Page 161 - DECO402_Macro Economics

Macroeconomic Theory

Notes 6. Confidence of Depositors: Power of commercial banks to create credit is also influenced
by the confidence of the depositors. If depositors have full faith on the banking system then
they will let their money lie in the bank. It will increase the credit creation power of the
banks. As opposed to this, if people do not have faith in the banking system then they will
not keep their savings in banks. Less amount of cash balance with the banks reduces their
credit creation power.
7. Availability of Good Borrowers: Availability of borrowers worth credit also influences credit
creation power of the banks. If such borrowers are available in big numbers then more credit
will be created. If good borrowers are not available banks will hesitate in giving loans and
credit creation will be limited.
8. Commercial and Industrial Conditions: During the period of recession, businessmen’s and
industrialists’ demand for loan is very less. Hence not much credit is created by banks in
form of secondary deposits. But during boom period, giving loans is profitable for the banks
and they create more credit in form of secondary deposits.
Two principal parameters that Delimit the Credit Creation Capacity of the Commercial Banks
Two principal parameters that delimit the Credit Creation Capacity of the Commercial Banks are
as follows:
(i) Primary deposits of commercial banks or cash reserves: As much more will be cash
reserves that much more will be the power of the banks to create credit.
(ii) Cash reserve ratio determined by the central bank: It is compulsory for the commercial
banks to follow the orders of the central bank, relating to Cash Reserve Ratio (CRR). If
CRR is increased as in situation of inflation, credit creation power of banks is contracted.
As opposed to this if cash reserve ratio is reduced, as in the condition of recession, then
credit creation power of the banks increase a lot.

Self Assessment

State whether the following statements are True or False:
7. Money Supply in an economy depends on velocity of currency and demand deposits of the
bank.
8. Credit expansion capacity of commercial banks depends on their cash reserve ratio.
9. That deposit of the bank is called the demand deposit which the depositors cannot withdraw
anytime by issuing a cheque.
10. Supply of money and high powered money is retio.

17.6 Competitive Banking and Credit Expansion
Like Joint stock companies commercial banks also work for profit. According to the perspective of
credit expansion, commercial banks through the medium of credit expansion, want to maximise
their profits. But credit expansion is not always possible. If people decide to make an increase in their
primary deposits then, commercial banks will be able to increase their secondary deposits. Banks, with
the help of the primary deposits of the people, increase secondary deposits and expand credit. But
in current competitive age, commercial banks, in order to maximise their profits and for expanding
credit try other measures. Banks keep excess reserves with them which fulfil the increasing credit
requirement in money market. For expanding credit and increasing profits commercial banks plan
their policies demand and supply Parameters of money market.

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