Banking awareness : Concept of credit creation

Banking awareness : Concept of credit creation


The word „credit‟ has been derived from the Latin word „credo‟ which means „I believe‟ or „I trust‟, which signifies a trust or confidence reposed in another person. The term credit means, reposing trust or confidence in somebody. In economics, it is interpreted to mean, in the same sense, trusting in the solvency of a person or making a payment to a person to receive it back after some time or lending of money and receiving of deposits etc.


Credit instruments prove very helpful in encouragement and the development of credit and help in the promotion and development of trade and commerce. Some of the credit instruments are,

1. Cheque:
Cheque is the most popular instrument. It is an order drawn by a depositor on the bank to pay a certain amount of money which is deposited with the bank.

2. Bank draft:
Bank draft is another important instrument of credit used by banks on either its branch or the head office to send money from one place to other. Money sent through a bank draft is cheaper, convenient and has less risk.

3. Bill of exchange:
It enables a seller of commodity to issue an order to a buyer to make the payment either to him or to a person whose name and address is mentioned therein either on the site of the bill or within a period of time specified therein.

4. Promissory note:
According to the Indian negotiable instrument act, „a promissory note‟ is an instrument in writing containing an unconditional undertaking signed by the maker to pay a certain sum of money only to or the order of certain person or the bearer of the instrument.

5. Government bonds:
Government issues a sort of certificate to the person who subscribes to these loans. Such certificates are called government bonds. Some of them are income tax free.

6. Treasury bills:
These bills are also issued by the government. They are issued in anticipation of the public revenues.

7. Traveler‟s cheque:
This is the facility given by bank to the people. It was most useful when recent technological instrument like ATMs were not available. A customer was used to deposit money with the banks and banks give traveler‟s cheque in turn. It was used to avoid risk of having cash while travelling.

Credit Creation Capacity of a Bank?

The credit creation capacity of a bank depends on the cash reserve ratio. If the cash reserve ratio is higher, then the bank has to keep more cash to make payments to public and accordingly, fewer amounts will be available for giving loans. So less credit will be created. Credit creation will be higher, if the cash reserve ratio is lower.


Commercial banks continue to remain in the forefront of Indian financial system. Banks provide necessary finance for planned development. In developed and developing countries both, credit is the foundation upon which the economic structure is strengthening. Bank credit would play a significant role by influencing the types of commodities and quantum of their output. To achieve high rate of
economic growth over a long period, agriculture and industrial credit should be increased. At the time of sanctioning the credit, the purpose should be investigated by the bank to ensure that the end use of funds confirms to overall national objectives. Banks also give credit to the priority and neglected sectors by which the sectoral development can be possible. Easy availability of credit promotes the entrepreneurial and self employment venture in the country.