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प्रश्न
Explain the credit creation role of commercial banks with the help of a numerical example.
Discuss the role of commercial banks in credit creation.
Explain the money creation process by the commercial banks with the help of an example.
उत्तर १
Credit creation is now often seen as the primary activity of commercial banks. Commercial banks issue credit based on their deposits. Thus, credit creation refers to the ability of banks to increase their secondary deposits through loans, advances, and investments in excess of their main deposits. Commercial banks' money generation (or credit creation) process is influenced by the amount of initial fresh deposits and CRR, the minimum cash reserve ratio of deposits legally mandated to be maintained as cash by banks.
Example:
If the CRR is 20%, the fresh deposit is ₹ 10,000. The bank keeps 20%, or ₹ 2000, as cash. Assume the bank lends the remaining ₹ 8000 as loans. As a result, those who get payouts keep the funds in the bank. Banks get additional deposits of ₹ 8000. The bank maintains 20% (₹ 1600) as cash and lends the remainder ₹ 6400 (80% of the deposits). The money is returned to the banks, resulting in a new deposit of ₹ 6400. Money continues to multiply, resulting in a total of ₹ 50,000, as indicated in the table below.
Money creation by commercial banks:
| Rounds | Deposits (₹) | Loans (₹) | Cash reserve (₹) |
| Initial | 10,000 | 8000 | 2000 |
| I | 8,000 | 6400 | 1600 |
| II | 6,400 | 5120 | 1280 |
| − | − | − | |
| − | − | − | |
| Total | 50,000 | 40,000 | 10,000 |
Thus, credit is created or generated in commercial banks.
उत्तर २
Commercial banks create demand deposits and, hence, add to the supply of money.
Example: Suppose the amount of the initial deposit is ₹ 1000, and LRR is 10%. The banks will keep 10%, i.e., ₹ 100, as reserve and lend the remaining ₹ 900 to borrowers. The borrowers will spend this money. It is assumed that ₹ 900 comes back to the bank. The bank again keeps 10% of ₹ 900, i.e., ₹ 90 reserve and lends ₹ 810. This will further raise the amount of deposits with the banks. In this way, deposits continue to increase. The number of times the total deposits will become is determined by the money multiplier.
Money Multiplier = `1/"LRR"`
= `1/0.10`
= 10
The total deposits will be:
Initial deposits × Money Multiplier
= 1000 × 10
= 10,000
APPEARS IN
संबंधित प्रश्न
Credit creation by commercial banks is determined by (Choose the correct alternative)
The creation of ______ is called credit creation.
Banks are able to create credit many times more than initial deposits through ______.
The process of money creation or credit creation is done by ______.
What do you mean by credit creation by commercial banks?
Access to adequate and timely credit at affordable rates is critical for the rural poor to alleviate high cost debt and invest in livelihood opportunities. Despite the Government of India's best efforts, financial inclusion of the rural poor has been beset with multiple challenges. Lack of adequate banking infrastructure and human resources in rural areas, unplanned expansion leading to unviable bank branches and low levels of financial literacy amongst the rural populace have been some of the key challenges.
The most vulnerable communities, who often had no formal credit history or ability to provide collateral, have often been the worst affected. Inability to access loans from banks meant that the poorest had to resort to moneylenders for loans at unreasonably high rates of interest that invariably led them into a toxic debt trap.
In this context, the SHG-Bank Linkage programme, formalised by the National Bank for Agriculture and Rural Development (NABARD) in 1995, synthesizes 'formal financial systems' (in terms of a formal institution providing credit) with the 'informal sector' (comprising of rural poor with no formal credit history), has emerged as a preferred vehicle for providing financial services to the hitherto unbanked poor.
Community Based Repayment Mechanisms (CBRMs) have been institutionalised at branches involved in financing SHGs to monitor and ensure timely repayment of loans by SHGs. The number of SHGs with outstanding bank loans stands at nearly 5 million today, implying that the program has brought formal banking services to over 50 million women.
Why is it important to ensure access to cheap formal sector credit to the rural poor?
