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Question
''The process of credit creation by commercial banks comes to an end when the total of required reserves become equal to the initial deposits."
With the help of a numerical example, prove that the given statement is true.
Solution
The following statement is correct. "The credit creation process by commercial banks concludes when the total of required reserves equals the initial deposits."
Credit creation is a process in which a primary deposit (people's savings) becomes a secondary deposit (people's borrowings), which becomes a new deposit, and so on until the initial deposit equals legal reserves.
| Round | Primary Deposit | Secondary Deposit | LRR = 20% |
| 1 | 1000 | 800 | 200 |
| 2 | 800 | 640 | 160 |
| 3 | 640 | 512 | 128 |
| 4 | 512 | ........ | ........ |
| . | . | . | . |
| . | . | . | . |
| . | . | . | . |
| . | . | . | . |
| Total | 5000 | 4000 | 1000 |
`1/"LRR"` × Initial Deposits
= `1/(20%) × 1000`
= 5000
Credit has been created 5 times of initial deposits. When Initial deposits of 1000 become equal to legal reserves of 1000, the process of credit creation comes to an end.
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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.
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Which of the following is a crucial area of improvement for rural banking?
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)?
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| 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 |
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| Column I | Column II | ||
| A. | Formula of Money Multiplier | (i) | Inverse |
| B. | Money multiplier = 4 | (ii) | Money multiplier = 10 |
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