M1

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

Meaning

M1 (narrow money) is the money that people can spend at once. It is the cash held by the public, plus the net demand deposits of banks, plus "other deposits" kept with the RBI.

Formula: M1 = Currency with the public + Net demand deposits of banks + Other deposits with RBI

M1 is the narrowest and most liquid measure of money supply. It is the base on which the RBI's wider measures (M2, M3 and M4) are built. So you need to understand M1 before you can understand money supply and monetary policy.

Explanation

Components of M1

• Currency with the public
• These are the notes and coins held by households and firms.
• It equals currency in circulation minus the cash that banks keep in their own safes.

• Cash held by the government and by banks is not counted, because money supply counts only money held by the public.

• Net demand deposits of banks

• Demand deposits are savings and current accounts. You can withdraw them at any time, by cheque, ATM or digital transfer.
• "Net" means only the deposits of the public are counted. Deposits that one bank keeps with another bank are left out.

• Time deposits (fixed deposits locked for a period) are not in M1. They are added only in M3.

• Other deposits with RBI

• These are deposits kept with the RBI by bodies other than banks and the government. Examples are some quasi-government bodies, foreign central banks and international bodies such as the IMF and the World Bank.
• This is a very small part of M1.

Why M1 is the "most liquid" measure

• Liquidity means how easily money can be spent without delay or loss.
• Every part of M1 can be spent straight away. Cash is spent by hand, and demand deposits are spent by cheque or transfer.
• Liquidity falls as we move from M1 to M4:

Measure	Built from M1 as	Type
M1	Currency with public + net demand deposits + other deposits with RBI	Narrow (most liquid)
M2	M1 + Post Office savings bank deposits	Narrow
M3	M1 + net time deposits of banks	Broad
M4	M3 + total Post Office savings deposits (excluding NSC)	Broad (least liquid)

How banks create M1: a worked example (CRR 20%)

• Credit creation means banks lend deposits, the loans come back into banks as new deposits, and those deposits are lent again.
• Deposits are part of M1. So every loan that returns as a deposit adds to M1.
• Example: Leela deposits ₹100. The CRR (the share of deposits a bank must keep as reserves) is 20%.
• The bank keeps ₹20 and lends ₹80. The ₹80 is spent and comes back as a deposit, so deposits become ₹180.
• Required reserves are now 20% of 180 = ₹36. The bank can lend ₹64 more.

• This goes on until deposits reach ₹500.

• Why ₹500? The deposits form the series 100 + 80 + 64 + 51.2 + … with ratio r = 0.8.

• Sum = 100 × 1/(1 − 0.8) = ₹500.

• This is the money multiplier (rupees of money created for each rupee of reserves): m = 1/CRR = 1/0.2 = 5.

• Result: M1 (money held by the public) rises from ₹100 to ₹500.

What makes M1 rise or fall

• High-powered money (H or M0) rises
• The RBI buys government securities, lends to banks (for example through repo), or buys foreign currency.
• Banks get more reserves and lend more.

• Demand deposits grow, so M1 rises.

• CRR goes up

• The multiplier falls. For example, a CRR of 25% gives m = 4.

• Banks must call back loans, so deposits shrink and M1 falls.

• The public's cash habit (cdr) changes

• Currency deposit ratio (cdr) = the cash the public holds ÷ the public's bank deposits.
• When cdr falls, more money stays inside banks and the multiplier rises: m = (1 + cdr)/(cdr + rdr).

• Here rdr (reserve deposit ratio) is the share of deposits that banks keep as reserves.

• Demand for loans

• Banks cannot create deposits if firms and households do not want to borrow.

• Shifts between deposit types

• Money moved from a savings account into a fixed deposit leaves M1. It stays in M3.

In India

• Who measures M1: the Reserve Bank of India. It has compiled monetary statistics since July 1935 [3]. It uses a balance-sheet approach, which combines the balance sheets of the RBI and of the banking sector (commercial and co-operative banks) [3].
• Currency with the public (2024-25): about ₹36.3 lakh crore.
• Currency in circulation was ₹37,24,448 crore.
• Cash with banks was about ₹93,697 crore.

