Exam-useful questions from this chapter, grouped by marks, each with a full model answer. Try writing the answer yourself first, then check it against this one.
In CBSE 2026-27 the unit ‘Money and Banking’ carries 6 marks. The demand for money (transaction and speculative motives) and M2 to M4 are not in the CBSE syllabus, but the UP, Bihar, Rajasthan and MP boards teach from the same NCERT book; such questions are marked. The (½) and (1) marks in numerical answers show step marks as in the CBSE marking scheme.
1 1-Mark Questions
Q. What is barter exchange?
Answer: The exchange of goods directly for goods, without the mediation of money, is barter exchange.
Q. What is meant by double coincidence of wants?
Answer: A situation in which each of two persons has exactly the good the other wants, and both wish to exchange those goods.
Q. Write the formula of the money multiplier.
Answer: Money multiplier = 1 ÷ Cash Reserve Ratio (CRR).
Q. Who issues coins in India?
Answer: The Government of India (currency notes are issued by the Reserve Bank of India).
Q. What is ‘spread’ in banking?
Answer: The difference between the interest rate charged on loans and the rate paid on deposits; it is the bank’s profit.
Q. Name two qualitative tools of the RBI.
Answer: Moral suasion and margin requirement.
Q. What is legal tender?
Answer: Money (currency notes and coins) that no citizen of the country can refuse in settlement of any transaction.
Q. What is liquidity preference? (Not in CBSE 2026-27 syllabus)
Answer: The demand for money balance, decided by weighing the advantage of liquidity against the interest given up, is called liquidity preference.
Q. At a CRR of 20%, by which formula and to what does the series 100 + 80 + 64 + … sum?
Answer: S = a ÷ (1 − r) = 100 ÷ (1 − 0.8) = ₹500.
Q. Define the currency deposit ratio.
Answer: The ratio of currency held by the public to its bank deposits.
2 2-Mark Questions
Q. Distinguish between demand deposits and time deposits.
Answer: (1) Demand deposits (savings and current accounts) are payable on demand; time deposits (fixed deposits) have a fixed period to maturity. (1)
(2) Demand deposits can be used through cheques and are part of M1; time deposits enter M3, not M1. (1)
Q. Why is the RBI called the ‘lender of last resort’?
Answer: When commercial banks need funds to create more credit or to repay depositors and cannot get them elsewhere, the RBI provides funds through various instruments. (1) Because it is ready to lend to banks at all times, it is called the lender of last resort. (1)
Q. State two differences between CRR and SLR.
Answer: (1) Under the CRR the reserves are kept with the central bank; under the SLR the banks keep them with themselves. (1)
(2) The CRR is held as cash reserves; the SLR in the form of specified liquid assets. (1)
3 3-Mark Questions
Q. The initial deposit is ₹500 and the cash reserve ratio is 12.5%. Find the money multiplier, total deposits and total credit.
Answer: Money multiplier = 1 ÷ CRR = 1 ÷ 0.125 = 8 (1)
Total deposits = initial deposit × multiplier = 500 × 8 = ₹4,000 (1)
Total credit = total deposits − initial deposit = 4,000 − 500 = ₹3,500 (1)
Meaning: a new deposit of ₹500 lets banks give ₹3,500 of new loans.
Q. How does money overcome the shortcomings of the barter system? Explain in three points.
Answer: • No double coincidence → medium of exchange: everyone accepts money, so one sells for money and buys anything with it; no matching partner is needed. (1)
• No common measure of value → unit of account: every value is in rupees; with a pen at ₹10 and a pencil at ₹2, one pen = 5 pencils at once. (1)
• Wealth hard to carry forward → store of value: rice is perishable and takes space; money does not perish, costs little to store and is acceptable at any time. (1)
Q. Explain the ‘bank of issue’ and ‘banker to the government’ functions of the central bank.
Answer: Bank of issue: the central bank alone issues the country’s currency (in India the RBI issues notes; coins come from the government). This brings uniformity and gives direct control over money supply. (1½)
Banker to the government: it keeps the accounts of the central and state governments, receives and makes payments for them, gives short-term credit, manages public debt and advises on banking and financial matters. (1½)
Q. The RBI cut the CRR from 5% to 4%. Assume the whole banking system works as one bank and all transactions pass through banks. Using a new deposit of ₹1,000, explain the effect on total money creation.
