Question

what is credit creation in banks? and write the process of credit creation in banks​

Answer 1

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Question :-

➡️ what is credit creation in banks?

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Commercial Banks deals with credit.They create credit by its loan operations, advances and investments..through credit creation commercial banks are able to support economy.!

Question :-

➡️ process of credit creation in banks ?

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↪️ Loan Creation from Deposit

The commercial banks will pay back the people’s lazy money through various deposits and refund them. But the depositors do not take all the money at the same time. Occasionally, according to the needs taken. So, without taking all the money deposited by the bank, the profits earned by investing in some profitable sectors can be made from some portion of the bank. Thus, the bank creates debt deposits by making and contracting loans. Through these actions, the commercial banks make loans from deposits so that it called ‘Loan Creation from Deposit’. After all, it is the first process of credit creation by the commercial bank through loan creation from the deposit.

↪️ Deposit Creation through Loan

Deposit Creation through Loan is the second process of credit creation by a commercial bank.

1. Investment :-

Commercial banks invest money in shares, bonds, securities etc. Since it is deposited in any bank, the bank creates a debt deposit from that deposit. So investment is the first ways of deposit creation through loan.

2. Loan at call & loan payable at short notice :-

The commercial bank offers only the demands of borrowers and short-term loans through current accounting. The borrowers pick up the money as needed. Therefore, the bank makes a loan deposit by repaying it from that money. So the loan at call and loan payable at short notice is the second way of deposit creation through loan.

3. Bill Discounting :-

Bill discounting is the third way of the deposit creation through loan. The commercial bank exchanges the bill by purchasing the Bill with an interest. So this check is deposited in any bank. And from there it made the bank debt deposits. Therefore, all these activities are involved with bill discounting.

4. Purchasing Assets :-

Since commercial banks are purchasing the assets and paying them through check, As a result they help in generating credit deposits. The person who sells the wealth will not pick up the money and take it slowly through the check. As a result, debt deposits will be created. Therefore, the purchasing assets are the fourth number of the way from deposit creation through loan.

5. Through Bank Overdraft :-

Bank provides Bank Overdraft credit for the needs of the customers. The loan will also be credited to the credit bank in the form of the amount of loan deposited. The overall process of the bank is managed to generate credit deposits.

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Answer 2

Answer:

Credit creation is the most important 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 from time to time.

The process of credit creation by commercial banks is explained as follows: (with the help of an example).

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.

In other words, the bank X does not give B cash while sanctioning the loan. Instead the bank merely opens a loan account in the name of B and credits to his account with Rs. 9000. Then B pays to C, to whom he owes Rs. 9000, by way of cheque to settle his dues with C.

C now deposits the cheque of Rs. 9000 given by B in Y bank. The bank Y, after keeping a sum of Rs. 900 as CRR requirement of the Central Bank, lends Rs. 8100 to another borrower D. Thus, this process of deposits and credit creation continues till the reserves with commercial banks becomes zero.

Hence, the bank gets new deposit from the loan given and actively creates this new deposit. That is why it is always said that loans create deposits. The new deposit created in this manner will add to the money stock of the economy. Whenever the loan is returned by the borrower to the bank, then there is no further possibility of creating new deposit. This results in net decrease in money stock. DR. M.J. SUBRAMANYAM