
LRR this money and these `8,000 will come back to the
bank in the form of deposits. Bank again keeps
There is an inverse relationship between the two,
20% of `8,000, i.e., `1,600 as reserves and lends
i.e., lower the LRR, higher the value of money
`6,400 to those who need it. In this way, deposit
multiplier and vice-versa.
will go on increasing @ 80% of the last deposit.
For example,
This deposit creation comes to an end when the
Suppose, LRR is 20%, then money multiplier will
total reserves become equal to the initial deposit,
be
i.e., `10,000 in this case.
Money multiplier = 1 = 1 = 5 Deposit creation by Commercial Bank
LRR 0.20
Now, if LRR is 10%, then Rounds Deposits (`) Loons (`) Reserves(`)
Money multiplier = 1 = 1 = 10 I 10,000 8,000 2,000
LRR 0.10
Therefore, when LRR decreases, money multiplier II 8,000 6,400 1,600
increases. III 6,400 5,120 1,280
139. Suppose initial fresh deposits with banks = h h h h
`50,000 and LRR is 20%. How much would be the Total 50,000 40,000 10,000
total money creation in the economy?
Total Credit Creation = Initial deposits × 1
Ans : FOREIGN 2012 LRR
LRR = 20% or 0.20 = 10,000 × 1
Initial fresh deposit = `50,000 0.2
Total Deposit Creation = 10, 000 # 5 = `50, 000
= Initial fresh deposit # 1 Since LRR is 20% therefore money multiplier
LRR 1
b LRR l = 5
= 50,000 # 1
0.20 Thus, the total deposit creation is 5 times the
= 50,000 × 5 = `2,50,000 initial deposit.

140. “The process of credit creation by commercial 141. If Legal Reserve Ratio is 0.2 and new deposits are
banks comes to an end when the total of required `1,000, explain the process of money creation by
reserves become equal to the initial deposits.” the commercial banks.
With the help of a numerical example, prove that Ans : SQP 2004
the given statement is true.
Process of Money Creation
Ans : DELHI 2023

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 113

purchasing securities from the market. These (ii) Which of the following is not a quantitative
securities are generally bought at a higher method of credit control?
price than the market price. As such, banks (a) open market operation
start selling them, as a result of which their (b) bank rate policy
cash reserves increase, i.e., their liquid assets (c) legal reserve requirements
increase. This means that banks now can (d) margin requirements
create more credit. (iii) The central bank does not performs the
(ii) On the contrary, when central bank wants to following functions.
control the volume of credit, it starts selling (a) conducts sale and purchase of securities
securities in the market which are bought by for foreign governments securities.
the commercial banks. With the result, cash (b) acts as a lender of the last resort.
reserves of commercial banks are reduced and (c) controls money supply and credit.
this adversely affects their power of creating (d) manages the nation’s reserves of
credit. international currency.
(iv) Loans offered by commercial banks _____
(increase/decrease) the money supply in the
CASE BASED QUESTION economy.
Ans :
(i) (a) accepting deposits and lending
147. Read the para given below and answer the
(ii) (d) margin requirements
questions that follow:
(iii) (a) conducts sale and purchase of securities
The Reserve Bank of India (RBI) announced on
for foreign governments securities.
Friday that interest rates will remain unchanged,
(iv) Increase
while ensuring ample liquidity to support economic
recovery and manage the government’s borrowing 148. Read the para given below and answer the
requirements. The six-member Monetary Policy questions that follow:
Committee (MPC) decided to continue its The money supply encompasses all currency and
accommodative stance to revive growth and liquid instruments in a country’s economy at a
mitigate COVID-19’s economic impact, while specific time, including cash and deposits easily
keeping inflation within the target range, said convertible to cash. Governments, through central
Governor Shaktikanta Das. banks and treasuries, issue currency and coins,
The Union Budget 2021 outlined an while regulators influence the money supply
expansive fiscal approach to boost growth, and through reserve requirements, credit policies, and
the RBI affirmed its support through appropriate other regulations.
monetary policies. To manage higher government Economists assess the money supply to
borrowings, retail investors were given direct design policies by controlling interest rates and
access to invest in government securities. The regulating the economy’s money flow. An increase
RBI also raised the Cash Reserve Ratio (CRR) to in money supply typically lowers interest rates,
withdraw surplus funds from banks and use them boosting investment, consumer spending, and
for targeted market operations. business production. This, in turn, raises labour
The MPC kept the repo rate at 4 percent and demand. Conversely, a reduction in money supply
the reverse repo rate at 3.35 percent. Governor or slower growth can lead to opposite effects,
Das announced CRR restoration to 3.5 percent in reducing economic activity.
March and 4 percent in May, enabling the central
bank to use the funds for open market operations (i) Which of the following statement is not true
and liquidity management. regarding money supply?
(a) It is a stock variable.
(i) The two essential conditions for a financial (b) It does not include money held by
institution to become a bank are: government and the banking system.
(a) accepting deposits and lending (c) It includes term deposits with the banks.
(b) printing currency notes (d) It includes currency held with the public.
(c) both (a) and (b)
(d) neither (a) nor (b)

