We hear about money supply, repo rates, RBI moves, and credit growth all the time. But what do these terms really mean for a layperson?

Like many of you, I’ve often had basic but essential questions. Instead of shying away, I decided to ask them openly and then answer them by researching, reflecting, and writing through my own lens and reformatted using Grammarly for clear communication. This is my attempt to remove the hesitation around “simple” questions and uncover clear, practical explanations.

In this first part, we’ll walk through 26 FAQs starting from the basics of money supply, moving through how banks create credit, and ending with how RBI’s tools influence liquidity, lending, and the broader economy.

While working on this, I realized there are still more questions I’d like to explore. I’ll take those up in the next part of this series.

Note: Wherever I mention “current” values (like CRR, corridor, etc.), treat them as examples—always check RBI’s latest releases for exact, up-to-date numbers.

1) What is money? (M0, M1, M2, M3, M4—simple)

M0 (Base money / reserve money): Notes + coins in circulation with the public and banks’ reserves with the RBI. This is the foundation RBI creates.
M1 (Narrow money): Currency with the public + demand deposits with banks (current & savings you can use instantly).
M2: M1 + certain small savings (e.g., post office savings).
M3 (Broad money, most used): M1 + time deposits (FDs/RDs). This is the typical “money supply” you hear about.
M4: M3 + broader post office deposits.

Think of it as expanding circles: M0 (cash & reserves) at the core; M3 includes most bank money people actually hold.

2) How does today’s money supply compare to GDP? Why are they different?

GDP is a flow (what we produce/income over a year).
- India’s GDP (nominal) is about ₹331 lakh crore (FY 2024-25)
Money supply is a stock (how much money/deposits exist at a point in time).
- M0 (base money) is typically much smaller, usually accounting for around 15–20% of GDP (₹49.6 lakh crore as of May 2025)
- M3 (broad money) is typically about 80–100% of GDP (₹279 lakh crore as of May 2025)
They differ because bank lending multiplies deposits (see money creation below) and because GDP isn’t “how much money there is,” but how much stuff/services we produce.

Quick Info

If money supply outpaces GDP for long → inflation/bubbles risk.
If GDP outpaces money supply too much → funding/credit constraints.

3) Is there a “multiplier” between M0 and M3 (or GDP)?

Money multiplier ≈ (Broad money M3) / (Base money M0).
In India it’s often in the 4–6× zone over long stretches (varies with cash habits, CRR, banks’ risk appetite).
There’s no fixed multiplier for GDP. GDP also depends on productivity, investment, and how quickly money circulates (velocity).

4) Who creates money—RBI or banks (or both)?

RBI creates M0 (prints currency, provides reserves).
Banks create deposit money when they lend (your loan becomes someone’s deposit). So, the system is: RBI lays the base; banks multiply it.

5) How do banks actually create money? (1-bank, 2-people example)

Two people deposit ₹1,000 each in the only bank.
- Bank balance sheet: Assets: ₹2,000 cash; Liabilities: ₹2,000 deposits.
Person A takes a ₹1,000 loan and redeposits it.
- Now deposits = ₹3,000, although the initial cash was ₹2,000.
Lending created new deposit money. That’s how M1/M3 expands beyond M0.

(Real life adds brakes: CRR/SLR, capital rules, risk checks, cash leakage, etc.)

6) What is CRR and how does it impact lending?

CRR (Cash Reserve Ratio) = % of a bank’s NDTL (Net Demand & Time Liabilities—basically deposits) that must be kept in cash with RBI.
Banks earn no interest on CRR; they can’t lend it.
Higher CRR → less lendable funds, tighter credit; lower CRR → more lendable funds.

Example: If CRR is 4.5%, every ₹100 of deposits requires ₹4.5 at RBI, leaving ₹95.5 (before other constraints) to deploy.

7) What is CET1 / Tier-1 capital, and why does it matter?

CET1 (Common Equity Tier-1) = pure shareholder equity & retained earnings (these are first loss absorber**)**
Tier-1 = CET1 + perpetual instruments.
Regulators set minimum ratios (CET1 %, Tier-1 %, Total Capital %) to ensure banks don’t over-leverage.
Higher capital → safer bank → can absorb shocks; but equity is expensive, so loan pricing must cover a capital charge.

8) What is a bank’s “cost of capital”? Why does it differ by bank?

