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Unit 4: Credit Creation

Uniform Policy: If all the commercial banks follow a uniform policy related to CRR, then Notes
credit creation would be smooth. If some banks follow liberal and others follow a
conservative one, then credit creation would be affected.
Thus, various limitations hinder the path of ability of the banks to create credit. Still, one should
not underestimate the significance of credit creation function of the banks. This function has
long-run implications on the functioning of the economy, particularly on the activities of business.
Bank credit acts as the oil which lubricates the wheels of the business machine.

Self Assessment

Fill in the blanks:
10. External Drain refers to ……………………. of cash from the banking system by the public.
11. Bank credit is the oil which ……………………. the wheels of the business machine.
12. Loans are sanctioned on the basis of the ……………….. provided to the banks.
13. There is a/an ……………… relationship between the amount of deposits and supply of
credit.
14. Credit is created by ……………… banks, it is controlled by the …………… Bank.
15. External Drain ………………… the reserves of the banks.

Case Study Bhatt Enterprises – Cash Forecasting and Investing

ushma is the Treasurer of Bhatt Enterprises, a poorly organized collection of financial
services companies. The composition of Bhatt’s activities can best be seen in a
Sstatement of forecasted cash flow by each major business line, namely:
Annual Cash Flow
Insurance policies $ 85,000,000
Insurance underwriting 55,000,000
Assets based lending 200,000,000
Consumer paper 155,000,000
Auto dealer paper 80,000,000
$ 575,000,000

Sushma has inherited a concentration banking system, as shown in Figure 1. After examining
its features, he felt satisfied that it meets the needs of Bhatt Enterprises. The hometown
bank in San Francisco. California is not a member of any clearinghouse; all cheques are
processed through a correspondent relationship with security. The lockboxes in Phoenix
and Seattle are efficiently managed by security and thus, average only one day float. This
is the same as for funds deposited directly as security. Excess funds are wired daily to New
Jersey for same day investment.

Contd...

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