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= `5,000 # 1 = `25, 000 First 900 90 810

0.2
Round
144. Explain the process of money creation by the Second 810 81 729
commercial banks with the help of a numerical Round
example.
h h h h
Ans : OD 2005
Total 10,000 1,000 9,000
Money or credit creation by commercial banks is
Money Multiplier = 1 = 1 = 10
one of the most important function of commercial LRR 0.10
banks. It is determined by: Total Demand Deposits
(i) the amount of initial deposits; and
(ii) the Legal Reserve Ratio (LRR). It is the = Money Multiplier × Cash Reserve Deposits
minimum ratio of deposits legally required by = 10 × `1,000 = `10,000
the commercial bank to be kept as cash. This shows that the supply of money has increased
Process of credit creation : The process of credit by `10,000 in the form of demand deposits.
creation by banks is made on the assumption
that all receipts and payments in the economy 145. Explain the ‘lender of last resort’ function of
are made through banks. This can be illustrated Central Bank.
with the help of an example. Suppose, that all Ans : FOREIGN 2014
banks receive initial cash deposits of `1,000 and
CRR is 10%. It means that banks are required to When commercial banks exhaust all resources to
keep only 10% of deposits (i.e., `100) and lend supplement their funds at the time of liquidity
the remaining amount of `900. Banks do not give crisis, the Central Bank acts as the lender of the
loans in cash rather they open an account in the last resort for them. When commercial banks
borrower’s name and deposit the loan amount in cannot meet obligations of their depositors, the
his account. The borrower is free to withdraw the Central Bank comes to their help. The Central
amount as and when he wishes. These are called Bank advances credit against eligible securities
secondary deposits. subject to certain terms and conditions. This saves
Suppose, borrowers withdraw the entire amount the commercial banks from a possible breakdown.
of loan and spend it for making payments of This is an important function of the Central Bank
goods and services received. The sellers of these in the banking system of a country.
goods and services receive `900 as revenue and 146. Explain how open market operations are helpful
deposit the same in their respective banks. It will in controlling credit creation.
increase the demand deposits of banks by `900. or
Now, Banks keep 10% of these new deposits, “Open Market Operation by the Reserve Bank of
i.e., `90 as cash reserve and lend the remaining India (RBI) helps in regulating money supply in
amount of `810. The borrowers will again use the economy.” Justify the given statement.
their loans for making payments which again
come back into the accounts of those who have Ans : SQP 2020

received these payments. An important tool in the hands of the Central

Banks again will keep 10% of `810 and lend the Bank for affecting money creation by Commercial
remaining amount of `729 (`810 – `81). banks is open market operations. Open market
Like this in each successive round creation of operations mean the sale and purchase of all kinds
deposits will be 90% of the previous round. of bills and securities by the central bank in the
This working has been shown in the following open market.
table: Process of Credit Creation According to this method, central bank controls
the volume of credit by increasing or decreasing
Round Deposits Legal Loan
the quantity of money in the economy through
(`) Reserves (`)
sale and purchase of securities in the money
(LRR = 10%)
market.
Initial 1,000 1,000 9,000 (i) When central bank of the country wants
to increase the volume of credit, it starts

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CBSE CHAPTERWISE QB CLASS 12 ECONOMICS PAGE 115

