3. Change in CRR- The central bank also influences the amount of credit creation by making change in Cash Reserve Ratio. When it wants to expand credit, it reduces this ratio and in order to contract credit, it increases this ratio.
R.B.S.E. Deskwork & Question Bank, Economics-12
Answers
Credit creation or money creation refers to the power of the banks to expand or contract demand deposits through the process of more loans, advances and investments.
Some writers express the view that a bank could never lend more than the amount deposited by the depositors; this may be partially true.
But it is also true that whatever is lent out by a bank may come back by way of new deposits, which may be lent out again and so on, a deposit becoming a loan which again returns to the bank as a deposit and becomes the basis for a new loan and so on.
A commercial bank, therefore, has been aptly described as a ‘factory of credit’, which is able to multiply loans and investments and hence deposits. With a little cash at the disposal they are able to create additional purchasing power to a considerable degree. It is in this sense that banks create credit. An increase in bank credit will, therefore, mean multiplication of bank deposits.