Q.Explain the concept of credit creation by commercial banks with a simple example.
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Start your 14-day free trial to unlock the full solution →Credit creation refers to the ability of the banking system, taken as a whole, to expand a single original deposit into a much larger total volume of deposits and loans through successive rounds of lending.
Consider a simple example. A bank receives a fresh deposit of ₹1,00,000 and, keeping 10% as cash reserve, lends out the remaining ₹90,000. The borrower spends this ₹90,000, and the recipient deposits it into their own bank account — a fresh deposit of ₹90,000 somewhere in the banking system. That bank again keeps 10% as reserve (₹9,000) and lends out ₹81,000, which is spent and re-deposited again, continuing the cycle. Although each successive deposit is smaller than the one before it, the total of all these deposits taken together across the whole system is a multiple of the original ₹1,00,000 — this is what is meant by credit creation. …
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