Credit creation is inversely related to the reserve deposit ratio ‟ .Justify
the given statement ,using a hypothetical example..
Answers
Answer:
hope this helps you mate xD..
Answer:
Credit creation is the most importnt function of commercial banks. Commercial banks accept deposits and lend money to the needy borrowers. Through this process they create two types of deposits, (i) primary deposits and (ii) derivative or active deposits.
The former deposits refers to the cash or cheque deposited by a customer in a bank. The banker merely accepts cash and converts it into a deposit. But, this is merely a passive role performed by the banks,because these primary deposits do not add to the money stock in the economy. Banks know, from their experience and observation, that not all the customers will withdraw their deposits on any single day. However, commercial banks cannot use the entire amount of public deposits for lending purposes. They are required to keep a certain percentage of amount as reserve with the Central Bank for serving the cash requirements of depositors. After keeping the required amount of reserves, commercial banks lend the remaining portion of public deposits as loans. The amount of reserve maintained by the banks is known as Cash Reserve Ratio (CRR) and is determined by the Central Bank.
The process of credit creation by commercial banks is explained as follows:
Suppose ‘A’ deposit Rs. 10,000 in a bank X, which is the primary deposit of the bank. The cash reserve requirement of the Central Bank is 10%. Then, bank X will keep Rs. 1000 as reserve with the Central Bank and will lend remaining Rs. 9000 to needy borrowers.