Sunday, February 5, 2017

Commercial banks cannot create credit money.

Ans. No, I do not agree with the given statement. This is because Commercial banks do create credit money.

Credit Creation :
The main source of funds, which is available to commercial banks, is in the form of deposits from the public.

Primary Deposits :
Primary deposits are also known as cash deposits. Such deposits refer to money deposited by the people in the form of cash with the banks. These deposits are withdrawable by the depositors.
A part of these deposits are kept by the bank, to meet the demand for cash of the depositor. This is termed as minimum cash reserves. The banks are able to do with a very small reserve because all depositors do not withdraw money at the same time.

Secondary/Derivative Deposits :
The balance over the minimum cash reserves, which is used by the banks to create credit by way of providing loans is known as derivative deposit. or Derivative deposit is a deposit which is left over after deducting cash reserve from primary deposits. When a bank grants loan to a borrower, bank opens a deposit account in the name of the borrower. Borrower can withdraw money from this account by means of cheque.
If a bank purchases securities from a seller, it opens an account in the name of the seller who can withdraw from it.

When the borrower withdraws money from his loan account by a cheque, it is deposited by the payee in some other bank. These banks again create credit on the basis of fresh deposits received after keeping the required reserves. In this way, commercial banks create credit money, which is the part of total money supply.