Why do we say that commercial banks create credit while we also say that the central bank has the sole right to issue currency?
The commercial banks are able to create credit in excess of the amount if initial deposits due to the money multiplier concept.
Money multiplier= 1/LRR.
For example, let initial deposits be Rs 10000 and Legal Reserve Ratio be 20%.
It is assumed that the public conducts all financial transactions through banks only.
Now from the initial deposit from 10000, banks will keep 20% (2000 rs) as reserve. Remaining 8000 will be lent out to public.
When the public deposits these 8000 rs back into the bank, again the bank will keep 20% (1600 rs) as reserve and lend out the rest.
This process keeps on continuing until the total amount of deposits becomes 50000.
That is because money multiplier is 1/LRR= 1/20%=5.
Therefore total deposits= 10000 x 5= 50000.
Money multiplier= 1/LRR.
For example, let initial deposits be Rs 10000 and Legal Reserve Ratio be 20%.
It is assumed that the public conducts all financial transactions through banks only.
Now from the initial deposit from 10000, banks will keep 20% (2000 rs) as reserve. Remaining 8000 will be lent out to public.
When the public deposits these 8000 rs back into the bank, again the bank will keep 20% (1600 rs) as reserve and lend out the rest.
This process keeps on continuing until the total amount of deposits becomes 50000.
That is because money multiplier is 1/LRR= 1/20%=5.
Therefore total deposits= 10000 x 5= 50000.