Banking – CBSE Notes for Class 12 Macro Economics Introduction: This is a textual description of commercial bank, credit creation by commercial bank, central bank and its functions. Commercial Bank And Credit Creation By Commercial Bank 1. Commercial bank is a financial institution which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit. 2. Process of money creation/deposit creation/credit creation by the commercial banking system. (a) Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply “banks’. Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing cheque. The one who receives payment deposits the same in his deposit account. (b) Suppose initially people deposit Rs.1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank. It has two components. A part of the LRR is to be kept with the Central bank and this part ratio is called the Cash Reserve Ratio. The other part is kept by the banks with themselves and is called the Statutory Liquidity Ratio. (c) Let us now explain the process, suppose the initial deposits in banks i ...
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