Process of Creation of Money:
The process of money creation by the commercial banks starts as soon as people deposit money in their respective bank accounts. After receiving the deposits, as per the central bank guidelines, the commercial banks maintain a portion of total deposits in form of cash reserves. The remaining portion left after maintaining cash reserves of the total deposits is then lend by the commercial bank to the general public in form of credit, loans and advances. Now assuming that all transactions in the economy are routed through the commercial banks, then the money borrowed by the borrowers again comes back to the banks in form of deposits. The commercial banks again keep a portion of the deposits as reserves and lend the rest. The deposit of money by the people in the banks and the subsequent lending of loans by the commercial banks is a never-ending process. It is due to this continuous process that the commercial banks are able to create credit money a multiple time of the initial deposits.
The process of creation of money is explained with the help of the following numerical example.

Suppose, initially the public deposited Rs 10,000 with the banks. Assuming the Legal Reserve Ratio to be 20%, the banks keep Rs 2,000 as minimum cash reserves and lend the balance amount of Rs 8,000 (Rs 10,000 – Rs 2,000) in form of loans and advances to the general public.
Now, if all the transactions taking place in the economy are routed only through banks then, the money borrowed by the borrowers is again routed back to the banks in form of deposits. Hence, in the second round there is an increment in the deposits with the banks by Rs 8,000 and the total deposits with the banks now rises to Rs 18,000 (that is, Rs 10,000 + Rs 8,000). Now, out of the new deposits of Rs 8,000, the banks will keep 20% as reserves (that is, Rs 1600) and lend the remaining amount (that is, Rs 6,400). Again, this money will come back to the bank and in the third round, the total deposits rises to Rs 24,400 (i.e. Rs 18,000 + Rs 6,400).
The same process continues and with each round the total deposits with the banks increases. However; in every subsequent round the cash reserves diminishes. The process comes to an end when the total cash reserves (aggregate of cash reserves from the subsequent rounds) become equal to the initial deposits of Rs 10,000 that were initially held by the banks. As per the above schedule, with the initial deposits of Rs 10,000, the commercial banks have created money of Rs 50,000.

India at present follows the Paper Currency Standard because here standard currency is made of paper. This is also referred to as Managed Currency Standard as any amount of notes can be issued with the minimum backup of gold worth र 115 crores. Remember, a monetary system refers to the form of standard money used in the economy. It is legal money through which government discharges its obligations. The standard money which is used in India is made of paper. In India the monetary authority is Reserve Bank of India (RBI) which has adopted a standard currency made of paper. That is why India is said to be on a paper currency standard. Following points need to be noted in this regard.
(i) Paper currency is the main currency of the country. It is unlimited legal tender which means that it can be used to settle debts and make payments up to an unlimited amount. Coins made of cheap and light metals are used for making smaller payments. Again these coins are limited legal tender because they can be used for making payments and setting debts only up till a limited amount. For instance, it would be inconvenient to settle a debt of र 2,000 with 50 paise and 25 paise coins.
(ii) RBI has the sole monopoly to issue currency notes in India from र 2 and above. The central government (Ministry of Finance) issues the one-rupee note and all coins but the responsibility for putting them into circulation rests with the RBI.
(iii) The system which governs note issue in India is the Minimum Reserve system according to which the Central Bank keeps a minimum reserve of gold and foreign exchange and on this basis can issue notes to any limit. Since paper currency is not convertible into precious metal gold which is backing it, therefore, the currency is said to be inconvertible.

Meaning of Central Bank. The Central Bank is the apex institution of monetary system of a country. It is banker to the other banks and to government, it issues notes, controls money supply and credit, and maintains monetary stability.
Central Banks have been established in all financially developed countries. They are known by different names in different countries. In India the Central Bank is known as Reserve Bank of India which was established in 1935 as a shareholder bank and nationalised on first January, 1949. In U.K. it is called Bank of England and in Russia it is known as Gosbank.
Necessity of Central Bank. Since the first world war, the most important development in the field of monetary system is the emergence of Central Banks with added prestige and power. Now-a-days the institution of Central Bank is considered indispensable in every country. Now there is hardly a civilised country which does not possess a Central Bank. Central Banks are necessary because of the following reasons.
(i)    Monetary System requires Management. “Money will not manage itself,” said Begehot long ago. Even gold standard was not fully automatic. The paper standard which is in operation in every country now, has to be directed by some central authority.
(ii)    Banking System requires Control and Regulation. The banks of a country, being private institutions, act by profit motive. Because they are competitive concerns, they cannot follow a common policy according to national requirements. The result is either creation of too much credit sometimes or too little at other times. Therefore, a central coordinating authority, which will compel them to follow the appropriate policy under economic situation is necessary. Hence an institution is established which is called Central Bank.

High Powered Money. The Total liability of the monetary authority of the country, RBI, is called the high powered money or monetary base. It is the money created/produced by RBI and government of India. It consists of currency (notes and coins) in circulation with the public and vault cash of commercial banks and deposits held by government and commercial banks with RBI. It is high powered money because these are liability of RBI to refund deposits on demand from the deposit holders. Again if a person presents a currency note to RBI, the latter has to pay him value equal to the amount printed on the note. Remember, RBI acquires assets against these liabilities.
In short, RBI regulates money supply by controlling stock of high powered money, bank rate and reserve requirements of commercial banks.
Money creation by RBI. Suppose RBI wishes to increase money supply. For this it will inject additional high powered money into the economy. Let us assume that RBI purchases gold worth र 100 crores. It issues currency and makes payment for gold. This results in an increase in currency in circulation equal to र 100 crores. Further suppose that RBI purchases securities worth र 400 crores in the open market. It will issue a cheque of र 400 crores to the seller of the securities. The seller encashes the cheque at his account in, say, Canara Bank which receives this amount. Clearly currency held by the public, thus, goes up. Here comes the part played by money multiplier.