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Commercial Bank
INTRODUCTION: -
Credit Creation
Introduction:
1) The most important function of the commercial bank is a certain of credit.
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1000 1000
1) Each bank keeps 20% amount in cash and remaining amount lends in
terms of loans and advances.
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1) When Mr. Z issues a cheque of Rs. 800 to Mr. Y then Mr. Y deposits
this cheques in his bank, say B, then Bank A surrenders Rs. 800 to Bank
B and final position of Bank A will be as follows:
Final position of Bank A
Liabilities Amount Assets Amount
Original Deposit 1000 Cash 200
Deposits Loan 800
Total 1000 Total 1000
Bank B
Liabilities Amount Assets Amount
Deposit 800 Cash 800
New Deposit 640 Loan 640
Total 1440 Total 1440
Limitations:
1) Cash Reserve Ratio [CRR]: -
CRR is determined by the central bank of the country. When CRR is raised
during the period of inflation, credit expansion will be less.
2) State of economy: -
Credit creation depends upon state of economy. During the period of
depression, firms are unwilling to borrow from the banks, as a result, credit
expansion will be less.
3) Cash Drain: -
If borrowers withdraw part of their loan in terms of cash then credit
expansion will be less.
4) Banking habits and Banking system: -
Development of the banking system and banking habits among the people
also decide credit expansion.
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Central Bank
Introduction:
1) The central bank is an apex institution of the monetary system.
2) The principle on which central bank is run differs from banking
principle.
3) The objective of commercial bank is to maximize profit on the other
hand the primary objective of the central bank is to promote the
financial and price stability of the country.
4) The guiding principle of the central bank is that should act only in
public interest and for the welfare of the country.
Functions of Central Bank:
1) It acts as sole note-issuing agency.
2) It acts as a banker to the State
3) It is a banker’s bank.
4) It controls the credit.
Methods of credit control:
1) The central bank of the country regulates the volume and direction of
the credit.
2) Bank credit is an important constituent of money supply.
3) Excessive credit will result in inflation; where as deficiency in credit
will result in recession.
4) Broadly speaking there are two types of credit control methods.
a) Quantitative Method
b) Selective method of Credit Control
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a) Quantitative Method: -
1) Quantitative method tries to change the quantity of credit.
2) Quantitative methods of credit control are-
Bank Rate
Open Market Operation (OMO)
Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)
Bank Rate: -
Bank rate is that rate of discount at which central bank discounts first class
bills of exchange of commercial banks.
In other words, it is the rate at which central bank provides loans and
advances to commercial bank by discounting bills of exchange.
Therefore, it is also known as Discount Rate.
Through changes in the bank rate, central bank can influence credit
creation of commercial bank.
Change in bank rate will be followed by changes in the market rate of
interest.
When central bank wants to control the inflation, it raises bank rate.
With the increase in bank rate, market rate of interest also rises.
As a result, investment falls down.
As a result, purchasing power decreases and aggregate demand can be
regulated.
Open Market Operation (OMO)
It refers to the purchase and the sale of government securities in the open
market by the central bank.
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