Explain the process of credit creation by commercial banks.

Commercial banks create money from the deposits made by the customers. The credit creation process works in the following manner -

a) Banks accept deposits from the public by opening a deposit account and it is called primary deposit.

b) They retain only a small portion of the total deposits in the bank as the cash reserve and advance remaining money as loans to business persons.

c) The cash reserve ratio is decided by the Central Bank.

d) The loans create a derivative deposit which is called a secondary deposit.

e) This secondary deposit is called the creation of credit.