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प्रश्न
Answer the following question.
Explain, using a numerical example, how a reduction in reserve deposit ratio, affects the credit creation power of the banking system.
उत्तर
Reserve Deposit Ratio or Cash Reserve Ratio refers to the minimum proportion of the total deposits that the commercial banks have to maintain with the central bank in the form of reserves. An increase in this ratio would mean that banks would be required to keep a greater portion in the form of deposits with the central bank. This implies that commercial banks are left with a lesser amount of funds to lend out. Hence, the lending capacity of the banks reduces, leading to a fall in the money supply. On the contrary, a fall in CRR will lead to an increase in the money supply.
To summarise,
CRR ↑ ⇒ Deposits with the bank's ↓ ⇒ cash reserves of the bank ↓ ⇒ Lending capacity of the bank's ↓ ⇒ Money supply ↓
CRR ↓ ⇒ Deposits with the bank's ↑ ⇒ cash reserves of the bank ↑ ⇒ Lending capacity of the bank's ↑ ⇒ Money supply ↑
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, the 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 a credit to other customers. This further creates deposits for the bank XYZ of Rs 9000. Now in the next round, out of Rs 9000, Rs 900 goes as cash reserves and the remaining Rs 8100 are extended as loans. And so the process will continue. Such a process will increase the money supply in the economy by the amount (times) of credit multiplier. Suppose the reserve deposit ratio or cash reserve ratio is equal to 10%. Then:
Credit multiplier = `1/"CRR" = 1/10` % = 10
Therefore, the money supply will increase by 10 times and the total credit created in the economy will be equal to around Rs 1,00,000.
The process can be supported by the following table:
| Rounds | Deposits Received A |
Loans Extended B |
Cash Reserves |
| Initial | 10,000 | 9000 | 1000 |
| Round I | 9000 | 8100 | 900 |
| Round II | 8100 | 7290 | 810 |
| Round III | - | - | - |
| Round IV | - | - | - |
| - | - | - | - |
| - | - | - | - |
| Round N | - | - | - |
| Total | 1,00,000 | 90,000 | 10,000 |
Now suppose the CRR reduces to 5%. Then:
Credit multiplier = `1/"CRR" = 1/5` % = 20
Therefore, the money supply will increase by 20 times and the total credit created in the economy will be equal to around Rs 2,00,000.
| Rounds | Deposits Received A |
Loans Extended B |
Cash Reserves |
| Initial | 10,000 | 9,500 | 500 |
| Round I | 9,500 | 9,025 | 475 |
| Round II | 9,025 | 8753.75 | 451.25 |
| Round III | - | - | - |
| Round IV | - | - | - |
| - | - | - | - |
| - | - | - | - |
| Round N | - | - | - |
| Total | 2,00,000 | 1,90,000 | 10,000 |
With the fall in Reserve Deposit Ratio or CRR, the money supply increases in the economy.
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संबंधित प्रश्न
Explain the concept of ‘inflationary gap’. Also explain the role of ‘legal reserves’ in reducing it.
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.
Which of the following is a crucial area of improvement for rural banking?
Read the given extract carefully and answer the following questions.
| Mr. X wanted to buy an expensive motorcycle for his son but he did not have sufficient money to buy it. He approached a public sector commercial bank for the loan. The bank asked Mr. X to deposit 20% cash of the loan amount and rest 80% of the loan amount was given by the bank. |
- Briefly explain a Commercial Bank.
- What is the regulation of consumer credit in selective credit control?
- Name the bank which controls all the commercial banks and financial institutions in the country.
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?
Deposits made by the people from their own resources are called ______.
The ratio of total deposits that a commercial bank has to keep with Reserve Bank of India is called ______.
Credit money is increased when CRR:
Suppose in an economy, the initial deposit of ₹ 400 crores lead to the creation of total deposits worth ₹ 4000 crore. Then the value of reserve requirements would be ______.
Match the following and select the correct option.
| Column A | Column B | ||
| (i) | A deposit created by a customer | A. | Term deposit |
| (ii) | A deposit created by bank when loan is granted | B. | Demand deposits |
| (iii) | Deposits payable by bank on demand | C. | Initial deposit |
| (iv) | Deposits the amount of which can be withdrawn only after a fixed period of time | D. | Secondary deposit |
To ensure that the citizens of the country have faith in the currency, the currency is issued by:
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).
What is meant by credit creation?
Explain briefly the process of credit creation by commercial banks.
What are secondary (derivative) deposits?
