money & banking credit creation by rabia qayyum
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Credit Creation
Presented By:
Alveena Qayyum 3003
Rabia Qayyum 3037
Ayesha Munir 3013
Sidra Sajjad 3049
Qurat-ul-ain Aziz 3035
Noureen Nasir 3034
Nimra Shahid 3033
CREDIT CREATION:
In simple words credit creation means the multiple loaning by commercial banks. A single bank cant create credit. But banks in multi banking system can grant several loans out of a single deposit.
LIMITATIONS OF CREDIT CREATION:
The credit creation process just discussed
is very simplified one. Infect there are
many restrictions and constraints over
this. This process is guided and affected
by variety of factors like:
Currency Drains
Excess Reserves
Primary Depositor
Cash Reserve Ratio
Economic circumstances
Monetary Policy
Different Types of Deposit
1.CURRENCY DRAINS:
An assumption of our credit creation process is that all receipts and payments are made by cheques. In reality this may not go like this. A borrower may wish to take cash instead of cheques.
In our simplified model we have said that banks
hold only 20 percent reserves and rest of the
amount is lent out. However in reality no
commercial bank works like that.
2 . EXCESS RESERVES:
3. PRIMARY DEPOSIT:
The credit creation process depends on the
availability of primary deposit. If banks have
adequate primary deposit only then they can
create credit. There is a direct relation between
primary deposit and credit creation.
4. CASH RESERVE RATIO:
Another constraint on the lending potential of
the commercial banks is the reserve ratio.
Our banks are required to hold some percentage of
their demand deposits as reserve with the central
Bank.
5. ECONOMIC CIRCUMSTANCES:
Commercial banks can’t create credit on their own oraccording to their own will and wish. They can onlymake it when borrowers demand loans. The economiccircumstances and monetary situation effect the creditcreation.
6. MONETARY POLICY:
The extra ordinary or unnecessary credit expansion
may prove harmful for the economy in all countries
central banks are vested with power to influence
lending powers of commercial banks.
7. DIFFERENT TYPES OF DEPOSITS:
Commercial banks accept three main different
Types of deposits which are: Demand Deposits Saving Deposit Fixed Deposit
DEMAND DEPOSITS:
All deposit received by banks are demand deposit.
Funds held in an account from which deposited funds
can be withdrawn at any time without any advance
notice to the Depository institution. Demand deposits
can be "demanded" by an account holder at any time.
SAVING DEPOSIT:
A deposit account held at a bank or other financial institution that
provides principal security and a modest interest rate. Depending on
the specific type of savings account, the account holder may not be
able to write checks from the account (without incurring extra fees
or expenses) and the account is likely to have a limited number of
free transfers/transactions.
FIXED DEPOSIT: Fixed Deposit refers to a savings account or certificate of deposit that pays a fixed rate of interest until a given maturity date. Funds placed in a Fixed Deposit usually cannot be withdrawn prior to maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty assessed.
CREDIT ANALYSIS:
According to some bankers “credit” is an
evolution of Latin word “creditium” which means
“trust”. Basically it is element of trust that runs
the whole mechanism of credit. The first relation
between lender and borrower is that of trust.
TRADITIONAL FACTORS:There are certain policy guidance and factors which
have been followed since long by the bankers while
making a lending decision.
These factors are:
Credit worthiness of the borrower Record of Bank Dealings Size of Business
CREDIT WORTHINESS OF THE BORROWER:
This was dependent on the information that lending
officer “possessed” about the borrower.
RECORD OF BANK DEALINGS:
SIZE OF BUSINESS:
The borrower record of bank dealing was next to examine. A normal record of dealing with bank was considered positive sign to grant credit.
If the size of business was found comparable with the amount of loan applied, the lending officer gave approval of credit.
DIFFERENTIATING RETAIL AND CORPORATE CREDIT:
RETAIL CREDIT:Retail credit is the usual
business credit. Such
Credit requirements are
not extraordinary huge
and the business
structure is also simple.
CORPORATE CREDIT:
Corporate credit deals
with corporate business
houses, industries,
concern etc.
Banks have differentiated modern retail and corporatecredit.
3CS WHICH ARE NORMALLY FOLLOWED FOR GRANTING CREDIT ARE:
CHARACTER:The character is established by the information like conduct the
borrower, background, means of earnings, mode of living etc.
CAPACITY:Capacity means the ability to repay the loan.
CAPITAL:Capital means the assets owned by the borrower. If the borrower is
sound in respect of the assets and properties held by them, then the
lending officer approves the credit.
OTHER MODERN & IMPORTED FACTORS ARE:
Financial statement analysis:
Financial statement have gained importance in
modern world.
There are three financial statement.
1) Profit and loss account
2) Balance sheet
3) Cash flow statement
PROFIT AND LOSS ACCOUNT:
It is a summary of revenues earned and
expenditures incurred by an enterprises in a
given year.
BALANCE SHEET:
It is a snapshot of the financial position of the
business at a particular date.
CASH FLOW STATEMENT:
These statements disclose the liquid cash available
and the net increase and decrease in cash equivalents
during a year.
RATIO ANALYSIS:
Ratios are various types. They may be financial,
managerial, commercial, or operational.
What all the ratios do is that they may help in the
understanding of a complex, diversified and vast
data in an easy way. They express complex
information in an understandable manner.
Ratio analysis are also important while making a
lending decision.
PROFIT PROJECTION ANALYSIS:
Such analysis help in determining the future trend of business and anticipated revenues.
SOURCES & APPLICATION OF FUNDS:
This involves the visualising of funds received by the business from sources and the applications andutilisation of these funds. Such analysis helps the lending officer to determines the credit worthiness of the borrower.
EXCHANGE TRANSLATION ANALYSIS:
Where the loans are to be given to the business
which is being operated from abroad or which is
export oriented, exchange translation analysis is
made.
INFLATION ACCOUNTING:A statement is prepared that shows the real worth
of the business according to the prevailing general
price level.