The Process of Credit Creation

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Bank will give loans to customers from deposited amount. But they can create credit up to certain limit. The process of credit creation is done in two types of deposits. Primary deposit (in our example initial deposit of Rs.100/- is primary deposit) and Secondary deposit (the deposit created in every round is called secondary deposit). Credit can be created until the initial increase in deposit is equal to cash reserve ratio amount.

Understanding Credit Creation using example:

Note: Assumption is that there exists only one bank in the economy. The rate of CRR is 20%.

Table: Credit Creation

Credit Creation
Credit Creation

Steps

Increase in Deposit

Cash Reserve

Loan

….

……

……

…..

……

…..

……

…..

Total

Total Credit
Total Credit

Here, in our example initial deposit is Rs

Total credit is

Cash reserve ratio i of

Loan amount =

Credit Creation Capacity of a Bank:

Credit creation capacity of bank is the ability to create credit. It depends on CRR.

  • If the CRR is high, bank need to keep high amount with bank. So, less will be available for lending, then the Credit creation capacity will be less.

  • If the CRR is less, bank need to keep less amount with bank. So, bank can lend more money.

    The credit creation capacity will be more.

Classification of Banks in India:

Based on their function’s banks could be divided into different categories. Those are

Reserve Bank of India (RBI):

Reserve Bank of India is the central bank of India. It is started its operations on April 1st, 1935 and it was established based on RBI Act, 1934. RBI nationalised on 1st Jan, 1949. The Bank was set up based on Royal Commission on Indian Currency and Finance, also called Hilton-young commission. RBI Head Quarters: Mumbai (Initially it was in Calcutta).

RBI has one governor (Present governor: Shaktikanta Das) and 4 deputy governors.

Image of RBI

Image of RBI

Image of RBI

Functions of RBI:

  • Monetary Policy: Monetary policy is to maintain price stability while keeping in mind the objective of growth. Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.

  • Issuer of Currency: RBI has the right to issue currency notes of denominations and t can issue currency notes of face value 10,000. Also controls the supply of money. It supplies money basing on Minimum Reserves Ratio system. It can supply up to cr value of assets ( . Of gold, and cr of for-ex reserves).

  • Banker to Banks: RBI do not accept money from individuals at the same time do not provide loans to individuals. RBI provide loans to banks at Bank Rate (present

  • Banker to Government: RBI sanctions loans to government in order to develop the nation.

  • Foreign Exchange Management : RBI will take care of Foreign Exchanges in order to balance the payments (Balance of Payments –BOP).

  • Regulator of all Banks: RBI issues the license to do banking business in India. At the same time all banks need to maintain their standards and should follow norms as per RBI guide lines.

  • Consumer Education and Protection by conducting campaigns and workshops.

  • Research and Data: RBI release reports periodically to provide country’s financial information.

  • Activities relating to Financial inclusion and development.

  • RBI fixes all Current Rates i,e. Policy rates, Reserve Ratios, Exchange Rates, Lending/Depositing rates etc.

RBI has wide range of functions to do. Entire Indian Economy depends on how it operates.

Classification of Banks as Per RBI:

Image of Classification of Banks as per RBI

Image of Classification of Banks as Per RBI

Image of Classification of Banks as per RBI