Economics

As we accept seen, depone deposits of one form or another constitute by far the largest component of (broad) notes supply. To understand how money supply leads and contracts, and how it can be controlled. It is then necessary to understand what determines the size of bank deposits. cambers can themselves expand the amount of bank deposits, and hence the money supply, by a process known as ‘credit creation’
To expound the process of credit creation in its simplest form, the following assumptions are made:
Banks have just one type of indebtedness i.e. deposits
And two types assets which are:
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Assume initially that the combined balance sheet of the banks is as shown in the slacken below:
Now assume that the government hands more money-Rs 10 billion, say, on roads or the National Health Service. It pays for this with cheques worn-out on its account with the Central Bank. The people receiving the cheques deposit them in their banks. Banks wages these cheques to the Central Bank and their balances correspondingly increase by Rs 10 billion.




The combined banks’ balance sheet now is:
and this not the end of the story. Banks now have surplus liquidity. With their balances in the central bank having increased to Rs 20 billion, they now have a liquidity ratio of 20/110. If they are to return to a 10 % liquidity ratio, they need only observe Rs 11 billion as balances at the Central Bank ( Rs 11 billion/ Rs110 billion = 10%). The remaining Rs 9 billion they can lend to customers.
Assume now that customers spend this Rs 9 billion in shops and the shopkeepers deposit the cheques in their bank accounts when the cheques are cleared, the balances in the Central Bank of the customers’ banks will duly be deposited by Rs 9 billion, but theIf you want to present a full essay, order it on our website: Orderessay



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