CREDIT CREATION PROCESS OF THE BANKING SECTOR

Assume the following scenario:

1. There is only one commercial bank in the economy and all transactions are done through the
bank
2. The central bank requires the commercial bank to maintain 10% of all its new deposits as
reserves to take care of customer cash withdraw requirements
3. The commercial bank finances its lending operations by using deposits. All the balance of the
cash deposit after removing the reserve requirement is used by the bank to give new loans
to customers in subsequent periods
4. A period is defined as the time the bank takes to get a new deposit and make a new loan
5. Every customer who receives a new loan first deposits it in the bank before spending it. All
the expenditures by clients who receive loans are handled through the banking system.
Hence new loans act as new deposits from which the bank makes new loans.
6. Assume that in period 1, a bank receives an initial deposit of shs1,000
7. The reserves to be kept in period 1 = 1000*0.1 = 100
8. Excess reserves that the bank lends out in period 2 is shs900
9. The customer who receives the loan in period 2 deposits all of it in the bank before spending
it. Hence the new deposit in period 2 = 900
10. The reserves in period 2 = 900*0.1 = 90
11. The bank makes a new loan in period 2 equivalent to shs810
12. The process repeats itself over subsequent periods until the new deposits tend to zero.

Required:

Calculate the total new deposits created by the commercial bank over a total of 50 periods from
the initial deposit of shs1,000 (Round off your answers to whole numbers i.e. zero decimal
places)

Complete Table below

Period New Deposits Reserves (10%) New Loans (Credit)

1 1000 100 900
2 900 90 810
. . . .
. . . .
50 . . .
TOTALS