Credit Creation

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CHAPTER –6
Credit creation by commercial Bank
Demand deposits as money
Bank deposits are two types.
1. Demand Deposit 2. Time deposit
The demand deposits on which cheques are issued are also called as cash deposits or current deposits. D.D are therefore, almost as good as cash money the depositor can convert a part or the whole of the current account in currency notes at any time. According to T.T Sethi “A demand deposit is the obligation of a bank to pay a certain sum of money to a specified individual (depositor) on demand.” 2. Primary and derivative Deposits

Demand deposits can be classified into two categories--
a. Primary deposit
b. derivative or passively and actively created deposit.

a) Primary deposit = current deposit + saving deposit
T.T Sethi “ primary deposits arise from the actual deposits of cash( or cheques and other claims on cash) in a bank account b) Derivative deposits: derivative deposits are created by bank based on the strength of primary deposits. D.D created by the bank through their operating strategies.

T.T Sethi “ Derivative deposits actively created by the bank creating claims against itself in favor of a borrower or of a seller of assets or securities acquired by the bank”. Derivative deposits can be created by two ways:

a) Deposits created by sanctioning credit
b) Deposits created by purchasing assets or securities

Derivative deposit also called secondary deposit.
3. The process of multiple credit expansion
a) The process of multiple credit/ deposit expansion by a monopoly bank : Assumption:
1. Let us assume a situation in which there is only one bank 2. The area in which all payments are made without cash
3. All payments are made by means of book transfers from one current account to another. 4. 4. There is thus no external drain of cash as a consequence of the expansion of the demand deposit. 5. What role play by a monopoly bank to multiple credit expansion we describe below. So we show an initial balance sheet of a bank. Sun-moon bank ltd.

Opening balance sheet

Suppose Govt. purchase a bond from open market which price is tk. 100. who got the money, he will be deposit it into the bank. So the new balance sheet of the bank- Sunmoon bank ltd.
Opening balance sheet

So the actual liquidity reserve ratio;

Ra = = =0. 273

Additional reserve = Ra – Rr =0.0273 – 0.20= 0.073
The deposit expansion ratio= 5 : 1
The credit expansion ratio= 4 : 1

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ΔDD= = = tk. 500

ΔC= ( - 1 ) ΔDD=Increased demand deposit =Increased liquid reserve = 100 ( - 1 ) = Required reserve = 100×4 = tk. 400 ΔC = Increased loan

The credit expansion ratio= 4 : 1

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After expansion of credit and deposit the new balance sheet of the bank; Now it will be shown in the following table ;
Sun-moon bank ltd.

Criticism;
a) Each transaction settled by cheque it is not realistic b) Bank provide loan, but the money remain in the bank vault it is not acceptable. c) Monopoly bank in a country, it is quite impossible in this modern banking age. By this way if a bank get any additional reserve credit deposit as well as credit. So it can increase total demand deposit. Criticism : the process of multiple credit expansion by a monopoly bank is criticized by following ways: a) Each transaction settled by cheque it is not realistic b) bank provide loan – but the money remain in the bank vault it is not acceptable. c) monopoly bank in a country- it is quite impossible in this modern banking age. b) The process of multiple credit or deposit expansion by a commercial bank under competitive banking sytem 0r Banking system as a whole In this case also maintain or consider some...
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