Page 70 - DCOM208_BANKING_THEORY_AND_PRACTICE

Unit 4: Credit Creation

Granting a loan is not the only method of creating deposit or credit. Deposits also arise Notes
when a bank purchase government securities or discounts a bill.

Contraction by any single bank in this system will place pressure on other banks and if
their excess reserve position is inadequate and the banks are unable to meet their excess
reserves through the agency of the central bank then a multiple process of credit contraction
will start.
The most significant factor which determines credit creation is the amount of deposits
made by the depositors. Higher is the amount of deposits; greater is the supply of credit
and vice versa.

If the banking habits of the people are well-developed, then all of their transactions would
be through banks, and this will lead to expansion of credit and vice-versa.
External Drain refers to withdrawal of cash from the banking system by the public. It
lowers the reserves of the banks and limits the credit creation.
If all the commercial banks follow a uniform policy related to CRR, then credit creation
would be smooth. If some banks follow liberal and others follow a conservative one, then
credit creation would be affected.

4.5 Keywords

Active Deposits: Its id the other name for derivative deposits.
Borrow: Take and use money from a person or bank under an agreement to pay it back later.

Contraction: The act of decreasing (something) in size or volume or quantity or scope.
Credit: The ability to obtain goods or services before payment, based on the trust that payment
will be made in the future.

Cash Reserve Ratio (CRR): CRR is the amount of funds that all Scheduled Commercial Banks
excluding Regional Rural Banks are required to maintain without any floor or ceiling rate with
RBI with reference to their total net Demand and Time Liabilities to ensure the liquidity and
solvency of Banks.

Deposit: A sum of money placed or kept in a bank account, usually to gain interest.
External Drain: It refers to withdrawal of cash from the banking system by the public. It lowers
the reserves of the banks and limits the credit creation.

Passive Deposits: It is the other name for primary deposits.
Statutory Liquidity Ratio (SLR): The ratio of liquid assets to demand and time liabilities is
known as Statutory Liquidity Ratio.

4.6 Review Questions

1. Define the term ‘Credit’.
2. What do you mean by ‘credit creation’?
3. Describe the measures by which banks create credit.
4. What is the basis of credit creation?
5. What do you understand by contraction of credit?

6. Write short note on multiple credit creation.

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