The creation of credit is one of the important functions of commercial banks. In the ordinary course of business, banks accept deposits from the public and lend money to its customers. When a bank advances a loan, it does not pay the amount in cash. But, it opens an account in the name of the customer and allows him to withdraw the required amount by cheque. In this way, a bank creates credit or deposit which are regarded as money can be used for the purchase of goods and services and also for the payment of dept just like currency notes.
Bank Deposits arise in two ways:
- Primary Deposits: When a person deposits money with the bank, it is credited in his account. It is a debt of the bank and it has an obligation to repay whenever demanded. The customer is free to withdraw the amount whenever he needs it. This type of deposit is known as primary deposit.
- Derivative Deposits: Using the cash received from the depositors, the banks grant advances to businessmen or buys assets such as bills, bonds, etc., from the market. Whenever a bank grants a loan or buys an asset, it does not usually pay cash for it. Instead of paying the cash, the banker actually places the amount of loans in the account of the borrower. Thus, the borrower acquires a claim against a bank just as he has deposited a sum of money. These deposits are derived from the primary deposits and hence they are known as derivative deposit.
Multiple creation of credit.
Loans and Advances: Banks provide credit facilities to businessmen by way of loans and advances, overdraft and cash credits. When a loan is granted or overdraft is sanctioned, the amount of loan or overdraft is entered in the account of the customer and he is allowed to draw cheques up to the amount agreed upon.
Money at call and short notice: Money at call and short notice is given to speculators and stock brokers extremely short period ranging from 24 hours to two or three days
Discounting of Bills: When a bank discounts a bill of exchange of a customer for a short period of 90 days or less, the amount of the bill is credited in the account of the customer who withdraws it through cheque. Or, it pays the sum through a cheque bon itself. In both cases, the bank creates a deposit equal to the amount of the bill of exchange.
Investments: A commercial bank also creates a deposit by making investment in securities like government bonds, shares, debentures, etc., which have longer life.
- Banking and Negotiable Instruments – Avtar Singh – Eastern Book Company
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