It’s the weighted average of:
1. Cost of funds (CASA, FDs, CDs, bonds, interbank),
2. Cost of equity (shareholders expect ~low to high teens returns),
3. Liquidity/capital costs.
A bank with high CASA and a strong credit rating raises money cheaply than one that relies on costly fixed deposits/wholesale borrowing or lends to riskier segments.

Pricing lens (in simple terms):

Loan Rate = External Benchmark (EBLR) + Bank Spread, where Spread must cover: operating costs + expected credit losses + capital charge + liquidity premium + profit.

9) Why link loans to EBLR?

EBLR (External Benchmark Linked Rate) ties floating retail/MSME loans to transparent benchmarks (e.g., repo, 3m/6m T-bill, or other FBIL benchmarks like overnight rates).
This makes policy transmission faster, i.e., when the RBI changes stance, your EMI moves quickly.

10) Which loans are on EBLR? Rough share?

New floating-rate retail/MSME loans must use an external benchmark.
Many legacy loans remain on the MCLR or Base Rate, unless you switch.
The share of EBLR loans is large and rising, but varies by bank. Check your bank’s disclosures or your loan agreement.

11) What is MCLR and was it discontinued?

MCLR (Marginal Cost of Funds based Lending Rate) is an internal benchmark (introduced in 2016).
It still exists (banks publish it monthly).
From Oct 2019, new floating-rate retail/MSME loans must use EBLR; MCLR continues for legacy/other categories.
EBLR replaced MCLR for those specific new loans to improve transparency & speed.

MCLR formula pieces (at a glance):

Marginal cost of funds + negative carry on CRR + operating costs + tenor premium.

12) What are the key indicators of credit tightening/loosening?

Bank credit growth vs deposit growth (gap widening can signal strain).
Call/notice money & TREPS rates relative to policy corridor (spikes = tight).
RBI’s LAF/SDF/MSF data (are banks borrowing from RBI or parking surplus?).
CD/CP issuance and spreads of bank/NBFC bonds.
Lending spreads (loan rate minus benchmark) and FD rate trends.

Every day signals you feel: EMIs rising, banks stricter on approvals, FD rates moving up → tighter. The opposite → looser.

13) Does RBI recommend the lending rate = 2× GDP growth?

RBI does not prescribe “lending rates = 2× GDP growth
A common rule of thumb in cycles is that credit growth (not lending rate) can run ~1.5–2× nominal GDP growth without overheating.
If credit growth persistently far exceeds nominal GDP, risks of bubbles & inflation rise.
- Credit Growth = How fast the total loan book of banks is expanding
- Lending Rate = The price of borrowing money

14) What is call money and how does it relate to repo?

Call money = overnight unsecured lending between banks (and PDs).
Notice/term money => 1 day.
TREPS = tri-party repo (secured overnight funding).
Repo rate (policy rate) anchors short-term rates; call/TREPS move with daily liquidity. If the call/TREPS trade above the policy mid, liquidity is tight.

15) Repo, reverse-repo/SDF, MSF—what are these?

Repo (policy rate): Banks borrow short-term funds from the RBI against Government Securities (G-Secs).
SDF (Standing Deposit Facility) is now the floor (replacing the old “reverse repo” as the effective floor); banks park surplus with RBI without collateral.
MSF (Marginal Standing Facility) is the ceiling—a more costly emergency window. Together they form the policy corridor (floor–mid–ceiling).
- The policy corridor is the range of short-term interest rates set by the RBI to guide liquidity and borrowing costs in the economy.
Analogy:
- Think of it like cruise control in a car:
  - The floor stops the speed from dropping too low.
  - The ceiling prevents overspeeding.
  - The repo keeps you cruising at the desired pace.

16) Why do banks borrow in markets instead of just from RBI?

Collateral constraints: You need unencumbered G-Secs for repo/MSF; sometimes banks prefer interbank, TREPS, CDs, or FX swaps.
Pricing & flexibility: Markets can be cheaper or better-tenored.
Operational & stigma considerations: Frequent recourse to RBI windows can signal stress; markets are routine.

17) What is OMO (Open Market Operations)?

RBI buys or sells government bonds in the market to inject or absorb liquidity beyond day-to-day LAF operations.
Variants include Operation Twist (buy long-dated, sell short-dated) to influence the yield curve shape.

18) How do banks get G-Secs in the first place?

