- Important Questions for Class 12 Economics Comercial Banks and Central Bank
- Explain the process of credit creation by commercial banks.
- Explain the Process of Credit Creation by Commercial Banks.
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Important Questions for Class 12 Economics Comercial Banks and Central Bank
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Explain the process of credit creation by commercial banks.
Commercial banks create deposits in by credit creation. A commercial bank creates credit in the sense that it gives more loans than the cash deposits received from the depositors. When a bank grants loan to a person, it does not give it in cash to the borrower rather loan is credited in the borrower’s account. Every bank loan, thus, creates an equivalent deposits with the bank. The bank on the basis of legal reserve ratio is required to maintain a specified percentage of its deposits as cash reserve. Legal reserve ratio (a mix of Cash Reserve Ratio and Statutory Liquidity Ratio) is determined by the central bank of the country. If legal reserve ratio is increased, the capacity of bank to create credit is reduced. Thus, the capacity of commercial banks to create credit depends on following two factors : 1. Amount of deposit 2. Legal reserve ratio Given the amount of fresh deposits and legal reserve total money creation will be as under : Total money creation = Initial Deposit x \(\frac\) = ₹ 2,00,000. Categories • • (31.9k) • (8.8k) • (764k) • (248k) • (2.9k) • (5.2k) • (664) • (121k) • (26.7k) • (26.9k) • (11.1k) • (18.4k) • (36) • (72.1k) • (3.8k) • (19.6k) • (1.4k) • (14.2k) • (12.5k) • (9.3k) • (7.7k) • (3.9k) • (6.7k) • (63.8k) • (26.6k) • (23.7k) • (14.6k) • (25.7k) • (530) • (84) • (766) • (49.1k) • (63.8k) • (1.8k) • (59.3k) • (24.5k)
Explain the Process of Credit Creation by Commercial Banks.
The process of credit creation by commercial banks can be easily understood by the following example. Suppose a person, say X, deposits ₹ 2000, with a bank and the LRR is 10% which means the bank keeps only the minimum required ₹ 200 as cash reserve. The bank can use the remaining amount ₹ 1800 (= 2000-200) for giving a loan to someone. The bank lends ₹ 1800 to, say F, for this purpose and an account is opened in the name of Y and the amount is credited in his account. This is the first round of credit creation in the form of a secondary deposit (₹ 1800) which equals 90% of the initial deposit. Now again from the deposit of Y, the bank keeps 10% or LRR i.e., 180 and remaining ₹ 1620 is advanced to, say, Z. The bank gets a new demand deposit. This is the second round of credit creation till secondary deposit becomes zero. In the end, the volume of total credit created becomes multiple of the initial deposit. The quantitative outcome is called money multiplier. In short, money (or credit) creation by commercial banks depends on two factors: (i) amount of initial deposit and (ii) LRR. Symbolically: Total credit creation = Initial deposit × (1/LRR) Also read: • • Stay connected with BYJU’S for more such questions and answers on various commerce topics.
