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Question
‘Reserve Ratio and Credit Creation are inversely related.’ Do you agree with the given statement? Justify your answer with a suitable numerical example.
Solution
Yes, there exists an inverse relation between Reserve Ratio and Credit Creation in the economy.
We know that:
Money Multiplier = `1/"Reserve Ratio"`
Credit Creation = Initial Deposits x Money Multiplier
Assuming that the value of initial deposits is ₹ 10,000 crore.
| Reserve Ratio | Money Multiplier | Initial Deposits | Credit Creation (Initial Deposits x Money Multiplier) |
| 10% | `1/0.1 = 10` | 10,000 | 1,00,000 |
| 25% | `1/0.25 = 4` | 10,000 | 40,000 |
From the above calculation, we can conclude that higher the reserve Ratio, lesser credit will be created by Commercial Banks in the economy.
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RELATED QUESTIONS
What is money multiplier? What determines the value of this multiplier?
Define 'money multiplier'.
Read the following statements carefully and choose the correct alternatives given below:
Statement 1 - The value of the money multiplier is determined by the reserve ratio prevailing in the monetary system.
Statement 2 - The process of credit creation directly relates to the value of the reserve ratio.
As per the following news published in The Economic Times on 26th December, 2021:
‘Reserve Bank of India has sold government securities worth ₹ 8,710 crore in the secondary market, over the last four weeks, to drain out excessive liquidity’.
Identify the likely cause and the consequences behind, this type of action plan of the Reserve Bank.
Read the following text carefully, discuss briefly the relevant function of the Central Bank, indicated :
Recently, Reserve Bank of India (RBI) conducted a statutory inspection for supervisory evaluation against a Commercial Bank. The commercial bank was imposed with stringent penalties, owing to deficiencies in regulatory compliances.
As per the Central Bank, the inspection revealed non-compliances vis-a-vis different directions issued by RBI, on the following fronts:
- ATM Card frauds
- Ensuring integrity and quality of data
- Loans to small borrowers
Find the missing figures and choose the correct alternative:
| Round | Deposits | Loans (80%) | Reserve Ratio (20%) |
| I | 1,000 | 800 | 200 |
| II | 800 | ….(i)…. | 160 |
| .. | .. | .. | |
| .. | .. | .. | |
| Total | …(ii)… | …(iii)… | …(iv)… |
