3. Learning Objectives
•To understand the functions of commercial banks
•To know the formulae for credit creation and credit
multiplier
•To understand the credit creation function of the
commercial banks
4.
5. Functions of Commercial Banks
Accepting Deposits
• Savings deposits – The commercial bank accepts small deposits
from households or persons in order to encourage savings in
the economy.
• Time deposits – The bank accepts deposits for a fixed time and
carries a higher rate of interest as compared to savings
deposits.
• Current deposits – These accounts do not offer any interest.
Further, most current accounts offer overdrafts up to a pre-
specified limit. The bank undertakes the obligation of paying all
cheques against deposits subject to the availability of sufficient
funds in the account.
8. Lending of Funds
• Another important activity is lending funds to customers in
the form of loans and advances, cash credit, overdraft,
discounting of bills, etc.
• Loans are advances that a bank extends to his customers
with or without security for a specified time and at an
agreed rate of interest.
• The bank credits the loan amount in the customers’ account
which he withdraws as per his needs.
9. Secondary Functions of Commercial Banks
Bank as an Agent
• Collecting bills, draft, cheques, etc.
• Paying the insurance premium, rent, loan installments, etc.
• Purchasing or redeeming securities in the stock exchange.
• Acting as an executor, administrator, or trustee of the
estate of a customer
• Preparing income tax returns, claiming tax refunds, etc.
11. Credit Creation by Commercial Banks
• Commercial banks increases the flow of money in an
economy by credit creation.
• The banks issue loans from their cash reserves with the
confidence on their historical experience that all depositors
will not withdraw their funds at the same time.
• Commercial banks create credit many more times than
their cash reserves and contributes to increase money
supply in the economy.
• It depends on initial level of deposits and money multiplier.
13. Money Multiplier
It refers to the fraction by which commercial banks would be
able to multiply money from their initial level of deposits. It
is obtained by the following formula
15. Credit Creation
• Let’s assume that the bank requires to maintain a CRR of 20 percent.
• If a person (person A) deposits 1,000 rupees with the bank, then the bank
keeps only 200 rupees in the cash reserve and lends the remaining 800 to
another person (person B). They open a credit account in the borrower’s
name for the same.
• Similarly, the bank keeps 20 percent of Rs. 800 (i.e. Rs. 160) and advances
the remaining Rs. 640 to person C.
• This process continues until the initial primary deposit of Rs. 1,000 and
the initial additional reserves of Rs. 800 lead to additional or derivative
deposits of Rs. 4,000 (800+640+512+….).
• Adding the initial deposits, we get total deposits of Rs. 5,000. In this case,
the credit multiplier is 5 (reciprocal of the CRR) and the credit creation is
five times the initial excess reserves of Rs. 800.
16. Review
•What are the main functions of commercial banks?
•Explain the process of credit creation.
17. Lets Recap
• The primary functions of commercial banks are accepting deposits
and lending.
• The commercial banks of the country perform a very valuable
function of credit creation in the economy
• One man’s spending is another man’s income.
• Initial deposit is multiplied by money multiplier to calculate total
quantity of credit created in the economy.
• Multiplier is the inverse of the legal reserve ratio.
