Limitations Of Credit Creation

Limitations Of Credit Creation – A part from the issue of reserve requirements repayment of loans and disposal of investments, there are quite a number of other factor which affect the ability of a commercial bank

to create credit and or destroy demand deposit money of some of the factors include;

  1. The demand of the non bank public for currency
  2. The relative preference of the non bank public fir time and demand deposit
  3. The bank’s clearing balances
  4. The willingness of banks to lend and of the borrower to borrow
  5. Unpredictability of business conditions and
  6. Government economic policy

In consideration of the Limitations Of Credit Creation, one can easily observe the tendency attached. For these facts, it is not possible to attempt to credit expansion beyond a certain limit.

Limitations Of Credit Creation

The demand for currency – The reserve position of the commercial banks depends on the willingness of the non bank public to maintain its existing level and distribution of currency and demand deposits. When people decide to redistribute currency and demand deposit, perhaps by drawing down the demand deposit for cash, the commercial bank reserves and deposits will be affected by an equal amount. The effect of a $1,000 cash withdrawal upon a bank that is fully loaned up and with a 20% cash reserve requirement has already been illustrated above.

The demand for time deposit – Note that reserve requirements may vary great deal depending on the type of bank and deposit. The difference in reserve requirements means that commercial banks reserve position of the bank is improved because the amount of reserves releases by the reduction in demand deposits is greater than the amount of reserves required to support the new time deposits.

Favorable And Adverse Clearing Balances – A bank continually receives cheques drawn on other banks while also redeeming cheques presented for collection by other banks. A reconciliation of these two processes provides a favourable or an adverse clearing balance. In the former the total value of the cheques redeemed is less than the value of cheques presented for collection. The reserve is true for the latter.

A bank that continues to experience favorable clearing balance over a period of time is in a position to expand loans and deposits beyond its excess reserve while one that experience adverse balance must its expansion and deposit to an amount less than volume of its excess reserve.

Willingness to borrow and lend – The extent to which a bank creates new savings deposits through loans also depends on its own willingness to lend and upon the demands of borrowers. For instance, banks are more willing to lend when there is prosperity in the community and the economy. In recession they generally follow a cautions lending policy, expanding investment instead.

The attitude of borrowers contributes to the Limitations Of Credit Creation, as it also count, when business expand an economic conditions are expected to improve, there is anticipated increase in demand and business borrow to build up inventories.

Nature Of Business Conditions (Limitations Of Credit Creation)

A bank may expect redistribution of time and demand deposits, cash drains, adverse clearing balances to confront it regularly, but it cannot always predict the size and timing of these events and for this reason, it sets aside a certain proportion of its excess reserves to meet these contingencies.

Government Economic Policy

In many this is single most important determinant of commercial banks power to create credit. Government policies can sometimes contribute to limitations Of Credit Creation, especially in an economy where the system is capitalism.

When government views economics as desirable, it attempts to stimulate the economy through various agencies like the Central bank of Nigeria which lowers the reserve requirement and gives the banks the signal to increase lending, again the government can increase the rate of its spending and in this way demand for goods and services may be increased lending to demands for loan-able funds from commercial banks by entrepreneurs. During prosperity and inflation, government economic policy may be contractionary rather than expansionary thus restricting commercial banking lending.

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