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Question
Write the mechanism of credit creation by commercial banks.
Solution
Mechanism / Technique of Credit Creation by Commercial Banks:
- Bank credit refers to bank loans and advances.
- Money is said to be created when the banks, through their lending activities, make a net addition to the total supply of money in the economy.
- Money is said to be destroyed when the loans are repaid by the borrowers to the banks and consequently, the credit already created by the banks is wiped out in the process.
- Banks have the power to expand or contract demand deposits and they exercise this power through granting more or less loans and advances and acquiring other assets.
- This power of commercial bank to create deposits through expanding their loans and advances is known as credit creation.
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