Question

Commercial banks create credit by

• A. advancing loans
• B. purchasing securities
• C. both (A) and (B)
• D. none of these

Hint:

Credit creation by banks isn't just about giving loans. Any action where a bank acquires an asset (like a loan or a security) and creates a new deposit as payment is a form of credit creation.

Answer 1

The Correct Option is C

Credit creation is the process by which commercial banks make more money available in the economy than their initial cash deposits. This is a core function of the banking system. It happens in two main ways:

(A) Advancing Loans: When a bank gives a loan, it doesn't hand over cash. Instead, it opens a deposit account in the borrower's name and credits the loan amount to it. This new deposit is a form of money, thus creating credit. This is the primary method.
(B) Purchasing Securities: When a bank buys securities (like government bonds) from the public or a corporation, it pays for them by crediting the seller's deposit account. This act also injects new money into the banking system, expanding the money supply and creating credit.
Both activities result in the expansion of bank deposits and are therefore methods of credit creation.