Deposits

Also called: bank deposits · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Class 7, Ch 8 "Banks and the Magic of Finance"

Meaning

Deposits (bank deposits) are money that people place in a bank account. They can take it out under the bank's terms, and it often earns interest. Deposits are the main raw material of banking. A bank takes deposits from people who have spare money and lends that money to people who need it. Its income is the interest rate spread:

Interest rate spread = lending rate − deposit rate

Explanation

Types of deposit accounts

Account	Who uses it	Interest	Withdrawals
Savings account	Individuals who save regularly	Yes	Minimum balance needed; limit on withdrawals each month
Current deposit account	Businesses and traders	No	Generally no limit on transactions
Fixed deposit (FD)	One-time deposit for a fixed period (e.g. 3–5 years)	Higher than savings	Early withdrawal only with a penalty

• Tools of an account:
• A cheque is a paper that orders the bank to pay a set amount from the payer's account to the person named on it.
• A passbook records every receipt and payment in the account.
• Debit means money going out of an account. Credit means money coming into it.
• Example: Salim pays his leather supplier by cheque. Salim's account is debited, and the supplier's account is credited within a couple of days. No cash changes hands.

Demand deposits vs time deposits

• Demand deposits are savings and current account balances.
• The bank must pay them the moment the holder asks.
• They can be used through cheques.

• They count as money. Currency plus demand deposits make up the money stock.

• Time deposits are fixed deposits.

• They can be withdrawn only after a fixed period, or early with a penalty.

• Where each type sits in money supply:

• M1 (narrow money) = currency with the public + demand deposits with banks + other deposits with the RBI
• M3 (broad money) = M1 + time deposits with banks
• So time deposits are not in M1. They enter only in M3.

Why an FD pays more, and how interest grows

• FDs pay a higher rate because:
• the depositor gives up liquidity (quick access to their money)
• so the bank knows the money will stay for a fixed time

• so the bank can lend it for longer periods and earn more, and it shares part of that extra income as a higher rate.

• Compound interest means you also earn interest on the interest you earned earlier. The formula is A = P(1 + r)ⁿ:

• A is the final amount and P is the principal (the original sum).
• r is the rate per period, written as a decimal.

• n is the number of periods.

• Worked example: ₹1,000 deposited at 6% a year

• After year 1, it is ₹1,060. After year 2, it is ₹1,123.60.
• After year 12, it is ₹1,000 × (1.06)¹² = ₹2,012.20, so the money has doubled.
• With simple interest, it would reach only ₹1,720.
• The Rule of 72 gives the same answer: years to double ≈ 72 ÷ 6 = 12 years.

What banks do with deposits

• Banks keep a part of deposits and lend the rest.
• Some depositors will come to withdraw, so banks cannot lend every rupee.

• The Cash Reserve Ratio (CRR) is the share of a bank's NDTL (net demand and time liabilities, which roughly means its total deposits and similar liabilities to the public) that it must keep with the RBI. The bank earns no interest on this balance [2].

• Spread example:

• Anand deposits ₹200 at 2%, so he earns ₹4.
• The bank lends the same ₹200 to Shreya at 5% and collects ₹10.

• The bank keeps ₹6. This pays salaries and running costs, covers loans that are not repaid, and gives the bank its profit.

• CRR example:

• On ₹100 crore of NDTL, a 4% CRR locks ₹4 crore with the RBI.
• At 3%, only ₹3 crore is locked.
• So ₹1 crore more of deposits is free to lend.

In India

• Deposit rates used to be controlled by the RBI but are now set by the market.
• The RBI fixed the savings bank rate at 3.5% a year from 1 March 2003 [4].
• It kept this control because most savings deposits belonged to households in semi-urban and rural areas, including pensioners and small savers [4].
• By 2011, rates on all deposits other than savings had already been freed [4].

• The savings rate was deregulated later in 2011. Each bank now sets its own deposit rates.

• Why the RBI freed the savings rate: its 2011 discussion paper gave two reasons [4].

• Better monetary policy transmission, meaning RBI rate changes would reach depositors and borrowers faster.

• Banks would be pushed to design new deposit products.

• Current CRR on deposits: banks must keep 3.0% of NDTL with the RBI, effective from the fortnight beginning 29 November 2025 [2].

• It was cut from 4.5% to 4.0% in two steps, effective 14 and 28 December 2024 [3].

• It was then cut 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 (Class 10) says banks keep "about 5 per cent of deposits as cash". This is outdated. The legal reserve is the CRR, and banks hold it with the RBI, not as cash in their own vaults.

Don't confuse with

• Legal tender: Demand deposits are money, but they are not legal tender. Anyone can refuse a cheque. No one can refuse coins or valid RBI notes.
• Time deposits vs demand deposits: Demand deposits (savings and current accounts) are in M1. Time deposits (FDs) are added only in M3.
• Current account vs savings account: A current account pays no interest and is used mainly by businesses. A savings account pays interest but limits withdrawals.
• CRR vs vault cash: CRR is a share of NDTL that banks must keep with the RBI. It is not cash kept in the bank's own vault.

Prelims Hooks

• Demand deposits (savings and current accounts) are part of M1. Time deposits enter only in M3 (M3 = M1 + time deposits with banks).
• Demand deposits count as money but are not legal tender.
• Current accounts earn no interest. Fixed deposits pay the highest rate because the depositor gives up liquidity. Early withdrawal from an FD carries a penalty.
• Interest rate spread = lending rate − deposit rate. It is a bank's main source of income.
• The savings bank rate was fixed at 3.5% from 1 March 2003 and deregulated in 2011. Banks now set their own deposit rates [4].
• CRR is held with the RBI as a share of NDTL and earns no interest. It has been 3.0% since 29 Nov 2025, down from 4.0% in Dec 2024 [2][3].

Mains Points

• Market-set deposit rates vs protecting small savers (GS-III):
• Freeing the savings rate in 2011 was meant to speed up transmission and push banks to create new products [4].
• The same paper warned of unhealthy competition among banks and of small savers being left out [4].

• Rural households and pensioners have little bargaining power. This is a trade-off between market efficiency and fairness to small savers.

• Mismatch between deposit rates and loan rates:

• From 1 October 2019, new floating-rate retail loans and loans to micro and small enterprises (MSEs) must be linked to an external benchmark, such as the repo rate (the rate at which the RBI lends to banks for a short time). These loan rates reset at least every three months [5].
• Most deposits, however, are at fixed rates.

• So when the RBI cuts rates, loan rates fall quickly while deposit costs stay high. This squeezes bank margins.

• Deposits, CRR and credit for growth:

• Cutting the CRR from 4.5% to 3.0% (Dec 2024 to Nov 2025) freed a larger share of deposits for lending [2][3].
• Less money sits idle without earning interest, so banks' cost of funds falls and they can offer cheaper loans.
• The flip side is a thinner buffer against deposit withdrawals, so prudential rules, such as the liquidity coverage ratio, matter more.

Related concepts

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

Read more

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