Question

Banks create credit ________________.

• A. Out of nothing
• B. On the basis of their securities
• C. On the basis of their total assets
• D. On the basis of deposits

Answer 1

Answer: (D)

On the basis of deposits

For example if you deposit Rs. 10,000 in a bank A, which is the primary deposit of the bank. The cash reserve requirement is 10%. In such a case, bank A would keep Rs 1000 as reserve with central bank and remaining Rs.9000 for lending purposes. The banks lends Rs.9000 to Mr.X by opening a account in his name, known as demand deposit account. However, this is not actually paid out to Mr.X . The bank has issued a check-book to Mr.X to withdraw money. Now Mr.X writes a check in favor of Mr.Y to settle his earlier debts.

Now the check is deposited by Mr.Y in bank B. Suppose it maintains cash reserve requirement of 5%. Thus Rs.450 will be kept as a reserve and remaining balance of Rs.8,550, would be used for lending purpose by bank B.