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Difficulty: HardSpecialized and Development Banks

Unlike commercial banks, specialized development banks in Nigeria do not expand the money supply through the credit creation process. Which structural characteristic of development banks accounts for this operational limitation?

  1. They rely on long-term capital grants, institutional funds, and government equity rather than holding demand deposits subject to clearing house transferAnswer
  2. B
    They trade exclusively in short-term money market instruments to maintain high cash reserves
  3. C
    They are prohibited from earning interest rewards on credit facilities extended to industrial projects
  4. D
    They operate under the direct oversight of clearing house settlement institutions rather than central monetary authorities

Answer

Specialized development banks do not create credit because they rely on long-term institutional funding, government equity, and capital grants rather than accepting demand deposits that participate in bank clearing settlement.
The correct answer correctly identifies that commercial bank credit creation depends on accepting demand deposits that recirculate in the banking system through checking accounts. Specialized development banks do not provide routine retail checking account facilities; instead, they disburse funds derived from long-term capital grants, government equity, and specialized development funds, preventing secondary credit multiplier expansion.

Step-by-Step Solution

1
Analyze how commercial banks create credit
Commercial banks create credit by accepting demand deposits (current accounts) and lending out a portion of excess reserves, generating derivative deposits across the banking network.
Credit creation requires transactional demand deposits that can be transferred via clearing systems.
2
Examine the funding mechanism of specialized development banks
Development banks receive funding from government allocations, international funding agencies, and long-term bonds to finance long-gestation projects in agriculture, industry, and housing.
Development banks are structured to provide long-term capital, not daily retail payment/checking services.
3
Deduce why credit creation is absent in development banks
Without demand deposits and checking account facilities, loans granted by development banks are disbursed directly to project accounts or equipment suppliers without generating secondary money expansion.
The absence of demand deposits eliminates the credit creation multiplier mechanism in these institutions.

Key Concept

Operational and structural differences between commercial banks and specialized development banks regarding credit creation and funding sources
Estimated Time:2m 0s
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Topics

Specialized and Development Banks

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