Question

Commercial banks are regarded as money creators because: (Choose the correct option)

• A. they purchase securities from the Central Bank.
• B. loans provided by them create deposits.
• C. they act as a banker to the government.
• D. they regulate the lending rate in the economy.

Hint:

Commercial banks create money through the loan-deposit cycle. The more they lend, the more deposits they generate, which expands the money supply without printing new currency.

Answer 1

The Correct Option is B

Commercial banks are essential for creating money in today's economy. This is called credit creation or money creation. When banks provide loans, they usually credit the borrower's account, not give cash. This creates new deposits in the banking system without printing more currency. This action increases the total money in the economy, known as money creation by commercial banks. Bank loans become new deposits, and those deposits can be used for more loans (after setting aside a reserve), amplifying the money supply through the money multiplier mechanism. For example:
If a bank gets a ₹ 1,000 deposit and keeps 10% as a reserve, it loans out ₹ 900. The borrower spends this, and it's redeposited in another bank, which lends out 90% of that. This repeats, significantly increasing deposits (money) in the banking system. Activities like buying securities from the Central Bank or acting as a government banker do not directly create money in the economy.