Question

State with reasons whether you agree or disagree with the following statements.
A commercial bank can create credit on the basis of primary deposit.

Answer 1

Yes, I agree with this statement.

Primary deposits are also known as cash deposits. A part of these deposits are kept by the bank, to meet the demand for cash of the depositor. This is termed as minimum cash reserves. The banks are able to do with a very small reserve because all depositors do not withdraw money at the same time.

When a bank grants loan to a borrower, the bank opens a deposit account in the name of the borrower and the money transferred on the account of the borrower creates secondary deposits.

When the borrower withdraws money from his loan account by a cheque, it is deposited by the payee in some other bank. Other banks again create credit on the basis of fresh deposits received after keeping the required reserves.