Credit creation of bank ppt

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Credit creation of bank ppt

  1. 1. A REPORT ON CREADIT CRATION OF BANK PRESENTED BY:-SATYABRATA PRADHAN KRUPAJAL BUSINESS SCHOOL REGD.NO:-11KB009 EGD.NO:-11KB009 BATCH.NO:-2011-13Friday, January 25, 2013 SATYABRATA PRADHAN
  2. 2. CREDIT CREATION� An important function performed by the commercial banks is the creation of credit.� The process of banking must be considered in terms of monetary flows, that is, continuous depositing and withdrawal of cash from the bank.� It is only this activity which has enabled the bank to manufacture money.� Therefore the banks are not only the purveyors of money but manufacturers of money. Friday, January 25, 2013 SATYABRATA PRADHAN
  3. 3. BASIC OF CREDIT CRATION� The basis of credit money is the bank deposits. The bank deposits are of two kinds viz.,� (1) Primary deposits, and� (2) Derivative deposits. Friday, January 25, 2013 SATYABRATA PRADHAN
  4. 4. PRIMARY DEPOSITS� Primary deposits arise or formed when cash or cheque is deposited by customers.� When a person deposits money or cheque, the bank will credit his account.� The customer is free to withdraw the amount whenever he wants by cheques.� These deposits are called “ primary deposits ” or “cash deposits.” Friday, January 25, 2013 SATYABRATA PRADHAN
  5. 5. CONT…..� It is out of these primary deposits that the bank makes loans and advances to its customers.� The initiative is taken by the customers themselves. In this case, the role of the bank is passive.� So these deposits are also called “ passive deposits.” These deposits merely convert currency money into deposit money. They do not create money.� They do not make any net addition to the stock of money. In other words, there is no increase in the supply of money. Friday, January 25, 2013 SATYABRATA PRADHAN
  6. 6. DERIVATIVE DEPOSITS� Bank deposits also arise when a loan is granted or when a bank discounts a bill or purchase government securities.� Deposits which arise on account of granting loan or purchase of assets by a bank are called “derivative deposits.”� Since the bank play an active role in the creation of such deposits, they are also known as “ active deposits.”� Thus, credit creation implies multiplication of bank deposits. Credit creation may be defined as “ the expansion of bank deposits through the process of more loans and advances and investments.” Friday, January 25, 2013 SATYABRATA PRADHAN
  7. 7. PROCESS OF CREDIT CREATION� An important aspect of the credit creating function of the commercial banks is the process of multiple-expansion of credit.� The banking system as a whole can create credit which is several times more than the original increase in the deposits of a bank.� This process is called the multiple-expansion or multiple-creation of credit.� Similarly, if there is withdrawal from any one bank, it leads to the process of multiple- contraction of credit. Friday, January 25, 2013 SATYABRATA PRADHAN
  8. 8. CONT…� The process of multiple credit-expansion can be illustrated by assuming:a) The existence of a number of banks, SBI, BARODA, AXIS etc., each with different sets of depositors.b) Every bank has to keep 20% of cash reserves, according to law, and,c) A new deposit of Rs. 1,000 has been made with SBI to start with. Friday, January 25, 2013 SATYABRATA PRADHAN
  9. 9. HOW CREADIT CRATION BY BANK� Suppose, a person deposits Rs. 1,000 cash in SBI BANK. As a result, the deposits of SBI BANK increase by Rs. 1,000 and cash also increases by Rs. 1,000. The balance sheet of the bank is as fallows: Balance Sheet of SBI BANK Liabilites Rs. Assets Rs. Primary 1,000 Cash 1,000 Demand receive Deposit Cash 200 Reserved Excess 800 Resorved Friday, January 25, 2013 SATYABRATA PRADHAN