Access to adequate and timely credit at affordable rates is critical for the rural poor to alleviate high cost debt and invest in livelihood opportunities. Despite the Government of India's best efforts, financial inclusion of the rural poor has been beset with multiple challenges. Lack of adequate banking infrastructure and human resources in rural areas, unplanned expansion leading to unviable bank branches and low levels of financial literacy amongst the rural populace have been some of the key challenges.
The most vulnerable communities, who often had no formal credit history or ability to provide collateral, have often been the worst affected. Inability to access loans from banks meant that the poorest had to resort to moneylenders for loans at unreasonably high rates of interest that invariably led them into a toxic debt trap.
In this context, the SHG-Bank Linkage programme, formalised by the National Bank for Agriculture and Rural Development (NABARD) in 1995, synthesizes 'formal financial systems' (in terms of a formal institution providing credit) with the 'informal sector' (comprising of rural poor with no formal credit history), has emerged as a preferred vehicle for providing financial services to the hitherto unbanked poor.
Community Based Repayment Mechanisms (CBRMs) have been institutionalised at branches involved in financing SHGs to monitor and ensure timely repayment of loans by SHGs. The number of SHGs with outstanding bank loans stands at nearly 5 million today, implying that the program has brought formal banking services to over 50 million women.
What could be the main reason for the institutionalization of Community Based Repayment Mechanisms (CBRMs)?
Access to adequate and timely credit at affordable rates is critical for the rural poor to alleviate high cost debt and invest in livelihood opportunities. Despite the Government of India's best efforts, financial inclusion of the rural poor has been beset with multiple challenges. Lack of adequate banking infrastructure and human resources in rural areas, unplanned expansion leading to unviable bank branches and low levels of financial literacy amongst the rural populace have been some of the key challenges.
The most vulnerable communities, who often had no formal credit history or ability to provide collateral, have often been the worst affected. Inability to access loans from banks meant that the poorest had to resort to moneylenders for loans at unreasonably high rates of interest that invariably led them into a toxic debt trap.
In this context, the SHG-Bank Linkage programme, formalised by the National Bank for Agriculture and Rural Development (NABARD) in 1995, synthesizes 'formal financial systems' (in terms of a formal institution providing credit) with the 'informal sector' (comprising of rural poor with no formal credit history), has emerged as a preferred vehicle for providing financial services to the hitherto unbanked poor.
Community Based Repayment Mechanisms (CBRMs) have been institutionalised at branches involved in financing SHGs to monitor and ensure timely repayment of loans by SHGs. The number of SHGs with outstanding bank loans stands at nearly 5 million today, implying that the program has brought formal banking services to over 50 million women.
Which of the following is likely to be the MAIN objective of this programme?
Explain the role of legal reserve ratio and Bank rate in correcting inflationary gap in an economy.
Identify which of the following Statement is true?
If legal reserve ratio is 20%, the value of money multiplier would be ______.
Which of these banks formulates the credit control tools?
To ensure that the citizens of the country have faith in the currency, the currency is issued by:
Match the following:
| Column I | Column II | ||
| A. | Primary deposits | (i) | Payable on demand |
| B. | Derivative deposits | (ii) | Deposits for a fixed period of time |
| C. | Demand deposits | (iii) | Cash deposits of people |
| D. | Term deposits | (iv) | Deposits created by banks (or loan deposits) |
Read the following statements - Assertion (A) and Reason (R). Choose one of the correct alternatives given below:
Assertion (A): Credit Creation comes to an end when total cash reserves become equal to the initial deposits.
Reason (R): The value of money multiplier is determined by Legal Reserve Ratio (LRR).
Match the following:
| Column I | Column II | ||
| A. | Formula of Money Multiplier | (i) | Inverse |
| B. | Money multiplier = 4 | (ii) | Money multiplier = 10 |
| C. | Relationship between LRR and money multiplier | (iii) | LRR = 0.25 |
| D. | LRR = 0.1 | (iv) | `1/"LRR"` |
What are secondary (derivative) deposits?
Why are the banks required to keep only a fraction of deposits as cash reserves?
