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Define Credit Multiplier. What role does it play in determining the credit creation power of the banking system ?
Use a numerical illustration to explain.
Credit multiplier measures the amount of money that the banks are able to create in the form of deposits with every initial deposit.
The credit creation by commercial banks depends on credit multiplier as it is inversely related to LRR. Higher the credit multiplier, higher will be the total credit created and vice - versa.
For Example suppose the LRR is 0.2 and initial deposit is 1000
Credit multiplier =
1
0.2 = 5
Total credit created = 5 x 1,000= 5,000
Whereas, suppose LRR is 0.5 and initial deposit is Rs. 1,000
Credit multiplier =1
0.5 = 2
Total credit created = 2 x 1000 = 2,000
Thus, with the same initial deposit total credit creation decreases with an increase in the value of credit multiplier.
Credit multiplier measures the amount of money that the banks are able to create in the form of deposits with every initial deposit.
The credit creation by commercial banks depends on credit multiplier as it is inversely related to LRR. Higher the credit multiplier, higher will be the total credit created and vice - versa.
For Example suppose the LRR is 0.2 and initial deposit is 1000
Credit multiplier =
1
0.2 = 5
Total credit created = 5 x 1,000= 5,000
Whereas, suppose LRR is 0.5 and initial deposit is Rs. 1,000
Credit multiplier =1
0.5 = 2
Total credit created = 2 x 1000 = 2,000
Thus, with the same initial deposit total credit creation decreases with an increase in the value of credit multiplier.
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