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Difficulty: MediumCommercial Banks: Functions, Services, and Credit Creation

A commercial bank receives an initial cash deposit of N100,000\text{N}100,000. If the Central Bank of Nigeria stipulates a Cash Reserve Ratio of 20%20\%, what is the total amount of credit that can be created by the banking system?

  1. N500,000\text{N}500,000Answer
  2. B
    N20,000\text{N}20,000
  3. C
    N80,000\text{N}80,000
  4. D
    N400,000\text{N}400,000

Answer

The total credit that can be created by the commercial banking system is N500,000\text{N}500,000.
The total volume of credit created by commercial banks depends on the primary deposit and the credit multiplier (1/Cash Reserve Ratio1 / \text{Cash Reserve Ratio}). With a cash reserve requirement of 20%20\%, the multiplier is 1/0.20=51 / 0.20 = 5. Multiplying the initial deposit of N100,000\text{N}100,000 by 55 yields a total credit expansion capacity of N500,000\text{N}500,000.

Step-by-Step Solution

1
Determine the credit multiplier.
Credit Multiplier = 1Cash Reserve Ratio=10.20=5\frac{1}{\text{Cash Reserve Ratio}} = \frac{1}{0.20} = 5
The credit multiplier is the reciprocal of the cash reserve ratio set by the central bank.
2
Calculate total credit creation.
Total Credit Created = Initial Deposit×Credit Multiplier=N100,000×5=N500,000\text{Initial Deposit} \times \text{Credit Multiplier} = \text{N}100,000 \times 5 = \text{N}500,000
Multiplying the primary cash injection by the credit multiplier gives the total possible deposit expansion across the commercial banking system.

Key Concept

Commercial Bank Credit Creation Multiplier
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Topics

Commercial Banks: Functions, Services, and Credit Creation

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