Creation and supply of credit

Creation and supply of credit - reserve funds maintained by...

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Creation and supply of credit: Modern commercial banking is a profit makin g activity. It appears that their profits arise out of the difference in the rate of interest that they pay to the depositors and the rate of interest that they charge on their loans or advances. But a major source of their profit is creation and supply of credit money. Such transactions in credit money are much in excess of the original cash deposits that the bankers receive. The ability of a banker to satisfy all its depositors by paying them cash is called 'liquidity' of a banker. But because bankers create credit and liabilities much in excess of their cash holding, no banker is ever fully liquid. The banking business is therefore an activity colored with risk. Hence commercial banks have to operate under some control of the central banking agency in the interest of the public. The central banks have legal authority to require commercial banks to maintain certain reserves with it. Such
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Unformatted text preview: reserve funds maintained by the central bank can be useful in the event of an emergency. In their credit creation activity commercial banks go by the saving habits of their depositors. If the depositors are known to demand about 10 percent of their total amount deposited then the remaining 90 percent of the amount is available for credit creation and the issue of loans. For example, if the total deposit amount received by the banker is $10,000 then 10 percent of this is set aside. This is also the proportion of the reserve fund that is required to be maintained with the central bank. After maintaining a reserve of $1000 the remaining amount of $9000 can be issued as credit or advance . But the borrower of a banker is also its own depositor since bankers issue advances in the form of a fresh bank account in the name of the borrower. This explains the chief principle on which the banking activity is based. It can be stated as:...
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This note was uploaded on 11/17/2011 for the course EC ec 201 taught by Professor - during the Fall '10 term at Montgomery.

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