Credit creation

credit is very important for business and economy. growth of economy depends on credit creation. commercial banks play an important role in it. but if it is uncontrolled then it can create fluctuations in economy. it can bring inflation or recession in economy.
in this PPT how commercial banks distribute loan and how it is affected by various factors are explained.

1. Credit Creation Process

2. Credit Creation PREPARED BY HEMANT KUMAR JAIN PGT ECONOMICS KV AMBIKAPUR

3. Introduction :- Central bank is the primary source of money supply in an economy through circulation of currency. Commercial banks are the secondary source of money supply in an economy. Credit creation or money creation process is the backbone of economy

4. Important facts:- Credit creation process is similar in signal banking system and multiple banking system. Commercial banks do not lend all the money available with them. They keep a certain part with them and remaining funds can be lend. Demand deposits are used as money supply in economy. With their experience they know that all the depositor will not come together and they will not withdraw their all deposits at a time. Commercial banks do not lend money in the form cash. But in the form of credit entry (called secondary deposits )

5. Credit Creation Process Steps Deposits Reserves Ratio Loan 1 st 1000 200 800 2 nd 800 160 640 3 rd 640 128 512 4 th 512 102 410 5 th 6 th And so on till reserves are exhausted 5000 1000 4000 Suppose primary deposits=1000, reserve ratio=20%

6. Explanation of Schedule In the schedule primary deposits are assumed 1000 rupees and reserve ratio is 20%. In first step/ round 200 rupees are kept by bank as reserve and remaining 800 rupees can be distributed as loan. This amount is distributed as credit entry. It means it will be deposited in bank accounts of borrowers. Commercial bank will keep again 20% of 800 and remaining amount can be distributed as loan to borrowers. This process will continue till reserves are exhausted.

7. Credit Multiplier = 1/ Reserve Ratio Reserve Ratio = CRR+SLR+cdr Credit Creation = Primary deposits X Credit Multiplier Cash Reserve Ratio:- it refers to the minimum ratio of bank’s total deposits that every commercial bank has to keep with RBI. Statutory Liquidity Ratio:- it refers to the fixed ratio of bank’s deposits that every bank has to keep with itself in the form of liquid assets. Cash Deposit Ratio:- the ratio of cash held by bank at cash counter and total deposits. CRR and SLR decided by RBI and CDR is decided by bank itself.

8. Credit Multiplier and Reserve Ratio CM = 1/20 = 5 (RR 20% assumed in schedule) Suppose RR is reduced to 10% CM = 1/10 = 10 RR↓ CM↑ Suppose RR is increased to 25% CM 1/ 25 = 4 RR ↑ CM ↓ CM and RR both are negatively related with each other.

9. Factors affecting credit creation process Availability of cash :- higher cash available then higher the credit creation and vice versa. CRR :- higher CRR then lower the credit creation and vice versa. Number of borrowers :- if number of borrowers are more then credit creation will be higher and vice versa. Economic conditions :- if recessionary condition are existing then credit creation will be lower and vice versa.