Question

what is the significance of credit creation?

Answer 1

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☜☆☞ Creation of credit is one of the most important function of a commercial banks. Banks take deposits from the customers and provides loans from their deposits after keeping necessary reserves like cash reserves etc. Actually the banking system creates credit rather than a bank individually. Let us understand this by a simple example, Mr A puts deposit worth Rs. 1000 in X bank. For simplicity assume that there us reserve requirememt of 10%. X bank can lend Rs 900. Suppose Mr B gets this loan and deposits in his bank account with Bank Y. Now if forms part of deposits of Y who can lend Rs 810 from the deposit. This chain continues till the time money remains in banking system. This process is called credit creation where deposit of Rs 1000 has created credit more than that. The process stops at the point where money is moved out of banking system.

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