Under Statutory Liquidity Ratio, commercial banks are required to keep a fraction of _____ in the form of liqu

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Q.Under Statutory Liquidity Ratio, commercial banks are required to keep a fraction of _________ in the form of liquid assets. (Choose the correct alternative) (A) Total deposits (B) Term deposits (C) Total demand and term deposits (D) Current deposits

Lakshadweep CbseCBSE Class XII Board 2020Subjective· 1mImportance★★★★★

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Concept understanding — Money Multiplier Determinants

The Money Multiplier: From a ₹100 Note to a River of Credit

Imagine you find a crisp ₹100 note on the street. You deposit it in your bank account. What happens next? That ₹100 doesn't just sit in a vault. The bank, keeping only a fraction aside as required by the RBI, lends out the rest — say ₹90. That ₹90 goes to someone who pays a shopkeeper, who deposits it in their bank. That bank again keeps a fraction and lends out, say ₹81. The cycle repeats.

Your single ₹100 note has now created deposits worth ₹100 + ₹90 + ₹81 + … — a total far larger than the original amount. This multiplying effect is the money multiplier in action.

The Precise Meaning

The money multiplier ( $m$ ) tells us the maximum amount of money the banking system can create from each rupee of fresh reserves (like your ₹100 deposit). It is the ratio of the total money supply ( $M$ ) to the monetary base ( $H$ , also called high-powered money — currency held by the public plus reserves of banks).

m = \frac{M}{H}

Where:

$M$ = total money supply (currency with public + demand deposits)
$H$ = high-powered money (currency with public + cash reserves of banks)

What Determines the Multiplier? (The NCERT Story)

The multiplier is not a magic number. It depends on two key behavioural ratios that the NCERT textbook emphasises:

1. The Currency-Deposit Ratio ( $c$ )

This is the proportion of money people prefer to hold as cash rather than in bank deposits.

c = \frac{C}{D}

$C$ = currency held by the public
$D$ = demand deposits with banks

If people trust banks and find digital payments easy, $c$ is low — more money stays in the banking system, and the multiplier is larger. If people panic and hoard cash (like during a bank run), $c$ rises, and the multiplier shrinks.

2. The Reserve-Deposit Ratio ( $r$ )

This is the fraction of deposits banks keep as reserves (both required by RBI and extra as precaution).

r = \frac{R}{D}

$R$ = total reserves of banks (vault cash + RBI deposits)
$D$ = demand deposits

The RBI sets a minimum Cash Reserve Ratio (CRR) — say 4%. If banks keep exactly that, $r = 0.04$ . If they keep more (excess reserves), $r$ is higher.

The Formula That Connects Everything

From the definitions, NCERT derives the money multiplier in terms of these two behavioural ratios:

m = \frac{1 + c}{c + r}

Let's see why this makes sense:

The numerator $1 + c$ reflects that total money supply $M = C + D = cD + D = D(1 + c)$
The denominator $c + r$ reflects that high-powered money $H = C + R = cD + rD = D(c + r)$
Dividing: $m = \frac{D(1 + c)}{D(c + r)} = \frac{1 + c}{c + r}$

What This Tells Us (The "Why It Matters")

If $c = 0$ (no cash holding, all money in banks): $m = \frac{1}{r}$ . With a 10% reserve ratio, the multiplier is 10 — each rupee of reserves creates ₹10 of deposits.
If $c$ is large (people prefer cash): the multiplier falls. Cash "leaks" out of the banking system and stops the chain of lending.
If $r$ is large (banks keep more reserves): the multiplier falls. Less money is available to lend.

Watch out

The multiplier is a maximum theoretical value. In reality, banks may not lend all excess reserves, and borrowers may not spend all borrowed money immediately. The actual multiplier is usually smaller.

A Simple Numerical Example (NCERT Style)

Suppose:

$c = 0.2$ (people hold ₹20 cash for every ₹100 in deposits)
$r = 0.1$ (banks keep 10% of deposits as reserves)

Then:

$m = \frac{1 + 0.2}{0.2 + 0.1} = \frac{1.2}{0.3} = 4$ …

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The Statutory Liquidity Ratio (SLR) is a monetary policy tool requiring commercial banks to maintain a fraction of their total demand and term deposits (Net Demand and Time Liabilities) in liquid assets, primarily to ensure bank liquidity and control credit.

Commercial banks operate on a system of fractional reserve banking, meaning they lend out a significant portion of the deposits they receive, keeping only a fraction as reserves. While this allows for credit creation and economic growth, it also exposes banks to the risk of liquidity crises, where many depositors might simultaneously demand their money back. To safeguard against such situations and maintain financial stability, central banks like the Reserve Bank of India (RBI) employ various regulatory tools. One crucial tool is the Statutory Liquidity Ratio (SLR).

The economic intuition behind SLR is rooted in the need for both individual bank stability and systemic financial stability. The RBI, as the central bank, acts as the "Lender of Last Resort" (LLR) to commercial banks. This means that in times of severe liquidity crunch, the RBI stands ready to provide emergency funds to solvent banks to prevent a collapse of the banking system. However, relying solely on the LLR function is reactive. SLR is a proactive measure designed to reduce the likelihood of banks needing to approach the RBI as an LLR in the first place. By mandating that banks hold a certain percentage of their liabilities in highly liquid assets, SLR ensures that banks have an internal buffer to meet unexpected withdrawals and maintain their solvency, thereby strengthening the overall financial system.

The Statutory Liquidity Ratio (SLR) is the percentage of a bank's total deposits that it is required to maintain in the form of liquid assets. These liquid assets typically include cash, gold, and unencumbered approved securities (like government securities). The RBI sets this ratio, and banks must adhere to it at all times.

The primary purposes of the SLR are:

Ensuring Liquidity and Solvency: It acts as a safety net, ensuring banks have sufficient liquid funds to meet their short-term obligations, such as depositor withdrawals, even during periods of high demand. This builds confidence in the banking system.
Credit Control: By requiring banks to hold a portion of their funds as SLR, the RBI effectively reduces the amount of money available for lending. This is a tool to control the overall credit flow and money supply in the economy, helping to manage inflation or stimulate growth.
Facilitating Government Borrowing: A significant portion of the assets held under SLR are government securities. This creates a captive market for government bonds, helping the government finance its fiscal deficit at reasonable interest rates.

The base on which the SLR is calculated is a bank's Net Demand and Time Liabilities (NDTL). Let's break down what this means:

Demand Deposits: These are deposits that can be withdrawn by depositors on demand, without prior notice. They include:
- Current Account Deposits: Held by businesses, typically for frequent transactions, with no interest or very low interest. …

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Q.Under Statutory Liquidity Ratio, commercial banks are required to keep a fraction of _________ in the form of liquid assets. (Choose the correct alternative) (A) Total deposits (B) Term deposits (C) Total demand and term deposits (D) Current deposits

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