1. What is Credit Creation?

It is an open secret that the banks do not keep cent per cent reserve against deposits in order
to meet the demands of depositors. The bank is not a cloak room where you can keep your
currency notes or coins and claim those very notes or coins back when you desire. It is
generally understood that money received by the bank is meant to be advanced to others. A
depositor has to be content simply with the bank’s promise or undertaking to pay him back
whenever he makes a demand.

This bank is able to do with a very small reserve, because all the depositors do not come to
withdraw money simultaneously; some withdraw, while others deposit at the same time. The
bank is thus enabled to erect a vast superstructure of credit on the basis of a small cash
reserve. The bank is able to lend money and charge interest without parting with cash. The
bank loan creates a deposit or, as we have seen above, it creates a credit for the borrower.

Similarly, the bank buys securities and pays the seller with its own cheque which again is no
cash; it is just a promise to pay cash. The cheque is deposited in some bank and a deposit is
created or credit is created for the seller of the securities. This is credit creation.

Thus, term ‘credit creation’ implies a situation, to use Benham’s words, when “a bank may
receive interest simply by permitting customers to overdraw their accounts or by purchasing
securities and paying for them with its own cheques, thus increasing the total bank deposits.”
 2. Accounts payable (money you owe to suppliers)
Salaries payable
Wages payable
Interest payable
Income tax payable
Sales tax payable
Customer deposits or retainers
Debt payable (on business loans)
Contracts you can’t cancel without penalty
Lease agreement
Insurance payable
Benefits payable

3. Central Bank as a Bank of Note Issue:

The central bank is legally empowered to issue currency notes — legal tender. Commercial

banks cannot issue currency notes. The central bank’s right to issue notes gives it the sole or

partial monopoly of note issue, while in India, the Reserve Bank of India has a partial

monopoly of note issue, for example, one rupee notes are issued by the Ministry of Finance,

but the rest of the notes are issued by the Reserve Bank.

According to De Kock, following are the main reasons for the concentration of the right of

note issue in the central bank:

(a) It leads to uniformity in note circulation and its better regulation.

(b) It gives distinctive prestige to the note issue.

(c) It enables the State to exercise supervision over the irregularities and malpractices

committed by the central bank in the issue of notes.

4. An open market operation (OMO) is an activity by a central bank to give (or
take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can
either buy or sell government bonds in the open market (this is where the name was
historically derived from) or, in what is now mostly the preferred solution, enter into
a repo or secured lending transaction with a commercial bank: the central bank gives the
money as a deposit for a defined period and synchronously takes an eligible asset as
collateral.

Central banks usually use OMO as the primary means of implementing monetary policy. The
usual aim of open market operations is—aside from supplying commercial banks with
liquidity and sometimes taking surplus liquidity from commercial banks—to manipulate the
short-term interest rate and the supply of base money in an economy, and thus indirectly
control the total money supply, in effect expanding money or contracting the money supply.
This involves meeting the demand of base money at the target interest rate by buying and
selling government securities, or other financial instruments. Monetary targets, such
as inflation, interest rates, or exchange rates, are used to guide this implementation.[1][2]

In the post-crisis economy, conventional short-term Open Market Operations have been
superseded by major central banks by quantitative easing (QE) programmes. QE are
technically similar open-market operations, but entail a pre-commitment of the central bank
to conduct purchases to a pre-defined large volume and for a pre-defined period of time.
Under QE, central banks typically purchase riskier and longer-term securities such as long
maturity sovereign bonds and even corporate bonds.
5. A central bank is the primary source of money supply in an
economy through circulation of currency.

It ensures the availability of currency for meeting the transaction needs of an economy and
facilitating various economic activities, such as production, distribution, and consumption.

However, for this purpose, the central bank needs to depend upon the reserves of commercial
banks. These reserves of commercial banks are the secondary source of money supply in an
economy. The most important function of a commercial bank is the creation of credit.

