Demand deposits

Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 10, Ch 3 "Money and Credit"; Class 12, Ch 3 "Money and Banking"

Meaning

Demand deposits are the money people keep in savings accounts and current accounts. The bank must pay this money back the moment the account holder asks, and the holder can spend it by cheque (a written order telling the bank to pay someone from the account).

• Demand deposits count as money. They are part of M1 (narrow money).

• M1 = currency with the public + demand deposits with banks + other deposits with the RBI.

• Most payments in a modern economy happen by moving these balances from one account to another, not by handing over notes. But demand deposits are not legal tender (money that no one is allowed to refuse).

Explanation

How demand deposits work as money

• A person puts spare money into a savings or current account. The balance becomes a demand deposit.
• The balance can be spent without taking out cash.
• Example (Class 10): Salim pays his leather supplier by cheque.
• Salim's account is debited (money goes out). The supplier's account is credited (money comes in) within a couple of days.

• No cash changes hands, but a payment has been made.

• So a demand deposit does the main job of money. It works as a medium of exchange, which means something people accept in payment for goods and services.

• The passbook records every receipt and payment in the account.

Types: savings account vs current account

Feature	Savings account	Current account
Main users	Individuals who save regularly	Businesses and traders
Interest	Yes	No
Withdrawals	Minimum balance needed; limit on withdrawals each month	Generally no limit on transactions

• Both are "demand" deposits because the bank must pay on demand.
• A fixed deposit (FD) is not a demand deposit. It is a time deposit.
• An FD can be withdrawn only after a fixed period, or early with a penalty.
• It pays more than a savings account because the depositor gives up liquidity (quick access to their money).

Why demand deposits are money but not legal tender

• Legal tender means coins and RBI notes. The law says no one can refuse them in payment.
• A cheque is only a request to a bank. The receiver can refuse it, for example if they doubt the balance behind it.
• So:
• Demand deposits = money, because they are widely accepted and counted in M1.
• Demand deposits ≠ legal tender, because accepting them is voluntary.

Why banks can lend out part of demand deposits

• All depositors do not come to withdraw on the same day.
• So a bank keeps only a part of its deposits as a reserve and lends the rest.
• Cash Reserve Ratio (CRR): the share of a bank's NDTL that it must keep as a balance with the RBI. The bank earns no interest on this balance [2].

• NDTL (net demand and time liabilities): roughly, a bank's total deposits and similar liabilities to the public. Demand deposits are the "demand" part of it.

• Worked example (CRR on deposits):

• A bank has ₹100 crore of NDTL.
• At a CRR of 4%, ₹4 crore stays locked with the RBI.

• At a CRR of 3%, only ₹3 crore is locked, so ₹1 crore more is free to lend.

• When banks lend, the loan is usually paid into the borrower's account. This creates new demand deposits. This is how banks create credit.

What makes demand deposits rise or fall

• People's choice between cash and bank balances: more use of cheques and bank payments → more money kept as demand deposits.
• Choice between liquidity and return:
• FD rates much higher than savings rates → people move money from savings accounts to FDs.

• So demand deposits (M1) fall and time deposits rise. M3 stays the same, because it includes both.

• Bank lending: more loans → more money credited to borrowers' accounts → demand deposits rise.

• Reserve rules: a lower CRR leaves banks more to lend, which supports more deposit creation.

In India

• RBI measures the money stock. Demand deposits with banks are counted in M1. Time deposits are added only in M3 (broad money) = M1 + time deposits with banks.
• Interest on savings deposits:
• Before 2011, the RBI fixed the savings bank rate. It stayed at 3.5% a year from 1 March 2003 [4].
• The RBI kept this control because most savings deposits belonged to households in semi-urban and rural areas, including pensioners and small savers [4].
• The RBI's 2011 discussion paper said that freeing the rate would improve monetary policy transmission (RBI rate changes reaching depositors and borrowers faster) and push banks to design new deposit products [4].
• It also listed two risks: unhealthy competition among banks and small savers being left out [4].

• Rates on all other deposits were already free by then [4]. The savings rate was freed later in 2011. Each bank now sets its own rate.

• Current accounts still pay no interest.

• Reserves on deposits:
• CRR is 3.0% of NDTL, effective from the fortnight beginning 29 November 2025 [2].
• It was cut from 4.5% to 4.0% in two steps of 0.25 percentage points each (effective 14 and 28 December 2024) [3].

• The June 2025 policy then cut it by 100 basis points (1 percentage point) in four steps: 3.75% (6 Sep 2025), 3.5% (4 Oct 2025), 3.25% (1 Nov 2025) and 3.0% (29 Nov 2025) [2].

• NCERT update: Class 10 says banks keep "about 5 per cent of deposits as cash". This is outdated. The legal reserve is the CRR, and it is held with the RBI, not as cash in the bank's own vault.

Don't confuse with

• Time deposits (fixed deposits): they can be withdrawn only after a fixed period, or early with a penalty. They are not in M1. They enter only M3. Demand deposits are in both M1 and M3.
• Legal tender (currency): RBI notes and coins must be accepted in payment. Demand deposits are money, but a cheque can be refused.
• Currency with the public: this is cash in people's hands. It is a separate part of M1. Demand deposits are balances held with banks.
• Credit (in an account) vs credit (a loan): "credit" in a passbook means money coming into an account. "Credit" as a loan means borrowed money that must be repaid under terms of credit.

Prelims Hooks

• Demand deposits = savings + current account balances. They are payable on demand and usable by cheque. They are part of M1.
• M1 = currency with the public + demand deposits with banks + other deposits with the RBI. M3 = M1 + time deposits with banks.
• Trap: demand deposits are money but not legal tender. Only coins and RBI notes are legal tender.
• Current accounts earn no interest and are used mainly by businesses. Savings accounts earn interest but limit withdrawals each month.
• The savings bank rate was fixed by the RBI at 3.5% from 1 March 2003 and deregulated in 2011. Banks now set it themselves [4].
• CRR is kept with the RBI as a share of NDTL, which includes demand deposits. It is 3.0% from 29 Nov 2025, down from 4.0% (Dec 2024) [2][3].

Mains Points

• Freeing the savings rate (GS-III, monetary policy):
• The 2011 move aimed at faster transmission and new deposit products [4].
• But most savings depositors are rural households, pensioners and small savers, who have little bargaining power [4].

• So there is a trade-off between market efficiency and protecting small savers.

• Demand deposits, the CRR and credit supply (GS-III, growth):

• Cutting the CRR from 4.5% to 3.0% (Dec 2024 to Nov 2025) freed deposit money that earned no interest [2][3].
• Banks have more to lend → their cost of funds falls → loans can become cheaper and growth gets support.

• But a lower reserve means a thinner buffer if many people withdraw their demand deposits together. So prudential rules like the liquidity coverage ratio matter more.

• Moving from cash to bank money (GS-III, inclusive growth):

• When more payments are made by moving demand deposits (the Salim cheque example), people carry less cash and every payment leaves a record.
• More bank deposits give banks more to lend in cheap formal credit. This reduces dependence on costly informal lenders.

Related concepts

• Deposits
• Savings account
• Current deposit account
• Fixed deposit
• Cheque
• Passbook
• Debit and credit
• Interest
• Compound interest
• Interest rate spread

Read more

• How a bank works: deposits, interest, spread and terms of credit