  10. 10. CONT….� Under the double entry system, the amount of Rs. 1,000 is shown on both sides. The deposit of Rs. 1,000 is a liability for the bank and it is also anof Rs. 800 which it can profitably employ in the assets like loans. asset to the bank. SBI BANK has to keep only 20% cash reserve, i.e., Rs. 200 against its new deposit and it has a surplus Suppose SBI BANK gives a loan to X, who uses the amount to pay off his creditors. After the loan has been made and the amount so withdrawn by X to pay off his creditors, the balance sheet of SBI BANK will be as follows: Friday, January 25, 2013 SATYABRATA PRADHAN
  11. 11. CONT… Balance Sheet of SBI BANK Liabilitie Rs. Assets Rs. s Primary 1,000 Cash 1,000 Demand received Deposit Derivative 800 Loan to X 800 Demand deposit Friday, January 25, 2013 SATYABRATA PRADHAN
  12. 12. CONT…..� Suppose X purchase goods of the value of Rs. 800 from Y and pay cash. Y deposits the amount with BARODA BANK. The deposits of BARODA BANK now increase by Rs. 800 and its cash also increases by Rs. 800. After keeping a cash reserve of Rs. 160, BARODA BANK is free to lend the balance of Rs. 640 to any one. Suppose BARODA BANK lends Rs. 640 to Z, who uses the amount to pay off his creditors. The balance sheet of BARODA BANK will be as follows: Friday, January 25, 2013 SATYABRATA PRADHAN
  13. 13. CONT…. Balance Sheet of BARODA BANK Liabilities Rs. Assets Rs. Primary 800 Cash 160 demand reserved Deposit Loans 640 Total 800 800 Friday, January 25, 2013 SATYABRATA PRADHAN
  14. 14. CONT…..� Suppose Z purchases goods of the value of Rs. 640 from S and pays the amount. S deposits the amount of Rs. 640 in AXIS BANK. AXIS BANK now keeps 20% as reserve (Rs. 128) and lends Rs. 512 to a merchant. The balance sheet of AXIS BANK will be as follows: Balance Sheet of AXIS BANK Liabilities Rs. Assets Rs. Primary 640 Cash Reserved 128 Demand Deposit Loans 512 Total 640 640 Friday, January 25, 2013 SATYABRATA PRADHAN
  15. 15. CONT…..� Thus looking at the banking system as a whole, the position will be as follow: Name of Bank Deposits (Rs.) Cash reserve Loan (Rs.) (Rs.) SBI BANK 1,000 200 800 BANK BARODA 800 160 640 BANK BANK AXIS BANK 640 128 512 Total 2440 488 1952 Friday, January 25, 2013 SATYABRATA PRADHAN
  16. 16. CONT….� In the above example, there will be 10 fold increase in credit because the cash ratio is 10%. The total volume of credit created in the banking system depends on the cash ratio. If the cash ratio is 10% there will be 10 fold increase. If it is 20%, there will be 5 fold increase� The extent to which the banks can create credit together could be found out with the help of the credit multiplier formula. The formula is: K=1/r K=1/r  � Where K is the credit multiplier, and r, the required reserves. If the reserve ratio is 20% the size of credit multiplier will be: K=1/r =1/0.2 = 5 Friday, January 25, 2013 SATYABRATA PRADHAN
  17. 17. Limitation on Credit Creation� The commercial banks do not have unlimited power of credit creation. Their power to create credit is limited by the following factors:1) Amount of Cash Cash2) Reserve Ratio3) Banking Habits of the People4) Nature of Business Conditions in the Economy5) Leakages in Credit-Creation6) Sound Securities7) Liquidity Preference8) Monetary Policy of the Central Bank Friday, January 25, 2013 SATYABRATA PRADHAN
  18. 18. CONCLUSION� To conclude, we can say that credit creation by banks is one of the important & only sources to generate income. And when the reserve requirement increased by the central bank it would directly affect on the credit creation by BARODA BANK because then the lendable funds with the bank decreases and vice versa. Friday, January 25, 2013 SATYABRATA PRADHAN
  19. 19. THANK YOU � PRESENTED BY:- SATYABRATA PRADHANFriday, January 25, 2013 SATYABRATA PRADHAN

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