Explain the process of credit creation by commercial banks. - Vidyadip

Question

Explain the process of credit creation by commercial banks.

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Answer

When a commercial bank receives deposits it keeps a part of it with the Central bank and a part with itself. These are called legal reserves. The money lent comes back to it as deposits. Again it keeps a part of it with the central bank and a part with itself and lends the rest.
This process continues. In this way bank gives loans which is many a times the original deposit. The total credit creation will be $\frac{1}{{{Legal\text{ } Reserve\text{ } Ratio\text{ }}}}$

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