Finance & We

What Is

Credit Creation?
Presented By

By

ARIF ISMAIL

11013548 - Q3R02

Getting Started . . .
What Is Credit Creation?

'Credit Creation' begins with banks lending money out of primary deposits, as loans to borrowers.

What Is Primary Deposit? Primary deposits are those deposits which are deposited in banks.

What Does Banks Lending Do?

What Happens By That?

The role of the banking sector is to receive deposit from the public and to lend out loans to the public sector.

1. Deposit $200 to the bank sector. 2. Bank lends some of it.

This phenomenon goes on Cycling

Credit Creation & Loans

People who borrow the Rs.150 may use the Rs.150 for any purpose, but the Rs.150 will eventually deposit back to the bank sector. (no cash leakage) The bank sector again have excess reserve Rs.112.5 (Rs.150 x 75%) The bank sector will lend out Rs.112.5 (the excess reserve)

It Goes On . . .

Rounds In Banks Lending . . .

Round - I

Round - II

Round - III

Keeps Counting Nth Round

Credit Creation
1st round : Rs.200

2nd round : Rs.150

3rd round : Rs.112.5 4th round : Rs.84.4 5th round : Rs.63.3 6th round : 7th round : . .

Credit Creation

Total ?

Calculation of Credit Creation

1 Bank multiplier = Required reserve ratio
Total deposit increment = initial deposit x banking multiplier

$ Bank

LIMITATIONS OF CREDIT CREATION?

The limitations of credit creation by commercial banks are

Briefing It Limitation - 1
Amount of Deposit
The most important factor which decides 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.

Briefing It Limitation - 2
Cash Reserve Ratio (CRR) There exists an indirect relationship between Credit Creation and Cash Reserve Ratio (CRR). Higher is the Cash Reserve Ratio (CRR) more will be the reserves to be maintained and less credit will be created by banks. The CRR is fixed by the RBI in India. It ranges between 3% to 15%.

Briefing It Limitation - 3
Banking Habits of People If the banking habits of the people are well-developed, then all their transactions would be through banks, and this will lead to expansion of credit and vice-versa.

Briefing It Limitation - 4
Supply of Securities Loans are sanctioned on the basis of the securities provided to the banks. If securities are available then the credit creation will be more and vice-versa.

Briefing It Limitation - 5
Willingness of people to borrow Commercial banks may have enough money to lend. Customers should be willing to borrow from the banks to facilitate credit creation. If they are willing to borrow, then the credit created by banks will be less.

Briefing It Limitation - 6
Monetary Policy of Central Bank While credit is created by commercial banks, it is controlled by the Central Bank. Credit control is one important function of the central bank. Central Bank uses various methods of Credit Control from time to time and thus influences the banks to expand or contract credit.

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