I want notes for credit Creation …

It is important function of commercial banks. When bank receives deposits from the public it keeps the fraction of deposit as cash reserve and uses the remaining amount for giving loans. This fraction is called LRR which is fixed by Central Bank. For example. Suppose a man deposits Rs. 2000 with a bank and LRR is 10% which means requirement of Rs.200 as cash reserve. The remaining amount 1800 for giving loan to other persons and this process continues till amount becomes zero.

The process of money creation can be explained by taking an example of a bank XYZ. A depositor deposits Rs.10,000 in his savings account, which will become the demand deposit of the bank. Based on the assumption that not all customers will turn up at the same day to withdraw their deposits, bank maintains a minimum cash reserve of 10 % of the demand deposits, i.e. Rs.1000. It lends the remaining amount of Rs.9000 in the form of credit to other customers. This further creates deposits for the bank XYZ. With the cash reserve of Rs.1000, the credit creation is worth Rs.10,000. So, the credit multiplier is given by: Credit multiplier = 1/CRR = 1/10% = 10 The money supply in the economy will increase by the amount (times) of credit multiplier.

Process of credit creation by commercial banks: Commercial banks create money even though they cannot print money. Bank deposits form the basis for credit creation. They accept deposits from the public by opening a deposit account known as the primary deposit. Banks do not hold the money in the account itself, and the entire amount is not withdrawn from the account at the same time. So, they advance loans to business persons and retain only a small portion of the total deposits in the bank. The Central Bank decides the amount to be held in the form of cash and the remaining amount is advanced as loans to business persons only against collateral securities. The bank will not give cash but open a derivative account in the name of the individual or institution. Here, the loans create a derivative deposit which is called a secondary deposit or derivative deposit. This secondary deposit is called the creation of credit. Hence, the banks are able to provide financial assistance to traders and industrialists. Their cheques and drafts are useful for trading on a large scale. It also provides concessional loans to the priority sectors such as agriculture, small-scale industry, retail trade and export. Thus, the production activity increases the overall development of the nation.