ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -1CRR×Total deposits is the total amount of credit banks can create.

Detailed explanation-2: -Cash reserves with the RBI determine the amount of credit banks can create.

Detailed explanation-3: -Legal Reserve Ratio: It is the minimum ratio of deposits legally required to be kept by the commercial banks with themselves (Statutory Liquidity Ratio) and with the central bank (Cash reserve Ratio).

Detailed explanation-4: -Credit creation is inversely related to the legal reserve ratio. X Total credit creation (or money creation) = Initial deposits × 1/Legal Reserve Ratio Higher the legal reserve ratio, lesser will be the credit creation by the commercial banking system and vice-versa.

Detailed explanation-5: -Banks use the deposits held with them for giving loans. However, they cannot use the whole deposits for lending. It is legally compulsory for the banks to maintain a certain minimum fraction of their deposits as reserves. This fraction is called Legal Reserve Ration (LRR), which is fixed by the central bank.