Q.Do you consider a commercial bank 'creator of money' in the economy?
You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
Start your 14-day free trial to unlock the full solution →Commercial banks are indeed "creators of money" in the economy through the process of credit creation — they multiply the initial deposits into a larger total money supply via the fractional reserve system, making them key drivers of money creation.
The idea that commercial banks create money often confuses students because it sounds like banks are printing currency. They are not. What banks create is credit money — not physical cash, but demand deposits (the money in your checking account) that function as a medium of exchange. This is a core function of commercial banks in a modern economy, and it is central to how the money supply expands.
Let’s understand the mechanism step by step.
Why can banks create money?
Banks operate on a fractional reserve system. They are required by law (in India, by the RBI) to keep only a fraction of their deposits as reserves — the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). The rest can be lent out. When a bank lends, it does not hand over cash from its vault; instead, it credits the borrower’s account with a new deposit. That new deposit is new money — it did not exist before the loan was made. The borrower then spends this money, which eventually gets deposited in another bank, and the cycle repeats.
Money multiplier =
Total credit created = Initial deposit Money multiplier
For example, if the reserve ratio is 20% (i.e., CRR + SLR = 20%), the money multiplier is . An initial deposit of ₹100 can lead to total deposits of ₹500 across the banking system. The bank has "created" ₹400 of new money out of thin air — but only because the system allows repeated lending against the same base of reserves.
A common mistake is to think that a single bank can create money infinitely. It cannot. Each bank can lend only its excess reserves. The system as a whole creates the multiple expansion. Also, credit creation is limited by the public’s willingness to hold cash (currency drain) and banks’ willingness to lend (excess reserves).
So, is a commercial bank a 'creator of money'?
Yes, but with two important clarifications:
- It does not create legal tender (currency). Only the central bank (RBI) prints currency notes. Banks create demand deposits, which are accepted as money because they are convertible into currency on demand.
- The creation is not unlimited. It is constrained by the reserve ratio, the central bank’s monetary policy, and the behaviour of depositors and borrowers. …
Unlock everything free for 14 days
- Full step-by-step solutions
- Concept-first explanations
- Methods, shortcuts & mistakes
- PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.