Answer:
Commercial banks play the important role of 'money creator' in the economy. They have the capacity to generate credit through demand deposits. These demand deposits make credit more than the initial deposits. The process of money creation can be explained by taking an example of a bank XYZ. A depositor deposit Rs 10,000 in his savings account, which will become the demand deposit of the bank. Based on the assumption that not all customers will turn up at the same day to withdraw their deposits, banks maintains a minimum cash reserve of 10% of the demand deposits, i.e., Rs 1000. It lends the remaining amount of Rs 9000 in the form of credit to other customers. This further creates deposits for the hank XYZ. With the cash reserve of Rs 1000, the credit creation is worth Rs 10,000. So, the credit multiplier is given by: Credit multiplier = 1/CRR = 1/10% = 10 The money supply in the economy will increase by the amount (rimes) of credit multiplier.
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