Answer: Multiplier before = 1 ÷ 0.05 = 20; after = 1 ÷ 0.04 = 25 (1)
Total deposits before = 1,000 × 20 = ₹20,000; after = 1,000 × 25 = ₹25,000 (1)
Effect: a lower CRR lets banks lend a larger part of each deposit, the multiplier rises and the same deposit creates ₹5,000 more money; credit and money supply rise. (1)
Q. What are open market operations? How do they affect the money supply?
Answer: Meaning: the buying and selling of government bonds in the open market by the central bank on behalf of the government. (1)
Purchase: the RBI pays by cheque, reserves in the economy rise, banks lend more, money supply rises. (1)
Sale: buyers pay the RBI, reserves fall, money supply falls. They can be outright (permanent) or repo (date and price of reversal fixed). (1)
Q. Explain margin requirement. If the margin on a security worth ₹50 lakh falls from 30% to 20%, what happens to the loan?
Answer: Meaning: the margin is the difference between the loan amount and the market value of the security offered against it; the central bank fixes it. It is a qualitative tool. (1)
Loan at 30% margin = 50 × (1 − 0.30) = ₹35 lakh (½)
Loan at 20% margin = 50 × (1 − 0.20) = ₹40 lakh (½)
Effect: a lower margin gives ₹5 lakh more credit on the same security; credit expands. A higher margin reduces credit. (1)
Q. What is high powered money? Why is it so called?
Answer: • Currency issued by the central bank and held by the public or by commercial banks (as reserves) is high powered money. (1)
• It is also called reserve money or monetary base. (1)
• Bank reserves are part of it and credit creation rests on them; through the multiplier one unit supports several units of deposits (₹100 supports ₹500 at a 20% CRR), hence ‘high powered’. (1)
Q. What are fiat money and legal tender? Why are demand deposits not legal tender?
Answer: • Fiat money: notes and coins have no intrinsic value (the paper of a ₹100 note is worth far less than ₹100); their value comes from the issuer’s guarantee (the RBI Governor’s promise). (1)
• Legal tender: notes and coins cannot be refused by any citizen in settling a transaction. (1)
• A cheque on a savings or current account can be refused by anyone, so demand deposits are not legal tender. (1)
4 4-Mark Questions
Q. Explain the process of credit creation by commercial banks with an initial deposit of ₹100 and a CRR of 20%.
Answer: Assumptions: the banking system is one bank, all payments go through it, and it keeps only the minimum required reserves. (½)
Round 1: Leela deposits ₹100; the bank keeps 20%, ₹20, as reserves and lends ₹80 to Jaspal Kaur. (1)
Round 2: the ₹80 is spent and comes back as a deposit; total deposits ₹180, required reserves ₹36, so the bank lends 100 − 36 = ₹64 to Junaid. (1)
End: the process stops when required reserves equal the whole ₹100, i.e. total deposits ₹500 (20% of 500 = 100) and total loans ₹400. (1)
Money multiplier = 1 ÷ 0.2 = 5; reserves of ₹100 support 5 × 100 = ₹500 of deposits. (½)
Q. Explain the ‘bankers’ bank’ function of the central bank.
Answer: • Holding reserves: banks must keep a stipulated part of their deposits (the CRR) with the central bank, which uses it as an instrument of credit control. (1)
• Lender of last resort: from this pool the central bank lends to banks temporarily short of funds; it stands ready to lend at all times. (1)
• Clearing and remittance: it provides centralised clearing and remittance facilities so that banks can settle dealings with one another. (1)
• Supervision and regulation: it regulates licensing, branch expansion, liquidity of assets, management, mergers and winding up of banks, through inspection and returns. (1)
