Credit creation is one of the most important function of commercial bank.

The process of credit creation occurs when bank accepts deposits and provide loans and advances from these deposits. Modern banks plays the dual role while performing this function. Its deposits may originate in two forms

When customer deposits money with the bank, they are called as PRIMARY DEPOSITS. Under the RBI Act of 1935, every commercial bank has to keep certain amount of deposit as reserve with RBI. Deposited amount is not withdrawn immediately by depositor so bank provide that amount as loans & advances . THUS, EVERY DEPOSITS CREATES A LOAN

Derivative deposits refer to the deposits created by the banking system while performing other fundamental functions of loans. When any bank sanctions a loan to its customer it does not make a cash payment to the party concerned but opens a new account i.e. DERIVATIVE DEPOSITS, in the name of borrower. Now this deposit is the result of lending activity of bank. THUS, EVERY LOAN CREATES A DEPOSITS.

LIABLITIES Deposits

BANK A AMOUNT 10000 10000

ASSETS Cash Loans

AMOUNT 1000 9000 10000

LIABLITIES Deposits

BANK B AMOUNT ASSETS 9000 9000 BANK C AMOUNT ASSETS 8100 8100 Cash Loans Cash Loans

AMOUNT 900 8100 9000

LIABLITIES Deposits

AMOUNT 810 7290 8100

The process of credit creation continues until last deposit becomes too small to create any more loans.