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Question
State with reason whether you agree or disagree with the following statement.
A commercial bank create credit on the basis of primary deposit.
Solution
No, we disagree with the given statement. Commercial banks can create credit only out of derivative deposits. Derivative deposit is the amount of deposits left after deducting the cash reserve from primary deposits. Suppose bank A receives a total deposit of Rs.10, 000, with mandatory cash reserve of 10%, then after keeping a sum of Rs.1000, he can loan out the remaining Rs. 9000 to others. Suppose, he gave the credit to a person who deposits it in bank B. Bank B also kept 10% of Rs. 9000 i.e. it kept Rs. 900 as a reserve and loaned out the remaining sum (Rs. 8100) to an individual who deposits it in bank C. Bank C further loaned out Rs. 7290, after keeping Rs. 810 as reserve. In this way, it can go on an infinite number of times and the credit goes on being created. Hence, we can say that the commercial bank creates credit from the derivative deposit and not from the primary deposits.
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