Q. Explain the repo rate and the reverse repo rate. How will the RBI change them to reduce money supply?
Answer: • Repo: the RBI buys a security under an agreement that fixes the date and price of resale; the interest rate on money lent to banks this way is the repo rate. (1)
• Reverse repo: the RBI sells a security with an agreement fixing the date and price of repurchase; the rate at which money is withdrawn this way is the reverse repo rate, the rate the RBI pays on banks’ funds. (1)
• To reduce money supply: the RBI raises the repo rate, so borrowing by banks becomes costlier and they raise lending rates. (1)
• It also raises the reverse repo rate, so banks prefer to park surplus funds with the RBI and have less to lend. (1)
Q. A bank has deposits of ₹5,000. The CRR is 10% and the bank lends out the rest.
(a) Prepare its balance sheet and state its net worth.
(b) If the whole banking system worked as one bank with ₹5,000 as the initial deposit, what would total deposits and total loans be at the end?
Answer: (a) Reserves = 10% of 5,000 = ₹500; loans = 5,000 − 500 = ₹4,500 (1)
| Assets | ₹ | Liabilities | ₹ |
|---|---|---|---|
| Reserves | 500 | Deposits | 5,000 |
| Loans | 4,500 | Net worth | 0 |
| Total | 5,000 | Total | 5,000 |
Net worth = assets − liabilities = 5,000 − 5,000 = 0 (1)
(b) Multiplier = 1 ÷ 0.10 = 10; total deposits = 5,000 × 10 = ₹50,000 (1)
Total loans = 50,000 − 5,000 = ₹45,000 (1)
Q. From the data find M1, M2, M3 and M4. (₹ crore) Currency with the public 400; net demand deposits with banks 600; savings deposits with post office savings banks 50; net time deposits of banks 1,500; total deposits with post office savings organisations (excluding NSC) 120
Answer: M1 = CU + DD = 400 + 600 = ₹1,000 crore (1)
M2 = M1 + post office savings deposits = 1,000 + 50 = ₹1,050 crore (1)
M3 = M1 + net time deposits = 1,000 + 1,500 = ₹2,500 crore (1)
M4 = M3 + total post office deposits = 2,500 + 120 = ₹2,620 crore (1)
M1 and M2 are narrow money; M3 and M4 are broad money.
Q. What was demonetisation (2016)? State its aims and two positive effects.
Answer: • Meaning: in November 2016 the Government of India ended the legal tender status of old ₹500 and ₹1000 notes and launched new ₹500 and ₹2000 notes. (1)
• Aims: to tackle corruption, black money, terrorism and fake currency. (1)
• Tax compliance: many people came into the tax net; tax evasion now meant penalty and social condemnation. (1)
• Formal finance: savings moved into the formal financial system, giving banks more resources to lend at lower interest rates; households and firms shifted from cash to electronic payments. (1)
Q. Distinguish between the quantitative and qualitative tools of the RBI, with two examples of each.
Answer: • Quantitative tools change the extent of money supply and total credit (by acting on bank reserves and the cost of borrowing). (1)
• Examples: cash reserve ratio, bank rate (also repo rate, open market operations). (1)
• Qualitative tools are the central bank’s ways of making banks encourage or discourage lending. (1)
• Examples: moral suasion (persuasion), margin requirement (changing the margin to change the loan allowed against a security). (1)
Q. What is the transaction demand for money? How is it related to the value of transactions over a period? (Not in CBSE 2026-27 syllabus)
Answer: • People hold money to carry out transactions, because income comes at discrete dates but spending is continuous; this is the transaction demand. (1)
• Income of ₹100 a month spent evenly: average cash = (100 + 0) ÷ 2 = ₹50, half the transactions. (1)
• In general $M^d_T = k.T$, where T is the value of transactions in the unit period and k a positive fraction; so the transaction demand is a fraction of the value of transactions. (1)
• v = 1/k is the velocity of circulation (in the two-person example ₹100 finances ₹200 of transactions, v = 2); $M^d_T = kPY$, so it rises with real income and the price level. (1)
