Question

If primary deposit is 20,000 and legal reserve ratio is 10% then explain the process of money creation by commercial bank.

Answer 1

Answer:

Cash Reserves Ratio (CRR) refers to the proportion  of total deposits of the commercial banks which they must have keep as cash reserves with the central bank. The ratio is fixed by the central bank and is varied from time to time to control the supply of money in the economy depending upon the prevailing situation of inflation or deflation.

Cash reserve ratio  = (primary deposit / total deposit) x 100

                               = (2,500 / 20,000) x 100

                               = 12.5 %

Multiplier refers to the number of times the commercial banks multiplies the primary deposit in the credit creation process in order to create total deposits. 

Multiplier = 1/ Cash reserve ratio 

                = 100 / 12.5 

                = 8 times 

Answer 2

Let total deposit=x

As, Cash reserve ratio = (primary deposit / total deposit) × 100%

= (20,000 / x) × 100%

The money creation process is a natural feature of fractional-reserve banking that occurs as banks act as both safekeepers of deposits and financial intermediaries making loans. Banks keep a portion of available reserves to back up deposits, then lend out excess reserves, creating checkable deposits in the process.

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