If the entire amount of money taken as loan from a bank remains in the non banking sector, then the deposit creation multiplyer will be equal to unity how?
If the entire amount of money taken as loan from a bank remains in the non banking sector, then the deposit creation multiplyer will be equal to unity how?
Sometimes economics can be tricky to understand if it is not given with examples and probably that is why you did not get it. For example, if the required unit reserve ratio is 20%, the deposit multiplier ratio is (1/0.20) = 5x.
When a customer borrows from bank and spends all of the money, Similarly, when banks lend out all money to you- no one has any money, Neither the bank nor you, and that is why they are in unity. From the above equation an bank needs 100% reserve ratio and 1/100% =1x.
Reserve ratio is 100% because the reserves are zero in a bank and it needs to fill it back to the required level, say, 40% level of ready cash must be there in reserves. I’ll inform you if I find any abetter examples in professional resources
Whenever a Commercial bank has excess cash reserves, it will lend or invest the same. And this amount will come back to the bank in the form of a new deposit which will become the basis for yet another loan and so on.
• The money which goes out from the bank by way of loans etc. and the money which comes back by way of new deposits are the same.
The formula , deposit ratio is cash reserves ratio= minimum cash reserves required/bank deposits*100%
if deposits are zero, then cash reserves ratio=Infinity or undefined. Substituting this value in deposit multiplier = 1/0= Undefined value. So no way, deposit creation multiplier will be in unity with anything when all the money is spent. However, if the money is with the non banking sector, the non banking sector people will make deposits with the bank again. There is no unity in this ratio, but assumin*that Basel 3 minimum cash reserves required= deposits created. Considering the population it is possible to achieve unity (1) easily as the entire population doesn’t live on bank loans.
Another philosophy I read from another economist is, you already know what goes out comes back in.
my understanding about this is simple
cash reserve ratio= 100₹/100₹ * 100%= 1%
deposit creation multiplier= 1/1=1
that means government rbi needs 100₹ cash reserves, only few people deposited 100 in the banks, and hence you got unity. Otherwise it is not possible to achieve unity. If everyone in India deposits 10000 then there is no unity.
Forgot rbi needs cash reserves of 10,000 not hundred. Sry. The edit button is missing
CAclubindia