Therefore, money supplied by commercial banks is called credit money. Commercial

banks create credit by advancing loans and purchasing securities. They lend money to
individuals and businesses out of deposits accepted from the public. However,
commercial banks cannot use the entire amount of public deposits for lending
purposes. They are required to keep a certain amount as reserve with the central bank
for serving the cash requirements of depositors. After keeping the required amount of
reserves, commercial banks can lend the remaining portion of public deposits.

6.   Role of Commercial Banks in economic development of country

Commercial Banks have always played an important position in the country’s economy. They
play a decisive role in the development of the industry and trade. They are acting not only as
the custodian of the wealth of the country but also as resources of the country, which are
necessary for the economic development of a nation.
1. Capital Formation
Banks play an important role in capital formation, which is essential for the economic
development of a country. They mobilize the small savings of the people scattered over a
wide area through their network of branches all over the country and make it available for
productive purposes.

Now-a-days, banks offer very attractive schemes to attract the people to save their money
with them and bring the savings mobilized to the organized money market. If the banks do
not perform this function, savings either remains idle or used in creating assets, which are
low in scale of plan priorities.
2. Creation of Credit
Banks create credit for the purpose of providing more funds for development projects. Credit
creation leads to increased production, employment, sales and prices and thereby they cause
faster economic development.

3. Channelizing the Funds to Productive Investment

Banks invest the savings mobilized by them for productive purposes. Capital formation is not
the only function of commercial banks. Pooled savings should be distributed to various
sectors of the economy with a view to increase the productivity of the nation. Then only it
can be said to have performed an important role in the economic development of the nation.

Commercial Banks aid the economic development of the nation through the capital formed
by them. In India, loan lending operation of commercial banks subject to the control of the
RBI. So our banks cannot lend loan, as they like.

4. Fuller Utilization of Resources

Savings pooled by banks are utilized to a greater extent for development purposes of various
regions in the country. It ensures fuller utilization of resources.

5. Encouraging Right Type of Industries

The banks help in the development of the right type of industries by extending loan to right
type of persons. In this way, they help not only for industrialization of the country but also
for the economic development of the country. They grant loans and advances to
manufacturers whose products are in great demand. The manufacturers in turn increase their
products by introducing new methods of production and assist in raising the national income
of the country.

6. Bank Rate Policy

Economists are of the view that by changing the bank rates, changes can be made in the
money supply of a country. In our country, the RBI regulates the rate of interest to be paid by
banks for the deposits accepted by them and also the rate of interest to be charged by them on
the loans granted by them.

7. Bank Monetize Debt

Commercial banks transform the loan to be repaid after a certain period into cash, which can
be immediately used for business activities. Manufacturers and wholesale traders cannot
increase their sales without selling goods on credit basis. But credit sales may lead to locking
up of capital. As a result, production may also be reduced. As banks are lending money by
discounting bills of exchange, business concerns are able to carryout the economic activities
without any interruption.
8. Finance to Government
Government is acting as the promoter of industries in underdeveloped countries for which
finance is needed for it. Banks provide long-term credit to Government by investing their
funds in Government securities and short-term finance by purchasing Treasury Bills.

7. Circumstances when a banker refuse payment of Cheque

1. When the customer has countermanded payment.
2. When the banker has received a garnishee order.
3. When the customer has died.
4. When the customer has become insolvent or insane.
5. Where the banker has received a notice of assignment.
6. When the customer has lost the instrument.
7. When the banker has come to know of any defect in the title.
8. Where the instrument has been materially altered.
9. When the account is closed.

8. Electronic Funds Transfer (EFT) is a system of transferring money

from one bank account directly to another without any paper money changing hands.
One of the most widely-used EFT programs is direct deposit, through which payroll is
deposited straight into an employee's bank account. However, EFT refers to any
transfer of funds initiated through an electronic terminal, including credit card, ATM,
Fedwire and point-of-sale (POS) transactions. It is used for both credit transfers, such
as payroll payments, and for debit transfers, such as mortgage payments.