Page 159 - DECO402_Macro Economics

Macroeconomic Theory

Notes
Final Balance Sheet of Bank 'B'

Liabilities ` Assets `
Reserves 81
Deposits 810
Loans 729
Total 810 Total 810

This process of credit expansion will go on until primary deposit of ` 1000, does not get distributed in
the complete banking system in form of reserve fund. All banks will collectively create a new deposit
worth ` 9000 and deposit of total banking system will be ` 10000 as is shown by table 17.1

Table 17.1

Bank New Deposits CRR New Loans
1,000 100 900
A
900 90 810
B
810 81 729
C
729 - -
Other bank
- - -
Total for the Banking 1,0000 1,000 9,000
System

Change in Total Deposit = Primary Deposit X Credit Multiplier
1 1
Credit Multiplier = = 10
CRR 10%
Change in total deposit = 1,000 × 10 = 1,0000
In short, total deposit of complete banking system, because of the primary deposit of ` 1,000, will
become ` 1,0000.

Task Express your thoughts in relation to money multiplier.

17.5 Limitations of Credit Creation

Banks cannot create credit in unlimited quantity. There are many limitations to the credit creation
power of commercial bank, details of which are as follows:
1. Cash Reserve Ratio: Power of credit creation mainly depends on cash reserve ratio (CRR).
There is a mutually inverse relation between credit creation and cash reserve ratio. As
much cash reserve ratio will be more, creation of credit will be as less. As opposed to this,

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