A commercial bank is a financial institution that provides services such as accepting deposits, giving business loans, mortgage lending, and basic investment products such as savings accounts and certificates of deposit.
Commercial Bank Credit Creation
Bank deposits form the basis for credit creation. Banks accept deposits from the public by opening a deposit account known as the primary deposit. Banks do not hold the money in the account itself and the entire amount is not withdrawn from the account at the same time. So, they advance loans to business people and retain only a small portion of the total deposits in the bank. The Central Bank decides the amount to be held in the form of cash. This is called the cash reserve ratio.
These banks advance loans to business people only against collateral securities. The bank will not give cash but open a derivative account in the name of the individual or institution. Here, the loans create a derivative deposit which is called a secondary deposit or derivative deposit. Thus, the second deposit is called the creation of credit.
Limitations of a Commercial Bank to Create Credit
- Commercial Bank Credit Creation is based on the primary deposit. Hence, there should be a large amount of cash, but the Central Bank has full control over the cash deposited by the individual. They decide the amount of cash to hold as a reserve and the amount for advancing loans.
- Business people can avail of loans from the bank only when they have good securities to submit against a loan. If the approved securities are not available to them, then the bank will not be able to create credit as loans.
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