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Solution - Commercial Banks Can Not Create Credit Money. - Central bank Function - Goverment Bank


Explain with reasons, whether you agree or disagree with the following statement

Commercial banks can not create credit money.

Solution 1

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.

Solution 2

No, we do not agree with the statement. Commercial banks, in fact, create the credit money.  The central bank (RBI as in India) prints new money (seigniorage), while on the other hand, the commercial banks multiply the money supplied by the RBI through the process of credit creation. The money created by the commercial banks is known as credit money. The process of credit creation initiates when the people deposit money in their respective bank accounts. As per the central bank guidelines, the commercial banks are required to maintain a portion of total deposits in form of cash reserves. The commercial banks lend the remaining portion (left after maintaining cash reserves) of the total deposits to the general public in form of credit, loans and advances. The process of creation of credit money begins as soon as the commercial banks start the lending process. The amount of the credit money increases as the banks lend loans to more and more number of people in the economy. The deposit of money by the people in the banks and the subsequent lending of loans by the commercial banks is a never-ending process. It is due to this continuous process that the commercial banks are able to create credit money a multiple times of the initial deposits.

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2015-2016 (March)
Question 5.5 | 4 marks
2013-2014 (March)
Question 5.5 | 4 marks
Solution for question: Commercial Banks Can Not Create Credit Money. concept: Central bank Function - Goverment Bank. For the courses HSC Arts, HSC Commerce, HSC Commerce (Marketing and Salesmanship), HSC Science (Computer Science), HSC Science (Electronics), HSC Science (General)