5 6-Mark Questions
Q. How do commercial banks create money? Explain with a table and the money multiplier. What limits credit creation?
Answer: Basis: banks know that all depositors will not withdraw at the same time, so they keep part of deposits as reserves and lend the rest. A loan opens a new deposit in the borrower’s name, so money supply = old deposits + new deposit. (1)
Example (CRR 20%, initial deposit ₹100): (2)
| Round | Deposits | Required reserves | Loans |
|---|---|---|---|
| 1 | 100 | 20 | 80 |
| 2 | 180 | 36 | 64 |
| … | … | … | … |
| Last | 500 | 100 | 400 |
Money multiplier = 1 ÷ CRR = 1 ÷ 0.2 = 5; total deposits = 100 × 5 = ₹500; total loans = ₹400; M1 rises from ₹100 to ₹500. (1½)
Limit: the CRR fixed by the RBI is a legal, binding requirement; once required reserves equal the initial deposit no more loans are possible. The higher the CRR, the smaller the multiplier and the credit (at 25% the multiplier is 4 and loans ₹300). (1½)
Q. Money supply in the economy has become excessive. Using any four instruments, explain how the RBI would reduce it.
Answer: • Raise the CRR: banks must keep a larger part of deposits with the RBI; the multiplier falls (from 5 to 4 when 20% becomes 25%) and loans shrink. (1½)
• Raise the bank rate / repo rate: borrowing from the RBI becomes costlier; banks raise lending rates, demand for loans and credit fall. (1½)
• Sell bonds in the open market: buyers pay the RBI, reserves in the economy fall, money supply falls. (1½)
• Raise the margin requirement: less credit against the same security (on a ₹10 lakh security, ₹6 lakh at a 40% margin, ₹5 lakh at 50%). Moral suasion can ask banks to lend less, and the SLR and reverse repo rate can also be raised. (1½)
Q. Describe the main functions of the Reserve Bank of India.
Answer: 1. Bank of issue: sole right to issue the country’s currency; uniformity and direct control over money supply. (1)
2. Banker to the government: government accounts, payments, short-term credit, management of public debt, advice. (1)
3. Bankers’ bank: holds banks’ cash reserves, provides clearing, supervises and regulates banks. (1)
4. Lender of last resort: ready to lend to banks at all times. (1)
5. Controller of credit: regulates money supply through CRR, SLR, bank rate, repo/reverse repo, open market operations (quantitative) and margin requirement, moral suasion (qualitative). (1)
6. Custodian of foreign exchange reserves: holds the economy’s foreign exchange reserves. (1)
Q. A new deposit of ₹2,000 enters the banking system and the CRR is 20%.
(a) Find the money multiplier, total deposits and total loans.
(b) The RBI raises the CRR to 25%. Find the new total deposits and total loans.
(c) What must banks do, and what happens to the money supply?
