Limitations of Credit Creation:
1. Total amount of cash in circulation- The amount of credit creation is directly linked with the amount of cash in circulation or the amount of primary deposit. The larger the amount of primary deposit, the larger is the amount of credit created.Suppose,
Primary deposit CRR Credit multiplier Total Deposit
10,000 10% 10 1,00,000
5,000 10% 10 50,000
2. Cash Reserve Ratio- The amount of credit creation is inversely linked with the CRR. The higher the CRR, the smaller will be the amount of credit created.Suppose,
Primary deposit CRR Credit multiplier Total deposit Credit creation
10,000 10% 10 1,00,000 90,000
10,000 20% 5 50,000 40,000
10,000 5% 20 2,00,000 1,90,000
3. Leakages- The actual credit creation by the banking system may not reach the required level due to certain leakages:
(I) Excess reserves- The banks may not be willing to utilise their excess reserves for granting loans.
(ii) Currency Drains-Since the process of credit creation assumes that the entire amount of loan comes back with the bank in the form of a deposit. But in reality public may not deposit the entire amount of loan with the bank. This affects the process of credit creation.
4. Availability of borrowers-The process of credit creation also depends a lot on the availability of borrowers having credit worthiness. The larger the number of borrowers, bank can creat credit to a large extent.
5.Other Limitations- The process of credit creation also depends on the following:
(I) Banking habits of people
(ii) Business conditions. . . . .
1. Total amount of cash in circulation- The amount of credit creation is directly linked with the amount of cash in circulation or the amount of primary deposit. The larger the amount of primary deposit, the larger is the amount of credit created.Suppose,
Primary deposit CRR Credit multiplier Total Deposit
10,000 10% 10 1,00,000
5,000 10% 10 50,000
2. Cash Reserve Ratio- The amount of credit creation is inversely linked with the CRR. The higher the CRR, the smaller will be the amount of credit created.Suppose,
Primary deposit CRR Credit multiplier Total deposit Credit creation
10,000 10% 10 1,00,000 90,000
10,000 20% 5 50,000 40,000
10,000 5% 20 2,00,000 1,90,000
3. Leakages- The actual credit creation by the banking system may not reach the required level due to certain leakages:
(I) Excess reserves- The banks may not be willing to utilise their excess reserves for granting loans.
(ii) Currency Drains-Since the process of credit creation assumes that the entire amount of loan comes back with the bank in the form of a deposit. But in reality public may not deposit the entire amount of loan with the bank. This affects the process of credit creation.
4. Availability of borrowers-The process of credit creation also depends a lot on the availability of borrowers having credit worthiness. The larger the number of borrowers, bank can creat credit to a large extent.
5.Other Limitations- The process of credit creation also depends on the following:
(I) Banking habits of people
(ii) Business conditions. . . . .
