Anonymous
Dec 7, 2023
By use of a deposit Kshs 120000 and required reserves, explain the process of credit creation by commercial banks of Kenya ?
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Dec 7, 2023
The process of credit creation by commercial banks in Kenya begins with the deposit of Kshs 120,000 by a customer. This deposit becomes a liability for the bank, as they are obligated to repay the customer upon request.
The Central Bank of Kenya (CBK) sets a reserve requirement for commercial banks, which is the minimum percentage of deposits that banks must hold as reserves. Let's assume the reserve requirement is 10%.
Based on the reserve requirement, the bank is required to hold 10% of the Kshs 120,000 deposit as reserves. In this case, the required reserves would be Kshs 12,000 (10% of Kshs 120,000).
The remaining amount of Kshs 108,000 (Kshs 120,000 - Kshs 12,000) is considered excess reserves. These excess reserves can be used by the bank to create credit.
The bank can lend out a portion of the excess reserves to borrowers who are in need of funds. Let's assume the bank decides to lend out Kshs 100,000 to a borrower.
When the bank lends out Kshs 100,000, it creates a new deposit for the borrower. This new deposit is an asset for the bank, as they have the right to collect interest and repayment from the borrower.
Now, the borrower has Kshs 100,000 in their account, which they can use for various purposes such as making purchases or investments. This increases the money supply in the economy.
At this point, the bank's balance sheet would show the following changes:
Assets:
- Excess reserves: Kshs 8,000 (Kshs 108,000 - Kshs 100,000)
- Loan to borrower: Kshs 100,000
Liabilities:
- Customer deposit: Kshs 120,000
The process of credit creation can continue as long as the bank has excess reserves and there are creditworthy borrowers. Each time the bank lends out a portion of its excess reserves, it creates new deposits, which further increases the money supply in the economy.
It's important to note that the actual credit creation process may involve more complex factors such as interest rates, creditworthiness assessments, and risk management practices. Additionally, the CBK may adjust the reserve requirement periodically, which can impact the amount of credit that banks can create.
The Central Bank of Kenya (CBK) sets a reserve requirement for commercial banks, which is the minimum percentage of deposits that banks must hold as reserves. Let's assume the reserve requirement is 10%.
Based on the reserve requirement, the bank is required to hold 10% of the Kshs 120,000 deposit as reserves. In this case, the required reserves would be Kshs 12,000 (10% of Kshs 120,000).
The remaining amount of Kshs 108,000 (Kshs 120,000 - Kshs 12,000) is considered excess reserves. These excess reserves can be used by the bank to create credit.
The bank can lend out a portion of the excess reserves to borrowers who are in need of funds. Let's assume the bank decides to lend out Kshs 100,000 to a borrower.
When the bank lends out Kshs 100,000, it creates a new deposit for the borrower. This new deposit is an asset for the bank, as they have the right to collect interest and repayment from the borrower.
Now, the borrower has Kshs 100,000 in their account, which they can use for various purposes such as making purchases or investments. This increases the money supply in the economy.
At this point, the bank's balance sheet would show the following changes:
Assets:
- Excess reserves: Kshs 8,000 (Kshs 108,000 - Kshs 100,000)
- Loan to borrower: Kshs 100,000
Liabilities:
- Customer deposit: Kshs 120,000
The process of credit creation can continue as long as the bank has excess reserves and there are creditworthy borrowers. Each time the bank lends out a portion of its excess reserves, it creates new deposits, which further increases the money supply in the economy.
It's important to note that the actual credit creation process may involve more complex factors such as interest rates, creditworthiness assessments, and risk management practices. Additionally, the CBK may adjust the reserve requirement periodically, which can impact the amount of credit that banks can create.
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