Money creation is the process by which a commercial bank creates total deposit number of times more than the initial deposit.
This process is based on 2 assumptions:
a.There is a single banking system in the country.
b. All the transactions are done through this bank.
The working of money creation is explained below:
Total money created = Money multiplier X initial deposits = 1/Legal reserve ratio X initial deposits
● The legal reserve ratio is 10%.
● The bank keeps Rs 1000 as a reserve and gives the remaining 9000 as loan which would come back to the bank in the form of deposits.
● Out of this 9000, the bank would keep 10%, (900) and the remaining 8100 would be extended as loans.
Total deposit created = New deposit X 1/LRR
= 10000 X 1/10%
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