Credit creation : It is most significant function of the commercial banks. While sanctioning a loan to a customer, a bank does not provide cash to the borrower Instead it opens a deposit account from where the borrower can withdraw. In other words while sanctioning a loan a bank automatically creates deposits. This is known as a credit creation from commercial bank.
One of the important functions of commercial bank is the creation of credit. Credit creation is the multiple expansions of banks demand deposits. It is an open secret now that banks advance a major portion of their deposits to the borrowers and keep smaller parts of deposits to the customers on demand. Even then the customers of the banks have full confidence that the depositor’s lying in the banks are quite safe and can be withdrawn on demand. The banks exploit this trust of their clients and expand loans by much more time than the amount of demand deposits possessed by them. This tendency on the part of the commercial banks to expand their demand deposits as a multiple of their excess cash reserve is called creation of credit.
Credit creation is the process by which banks and other creditors loan money to consumers, which increases the amount of money in circulation. Credit creation is not the same as money creation, but it does result in more money entering an economy.
Credit creation is customary with people to deposit a large part of their incomes and savings in the banks and withdraw small sums to meet their occasional needs. They usually receive and pay money by cheque and only very small sums are exchanged in private transactions. The cheques received in transactions are deposited in bank accounts rather than encashed. This is the manner in which generally payments and receipts in bank accounts are transacted.
The commercial banks create multiple expansion of their bank deposits and due to this, these are called the factories of credit. The banks advance a major portion of their, deposits to the borrowers and keep a smaller part with them. The customers have full confidence on the bank. The banks expand loans by much more than the amount of cash possessed by them. This tendency on the part of the banks to lend more than the amount of cash possessed by them is called Creation of credit in Economics.
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