Explain the

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.

● Eventually:

Total deposit created = New deposit X 1/LRR

= 10000 X 1/10%

=100000