Correct Option: C. by creating a demand deposit as it gives a new loan Explanation of the Correct Answer:

1. Understanding Money Creation:
2. Commercial banks have the ability to create money through a process known as fractional reserve banking. This means that banks are required to keep only a fraction of their deposits as reserves and can lend out the remainder. When a bank gives out a loan, it does not physically hand out cash; instead, it creates a demand deposit in the borrower's account.
3. Demand Deposits:
4. A demand deposit is a bank account from which funds can be withdrawn at any time without any advance notice. When a bank issues a loan, it credits the borrower's account with the loan amount, effectively creating new money in the form of a demand deposit. This is because the borrower can now spend this money, which was not previously in circulation.
5. The Loan Process:
6. For example, if a bank has $1,000 in deposits and the reserve requirement is 10%, it must keep $100 in reserve but can lend out $900. If a customer takes out a loan of $900, the bank creates a demand deposit of $900 in the borrower's account. This increases the total money supply in the economy because the borrower can now use this money to make purchases, which can then be deposited in other banks, allowing for further lending.

Why the Other Options are Incorrect:

• Option A: by printing it
• Explanation: Only central banks have the authority to print physical currency. Commercial banks do not print money; they create money electronically through the lending process. Therefore, this option is incorrect as it misrepresents the role of commercial banks in the money supply.
• Option B: by maintaining reserve
• Explanation: While maintaining reserves is a crucial part of banking operations, it does not directly lead to money creation. Reserves are the portion of deposits that banks must hold and cannot lend out. The act of maintaining reserves is a regulatory requirement and does not create new money; rather, it limits the amount of money that can be created through lending.
• Option D: by issuing cheques to depositors
• Explanation: Issuing cheques does not create new money; it merely facilitates the transfer of existing money from one account to another. When a bank issues a cheque, it is simply a method of accessing the funds already in the account. This option does not reflect the process of money creation, which occurs when loans are made and new demand deposits are created.

Summary of Key Points:

• Commercial banks create money through the process of fractional reserve banking by issuing loans, which generate new demand deposits.
• A demand deposit is created when a bank credits a borrower's account with the loan amount, increasing the money supply.
• Only central banks can physically print currency; commercial banks create money electronically.
• Maintaining reserves is necessary for regulatory compliance but does not directly contribute to money creation.

This understanding of how commercial banks create money is essential for grasping broader economic concepts related to money supply, banking operations, and monetary policy.