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

Under a commercial banking system with a mandatory Cash Reserve Ratio of 12.5%12.5\%, a customer makes a new cash deposit of N800,000\text{N}800,000. Assuming there are no cash leakages in the economy, what is the maximum amount of derivative deposits (credit created) that the banking system can generate?

  1. N5,600,000\text{N}5,600,000Answer
  2. B
    N6,400,000\text{N}6,400,000
  3. C
    N100,000\text{N}100,000
  4. D
    N700,000\text{N}700,000

Answer

N5,600,000\text{N}5,600,000
The total deposit expansion is given by dividing the initial deposit by the Cash Reserve Ratio (12.5%12.5\% or 0.1250.125), which yields N6,400,000\text{N}6,400,000. To determine net derivative credit created by commercial banks, the initial cash deposit (N800,000\text{N}800,000) must be subtracted from total deposit expansion, resulting in N5,600,000\text{N}5,600,000.

Step-by-Step Solution

1
Calculate the credit multiplier using the Cash Reserve Ratio (CRR).
Multiplier = 1CRR=10.125=8\frac{1}{\text{CRR}} = \frac{1}{0.125} = 8.
The credit multiplier determines the degree to which initial deposits expand total money supply.
2
Calculate total deposit expansion across the banking system.
Total Deposit Expansion = Initial Deposit ×\times Multiplier = N800,000×8=N6,400,000\text{N}800,000 \times 8 = \text{N}6,400,000.
Total deposits reflect the combination of primary initial cash deposits and subsequent derivative bank loans.
3
Calculate the derivative credit created (net credit expansion).
Derivative Credit Created = Total Deposit Expansion - Initial Deposit = N6,400,000−N800,000=N5,600,000\text{N}6,400,000 - \text{N}800,000 = \text{N}5,600,000.
Derivative deposits represent the secondary deposits created purely through bank lending.

Key Concept

Derivative Deposits and Credit Multiplier
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Topics

Commercial Banks: Functions, Services, and Credit Creation

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