SLR (Statutory Liquidity Ratio): Banks must hold a fixed % of NDTL in liquid assets—primarily G-Secs.
Banks also purchase G-Secs as a safe investment for liquidity management and generating interest income.
These holdings are what banks sell/buy in OMOs and use as collateral in repos.

19) How does RBI add/remove liquidity via OMO? (Simple example)

Inject: RBI buys ₹1,000 crore of G-Secs → pays banks cash → banks’ reserves rise → more room to lend.
Absorb: RBI sells ₹1,000 crore of G-Secs → banks pay cash → reserves fall → lending capacity tightens.

OMO complements the daily LAF/SDF/MSF tools.

20) Can banks decline to participate in an OMO?

Yes. OMOs are auctions, not orders. Banks (and other participants) bid if the price/yield is attractive. If not, they can skip. That’s why the RBI sometimes pairs OMOs with different tools to achieve the desired liquidity effect.

21) Why are banks obsessed with CASA and liquidity ratios?

CASA (Current & Savings Accounts) = low-cost funding (savings 2–4%, current ≈0).
More CASA → lower cost of funds → better net interest margin (NIM).
LCR (Liquidity Coverage Ratio) and NSFR (Net Stable Funding Ratio) ensure banks can survive stress and fund long-term assets with stable liabilities.

22) Why is India’s Credit–Deposit Ratio (CDR) ~70–80% while a big US bank’s is ~50%?

India is more bank-centric; firms and households rely on banks for credit.
The US has deep capital markets; loans are securitized or funded via bonds, so large US banks often keep a lower CDR.
Different financial structures → different steady-state CDRs.

23) If people move money from bank deposits to mutual funds, doesn’t it come back to banks anyway? Then why do banks say they lack deposits?

You’re right: the stock market is a transfer mechanism. When you buy equity, the cash goes to the seller (retail, corporate, FII) and lands in someone’s bank account. Still, banks feel deposit pressure because:

Not all flows are “sticky.”

An FD is committed for months/years—banks can lend confidently against it.
MF flows change hands quickly (invest/redeem/trade)—they don’t sit as dependable deposits. Different destinations.
Equity MFs: pay share sellers; that cash may be spent, reinvested, moved, not kept as deposits.
Debt MFs: fund govt/corporate borrowing (bonds/CP); recipients use funds, not park them as deposits. Stability matters for lending. Banks need predictable, low-cost deposits (CASA/FDs). Mobile, market-driven flows don’t provide the same base.

Hence, deposit growth can be weak even while MF AUM surges.

24) What types of loans are linked to EBLR, and what %?

Floating-rate retail & MSME loans (new) must use an external benchmark (repo, T-bill, or other FBIL benchmarks like overnight rates).
Corporate loans may use different benchmarks (including MCLR, market rates).
The exact % on EBLR differs by bank and increases as old MCLR/Base-Rate loans are refinanced or run off.

(Always check your loan sanction letter: benchmark, reset frequency, spread, and reset date.)

25) Why do some say “credit should grow ~1.5–2× nominal GDP”?

It’s a macro rule of thumb (not a law). Over long periods, credit can grow somewhat faster than nominal GDP as the financial system becomes more developed. If credit far outpaces GDP for too long, risks build (inflation, asset bubbles). If it lags persistently, growth can be constrained.

26) Does more digitization mean the economy can grow without growing M0?

Digitization raises velocity—the same rupee transacts more times (UPI, RTGS/NEFT, cards). That reduces the need for physical cash, but doesn’t eliminate the need for base money:

Banks still need reserves for settlement and CRR.
As GDP grows, the system typically needs more base money over time (even if cash-to-GDP falls).
If a retail CBDC (e₹) scales, it would also be an RBI liability, part of M0 and not a substitute for it.

So digitization makes money more efficient, but M0 remains the foundation.

Closing Mental Model

Money is layered: RBI builds the base (M0); banks multiply it into deposits (M1/M3) by lending.
RBI steers the flow: via SDF/Repo/MSF corridor, CRR/SLR, OMOs, and capital/liquidity rules.
Banks price credit: using EBLR + spread to cover costs, risks, capital, and profit.
Deposits matter: CASA/FDs are the stable fuel; market flows are mobile and can’t fully replace them.
Digitization boosts velocity, not the base: payments get faster, but reserves and base money still anchor the system.

One-liner:

Money = Base (RBI) × Multiplier (Banks), guided by RBI’s levers, funded by sticky deposits, priced by each bank’s cost & risk and sped up by digitization.