Commercial Banks and Credit Creation
NCERT Class 10 • Economics • Chapter "Money and Credit" | NCERT Class 12 • Introductory Macroeconomics • Chapter "Money and Banking"
Commercial Banks and Credit Creation
A commercial bank accepts deposits from the public and lends that money to borrowers, keeping a small part as reserve. The gap between the interest it charges borrowers and the interest it pays depositors is its main income. In this way banks move idle savings into productive investment.
Functions of Commercial Banks
- Primary functions are accepting deposits and advancing loans.
- Deposits are of several kinds: current deposits for daily business use, savings deposits for households, fixed or time deposits for a set period at higher interest, and recurring deposits paid in monthly instalments.
- Loans take the form of cash credit, overdraft, term loan and discounting of bills.
- Secondary functions include remittance of funds, locker facility, collection of cheques, sale of insurance and government schemes.
- Banks also act as agents for their customers by paying bills and buying securities on their behalf.
- Banking has spread through branch banking, business correspondents and now mobile and internet banking.
Credit Creation and Types of Credit
- Banks keep only a fraction of deposits as cash because not all depositors withdraw at once.
- The rest is lent out, the borrower spends it, and it returns to the banking system as a fresh deposit, which can be lent again.
- Through this repeated process banks create credit many times larger than the original deposit.
- The size of credit creation depends on the reserve ratio: the lower the reserve requirement, the larger the creation.
- Formal credit comes from banks and cooperatives, is supervised, and charges a reasonable rate.
- Informal credit comes from moneylenders, traders and employers, is unsupervised, and often charges very high interest, which can lead to a debt trap.
- Bank credit therefore has to reach small farmers and small businesses if growth is to be widely shared.
| Deposit Type | Main Feature |
|---|---|
| Current | Frequent transactions, no or low interest |
| Savings | Household saving with moderate interest |
| Fixed | Locked for a period, higher interest |
| Recurring | Monthly instalments for a fixed term |
Credit creation — the process by which banks generate deposits many times the original cash through repeated lending.
Exam me kaise aata hai
- The primary functions of a bank are — accepting deposits and advancing loans
- Deposit locked for a fixed period is called — fixed or time deposit
- Credit from a moneylender is — informal credit
- Credit creation depends mainly on the — reserve ratio
UPSC/State PSC ke liye
- The money multiplier is the reciprocal of the reserve ratio, so a lower ratio allows a larger expansion of deposits.
- Expanding formal credit to the poor matters because the terms of credit, not only its availability, decide whether a loan builds assets or creates a debt trap.
Yahan confuse hote hain
✗ Banks lend out all the deposits they receive | They keep a fraction as reserve and lend the rest | ✓
✗ Credit creation means printing money | It means expanding deposits through repeated lending | ✓
✗ Informal credit is cheaper | Informal credit usually charges much higher interest | ✓
Ek nazar me
- Banks accept deposits and advance loans; the interest gap is their income.
- Deposits: current, savings, fixed and recurring.
- Credit creation multiplies deposits, limited by the reserve ratio.
- Formal credit is supervised and cheaper; informal credit can trap borrowers.