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Discuss any two limitations of credit creation by commercial banks. |
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Answer» Lack of cash : The total amount of cash, available to the banking system limits the volume of credit that can be create. Credit is based on cash. The banks must keep a certain percentage of cash reserve. The total volume of credit cannot ordinarily be larger than the total amount of cash available multiplied by the customary reserve-ratio. The Central Bank control credit by measures, like open market operations and variations of the reserve ratio, which affect the quantity of cash in the hands of the banks and thereby influence their lending policy. The habits of the people The habit regarding the holding of cash can affect credit creation. If liquidity-preference increases, there will be less cash in the hands of the bank and they will be forced to lend less. In countries with an under developed banking system, the people tend to hoard cash. This reduce the power of banks to create credit. |
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