Social Science (087) — AI-generated practice question

Banks keep only about 5% of deposits as cash reserves because on any given day, only a small number of depositors withdraw money simultaneously. The remaining deposits are lent out to borrowers, earning interest — this is how banks function as mediators between depositors and borrowers.

This practice becomes a problem if all depositors try to withdraw their money at the same time. In such a situation, the bank would not have enough cash to repay everyone, causing it to fail. This is why the RBI monitors banks to ensure they maintain the required minimum cash balance.

Source: Money and Credit, Loan Activities of Banks / Formal Sector Credit in India

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• The examiner wants two clear parts: (1) why it normally works — not all depositors withdraw at once, and (2) the risk — if all depositors withdraw simultaneously, the bank cannot pay. Both are explicitly stated in the textbook passage.
• Mentioning the RBI's supervisory role adds a mark-worthy point for a 3-mark answer.
• Avoid over-explaining; keep it tight. The phrase "banks mediate between depositors and borrowers" is a key textbook line — use it.