Answer: (a) Multiplier = 1 ÷ 0.20 = 5 (½); total deposits = 2,000 × 5 = ₹10,000 (1); total loans = 10,000 − 2,000 = ₹8,000 (1)
(b) Multiplier = 1 ÷ 0.25 = 4 (½); total deposits = 2,000 × 4 = ₹8,000 (1); total loans = 8,000 − 2,000 = ₹6,000 (1)
(c) Loans must fall from ₹8,000 to ₹6,000, so banks must call back ₹2,000 of loans; deposits fall by ₹2,000 and money supply falls. (1)
Q. Explain the speculative demand for money through the relation between bond prices and the rate of interest. What is a liquidity trap? (Not in CBSE 2026-27 syllabus)
Answer: Bonds and present value: a bond with face value ₹100, 10% coupon and 2-year maturity has PV = 10/1.05 + 110/1.05² ≈ ₹109.30 at 5% and ≈ ₹107.33 at 6%. In equilibrium price = present value, so bond prices are inversely related to the rate of interest. (2)
Speculative demand: when the rate is high, people expect it to fall (bond prices to rise, capital gains) and convert money into bonds, so speculative demand is low; when the rate is low, fearing capital losses they sell bonds and hold money, so it is high. Hence $M^d_S = (r_{max} – r)/(r – r_{min})$, inversely related to the rate. (2)
Liquidity trap: at r = rmin everyone expects the rate to rise and nobody holds bonds; extra money is simply held as money and the rate falls no further. Speculative demand is infinitely elastic (the curve is flat). At r = rmax speculative demand is zero. (2)
6 10-Mark Questions
Q. State the functions of a commercial bank. Explain with an example how banks create credit, and how the central bank controls credit. (UP Board 10 marks)
Answer: 1. Functions of a commercial bank (3): (a) accepting deposits: demand deposits (savings, current) and time deposits, which earn interest; (b) giving loans: home loans, crop loans etc., at a rate above the deposit rate, the gap (spread) being profit; (c) payment services: cheques, debit cards; (d) credit creation.
2. Credit creation (4): banks keep only the CRR share of deposits as reserves. With a CRR of 20% and Leela’s deposit of ₹100: ₹20 reserves, ₹80 lent (Jaspal Kaur); the ₹80 returns as a deposit, total ₹180, reserves ₹36, loan ₹64 (Junaid) … finally deposits ₹500, reserves ₹100, loans ₹400.
| Assets | ₹ | Liabilities | ₹ |
|---|---|---|---|
| Reserves | 100 | Deposits | 500 |
| Loans | 400 | ||
| Total | 500 | Total | 500 |
Money multiplier = 1/CRR = 5. The CRR is the limit to credit creation.
3. Credit control by the central bank (3): quantitative: CRR, SLR, bank rate, repo/reverse repo rates (raising them cuts credit), open market operations (selling bonds cuts it, buying raises it); qualitative: margin requirement (a higher margin means less credit against a security), moral suasion. The RBI is also the lender of last resort.
7 Source-Based Questions
(A) 1 mark Which role of the central bank does ‘lend as a last resort’ show?
Answer: Lender of last resort (as the bankers’ bank).
(B) 2 marks What is a repo operation? How does a 14-day repo give banks funds?
Answer: In a repo the central bank buys securities from banks under an agreement that fixes the date (here 14 days later) and price of resale. (1) Banks receive the purchase money, so their reserves rise for 14 days; the interest on this lending is the repo rate. (1)
(C) 3 marks Analyse the effect of the repo rate cut on credit and money supply.
Answer: • A lower repo rate makes short-term borrowing by banks from the central bank cheaper. (1)
• Banks’ costs fall, so they can cut their lending rates; people and firms borrow more. (1)
• New loans create new deposits, so credit and money supply rise, which suits the shortage of funds mentioned in the passage. (1)
8 Data / Graph-Based Questions
2024-25: M1 = 65,84,081; M3 = 2,72,86,589
(A) 2 marks Find the net time deposits of commercial banks (M3 − M1) in 2014-15 and 2024-25.
Answer: M3 − M1 = net time deposits (the book: the difference is due to time deposits) (½)
2014-15: 1,05,50,168 − 22,92,404 = ₹82,57,764 crore (½ + ½)
2024-25: 2,72,86,589 − 65,84,081 = ₹2,07,02,508 crore (½)
(B) 2 marks Why is M1 called narrow money and M3 broad money? Roughly how many times M1 was M3 in 2024-25?
Answer: M1 has only currency and demand deposits, the most liquid forms; M3 adds time deposits, which are less liquid. The measures are in decreasing order of liquidity. (1)
2,72,86,589 ÷ 65,84,081 ≈ 4.14 times. (1)