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Question

Difficulty: MediumCommercial Banks: Functions and Credit Creation

Match each commercial bank credit creation term in the first list with its correct operational definition in the second list.

  • Cash Reserve Ratio (CRR)The legally mandated percentage of total deposits that commercial banks must keep with the central bank or as vault cash.
  • Credit MultiplierThe reciprocal of the mandatory reserve ratio that determines the theoretical maximum expansion of deposits.
  • Primary DepositThe initial cash sum paid into a bank account by a customer, which increases the bank's total cash reserves.
  • Excess ReservesThe portion of total reserves exceeding mandatory requirements, which banks use to issue new loans and create credit.

Answer

Cash Reserve Ratio pairs with the legal percentage of deposits held as reserves; Credit Multiplier pairs with the reciprocal of the reserve ratio determining maximum deposit expansion; Primary Deposit pairs with the initial cash sum paid into a bank; Excess Reserves pairs with reserves above mandatory requirements used to grant loans.
Cash Reserve Ratio is the mandated proportion of deposits held as liquid reserves. Credit Multiplier measures maximum potential deposit growth as the reciprocal of the reserve ratio. Primary Deposit is an initial deposit of physical currency into a bank. Excess Reserves are funds available beyond required reserves that enable commercial banks to create secondary deposits through loans.

Step-by-Step Solution

1
Analyze statutory liquidity requirements for commercial banks.
Cash Reserve Ratio (CRR) is matched with the statutory percentage of customer deposits banks must hold in reserve.
Central monetary authorities set reserve ratios to regulate commercial bank liquidity and money supply.
2
Evaluate the formula and function of money expansion in the banking system.
Credit Multiplier is matched with the reciprocal of the reserve ratio (1CRR\frac{1}{\text{CRR}}).
The multiplier determines how many times a given primary reserve can expand total commercial bank deposits.
3
Distinguish between primary cash inflows and loanable bank funds.
Primary Deposit is matched with customer cash payments into accounts, while Excess Reserves is matched with unreserved cash available for lending.
Primary deposits bring new currency reserves into the banking system, and excess reserves beyond the required percentage form the basis of credit creation.

Key Concept

Commercial Bank Credit Creation Concepts and Reserve Requirements
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Topics

Commercial Banks: Functions and Credit Creation