CREATION OF CREDIT BY COMMERCIAL BANKS (PART 1)

• Unlike the Central Bank, Commercial Banks do not have the authority of issuing notes and coins. But Commercial Banks have the ability to create money through credit
• Commercial Banks are able to create credit far exceeding the Primary Deposit
  
  
  Two assumptions, in order to understand credit creation by commercial banks:

  (i) The entire banking system is taken as a single unit i.e., BANKS

  (ii) All receipts and payments in the economy are done through BANKS
  
  
  - The depositors hold their primary deposits with the BANKS which are then given out as loans to the productive sectors - However, the BANKS cannot use the whole of deposit for lending - A certain minimum fraction of the deposits are kept by the BANKS as RESERVES, known as LEGAL RESERVE RATIO (LRR)
  LEGAL RESERVE RATIO (LRR) has two components. They are:
• Cash Reserve Ratio (CRR): Cash Reserve Ratio (CRR) is the share of a bank's total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with the latter as reserves in the form of liquid cash.
• Statutory Liquidity Ratio (SLR): Statutory Liquidity Ratio or SLR is a minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirement that banks are expected to keep before offering credit to customers.