(iv) The moral influence that the Central Bank (iii) The monetary policy generally targets to
applies on member banks in order to get ensure:
them to act in line with its policy is called as (a) price stability in the economy.
______. (b) employment generation in the country.
(c) stable foreign relations.
Ans :
(d) greater tax collections for the government.
(i) Qualitative
(iv) Lowering the bank rate is a measure to:
(ii) (b) 2-B
(a) encourage foreign investment in the
(iii) (a) Money Multiplier is inversely related to
economy.
LRR.
(b) increase money supply in the economy.
(iv) Moral suasion
(c) discourage investment activity in the
150. Read the para given below and answer the economy.
questions that follow: (d) increase government expenditure.
The Reserve Bank of India (RBI) serves as Ans : FOREIGN 2018
India’s central bank and stands at the apex of the
(i) (c) 5
country’s banking structure. As a key governing
(ii) (a) reduce cash reserve ratio.
and regulatory body, it plays a vital role in
(iii) (a) price stability in the economy.
facilitating the government’s economic functions.
(iv) (b) increase money supply in the economy.
Established on April 1, 1935, and nationalized
in 1949, the RBI operates under the provisions 151. Read the following text carefully. Answer the
of the RBI Act. Its activities are overseen by a given questions on the basis of the same and
government-appointed Board of Directors. The common understanding:
RBI is the sole authority for issuing currency, On 30th September 2022, the Reserve Bank of
responsible for printing, distributing, and India (RBI) raised Repo Rate for the fourth time
regulating the flow of money in the economy. in a row. The Monetary Policy Committee (MPC)
The RBI provides essential banking services decided to raise the policy rate by 50 basis points
to both central and state governments, including
(1 basis point = 1 th of a percent).
deposits, remittances, loans, and advances. It 100
supervises commercial banks, offering them After this announcement, the new Repo
financial assistance through short-term loans. rate stands at 5.9%, while the Reverse repo rate
As the custodian of foreign exchange reserves, continues to stand at 3.35%.
the RBI safeguards the value of the rupee in the Commercial banks borrow money from the
global market by maintaining adequate reserves Central Bank, when there is a shortage of funds.
to counteract fluctuations. With the surge in the Repo rate, borrowings
Additionally, the RBI regulates credit by general public will become costlier. This is
and money supply in the economy. It employs because, as RBI hikes its Repo rate, it becomes
qualitative and quantitative tools to expand or costly for the banks to borrow short term funds
contract available credit based on economic needs, from the Central Bank.
ensuring stability and growth. As a result, the banks hike the rate at
(i) If the legal reserve ratio is 20%, the value of which customers borrow money from them to
money multiplier would be: compensate for the hike in the Repo rate. This
(a) 2 happens because banks offer loans to retail
(b) 3 consumers at an interest rate which is generally,
(c) 5 directly proportional to the Repo rate.
(d) 4 The increase of 0.50 percent in Repo rate will
lead to higher interest rates on loans for borrowers,
(ii) In order to encourage investment in the implying that the Equated Monthly Installments
economy, the central bank may: (EMIs) for repaying the existing loans will also
(a) reduce cash reserve ratio. increase.
(b) increase cash reserve ratio. (i) Define ‘Repo Rate’.
(c) sell government securities in open market. (ii) Outline the recent change made by the
(d) increase the bank rate. Monetary Policy Committee of Reserve Bank
of India in the Repo rate.

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CH 2 : MONEY AND BANKING

(iii) “Increase in Repo rate is an important

tool used by Monetary Policy Committee
to combat the situation of inflation in the [Link]
Economy.” Justify the given statement.
(iv) State the meaning of reverse repo rate.
(v) In order to bring down the rate of inflation
outline and discuss the step taken by the
Monetary Policy Committee of Reserve Bank
of India.
Ans : OD 2023

(i) Repo Rate. It may be defined as the rate at

which the Central Bank lends money to the
commercial banks in the event of any shortfall
of funds in the short-run.
(ii) The Monetary Policy Committee decided to
raise the policy rate by 50 basis points
(1 basis point = 1 th of a percent).
100
The new Repo rate is now 5.9%.
(iii) Repo rate is the rate of interest charged by
Central Bank on loans given to commercial
banks. During a situation of excess demand
leading to inflation, the Central Bank raises
the Repo rate which discourages commercial
banks in borrowing from the Central Bank.
Increase in Repo rate forces commercial banks
to increase their own lending rates making
credit costlier. As a result, the demand for
loans falls discouraging investment. Also
reduction in availability of credit helps in
correcting the situation of excess demand and
reducing inflationary gap.
(iv) Reverse Repo Rate. It is the rate at which
the Central bank of a country borrows money
from the commercial banks.
Increase in repo rate encourages commercial
banks to deposit funds with the Central bank
reducing avail-ability of funds with it. This,
thus helps in curtailing money supply in the
economy and vice-versa.
(v) Steps taken in order to bring down the Rate of
Inflation. During a situation of excess demand
leading to inflation, the Central Bank raises
the repo rate which discourages Commercial
Banks in borrowing from the Central Bank.
Increase in repo rate forces Commercial Banks
to increase their own lending rates making
credit costlier. As a result, the demand for
loans falls discouraging investment. Also
reduction in availability of credit helps in
correcting the situation of excess demand and
reducing inflationary gap.

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