Social Science (087) — AI-generated practice question

Currency is paper notes and coins issued by the Reserve Bank of India on behalf of the central government. It has no intrinsic value but is accepted as a medium of exchange because it is legally authorised — no one can refuse payment in rupees.

Demand deposits are money held in bank accounts that can be withdrawn on demand. They function as money because cheques can be drawn against them, allowing payments to be settled without any physical cash changing hands.

Key difference: Currency is issued by the central government/RBI; demand deposits are created when people deposit money with banks.

Why the banking system is critical: Without banks, there would be no demand deposits and no cheque facility. Banks also hold only a fraction (~5%) of deposits as cash reserve. If the banking system fails — for example, if all depositors demanded cash simultaneously — cheque payments would collapse, destroying demand deposits as a form of money.

Source: Modern Forms of Money; Loan Activities of Banks, Chapter 3

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• Examiners look for: (1) definition/origin of each form, (2) what makes demand deposits function as money (cheque facility), (3) the specific link to banking — no bank = no demand deposits.
• The fraction-reserve point (banks hold ~5% as cash) is important to explain why the system must work properly — it shows demand deposits rest on trust in the banking system.
• Avoid long historical content on barter/coins — not relevant here.