• The rest is currency with the public, and this is the part that goes into M1.

• Other deposits with RBI (2024-25): ₹1,13,307 crore. This is a very small part of M1.

• Demonetisation (2016-17): currency with the public fell sharply, to about ₹12,64,124 crore. NCERT's Table 3.5 wrongly prints this figure as 124124.
• Committee link: the Working Group on Money Supply, chaired by Dr Y.V. Reddy, reported in June 1998 [3].
• It proposed new aggregates NM1, NM2 and NM3, based on residency and maturity, and liquidity aggregates L1, L2 and L3 [3].

• NM1 is the new-series version of narrow money.

• CRR today: CRR was cut to 4.0% of NDTL in December 2024 [4]. It now stands at 3.00% [2]. A lower CRR frees bank reserves for lending, which can raise the deposit part of M1.

Don't confuse with

• M0 (high-powered money or reserve money): M0 is what the RBI owes. It includes bankers' deposits with the RBI and all currency in circulation, including cash held by banks. M1 counts only currency with the public, and it adds the public's bank deposits. Only "other deposits with RBI" appears in both.
• M3 (broad money): M3 = M1 + net time deposits of banks. Fixed deposits are in M3 but not in M1. M3 is the most used measure ("aggregate monetary resources").
• M2: M2 = M1 + Post Office savings bank deposits. Post Office deposits are never part of M1 or M3.
• Demand deposits vs time deposits: demand deposits (savings and current accounts) can be withdrawn at any time and are in M1. Time deposits are locked for a period and are counted only from M3 onwards.

Prelims Hooks

• M1 = Currency with the public + Net demand deposits of banks + Other deposits with RBI. It is the narrowest and most liquid measure of money.
• M1 and M2 are narrow money. M3 and M4 are broad money. Liquidity falls from M1 to M4.
• Trap: "M1 includes time deposits of banks" is false. Time deposits come in only at M3 (M3 = M1 + net time deposits).
• Trap: "M1 includes Post Office savings deposits" is false. They appear in M2 and M4.
• "Other deposits with RBI" is counted in both M0 and M1.
• The Y.V. Reddy Working Group (June 1998) proposed NM1–NM3 and L1–L3 [3]. The RBI has compiled monetary statistics since July 1935 [3].

Mains Points

• Financial inclusion changes what M1 is made of, and this strengthens monetary policy.
• Jan Dhan accounts and digital payments move money from cash into demand deposits.
• The cdr falls, so the money multiplier rises.
• More of M1 now sits inside banks, where RBI signals (repo rate, CRR) can reach it.

• Demonetisation (2016-17) was a sudden, forced version of this change. Currency with the public fell sharply.

• The RBI controls M1 only partly.

• The RBI controls H and the CRR. A CRR cut (4% in Dec 2024 [4] → 3% [2]) releases reserves to banks.
• But the deposit part of M1 grows only if people want to borrow and choose to keep their money in banks.

• This explains why policy easing can reach the economy weakly (GS-III: effectiveness of monetary policy).

• M1 is built on fractional reserves, so it needs safeguards.

• Most of M1 is demand deposits, which people can withdraw at any moment.
• But banks hold only a fraction of these deposits as cash. So a bank run (many depositors withdrawing at once out of fear) is always a risk.
• This is why an economy needs a lender of last resort (the RBI, lending to sound banks in an emergency), deposit insurance (DICGC) and prudential rules (CRR, SLR, capital norms). This point suits GS-III answers on financial stability.

Related concepts

• Credit creation
• Bank balance sheet
• Bank reserves
• Money multiplier
• Currency deposit ratio
• Reserve deposit ratio
• Bank run
• High-powered money
• Currency in circulation
• Money supply

Read more

• Credit creation, high-powered money and the money supply