Banks’ credits can be seen as the risk rating of banks or internal credit rating. Credit is the way by which banks transact their businesses. This credit keeps most banks in business.
When banks receive deposits from customers they do not keep these monies in their vault waiting for the customers to come and withdraw. For the fact that there will never be a time that customers will coincidentally want to withdraw at the same time their deposits, therefore, these advantages provide avenues for transactions window for the banks to give out loans to those who want or need this idle cash balances to invest. For instance, when a customer deposits about N1000 in his/her account, the bank might give 10 percent interest payable on the deposit. The bank uses this money and gives out as loan to investors for about 15 percent interest chargeable. Based on this analogy, the bank is making a gain of five percent profit on the N1000 deposit of the customer. In this transaction, the bank has created a credit facility and has created money in circulation without the Central Bank of the country minting more money in circulation.
The most basic commodity being traded in financial markets is credit. Borrowers of funds can switch from one market to another, seeking the most favourable credit terms wherever they can be found.
Banks make credit available to commercial and industrial customers in the form of direct loans formally banks prefer to give out short term loans to businesses, but recently, however, banks have lengthened the maturity of their business loans to include term loan, which have maturities over one year, to finance the purchase of buildings, machinery, and equipment.
In recent time, banks have turned to the new style of depending on the non-deposit sources, including floating rate commercial deposits (CDS) and notes sold in international markets, sales of loans, securitisation of selected assets and standby credit guarantees.
These and so many other ways the banks can create credit in the economy, which helps to expand economic activities as it leads to growth.
When banks receive deposits from customers they do not keep these monies in their vault waiting for the customers to come and withdraw. For the fact that there will never be a time that customers will coincidentally want to withdraw at the same time their deposits, therefore, these advantages provide avenues for transactions window for the banks to give out loans to those who want or need this idle cash balances to invest. For instance, when a customer deposits about N1000 in his/her account, the bank might give 10 percent interest payable on the deposit. The bank uses this money and gives out as loan to investors for about 15 percent interest chargeable. Based on this analogy, the bank is making a gain of five percent profit on the N1000 deposit of the customer. In this transaction, the bank has created a credit facility and has created money in circulation without the Central Bank of the country minting more money in circulation.
OBJECTIVES
At the end of this unit, you should be able to:- explain how banks create credits
- discuss the importance and implication of bank’s credits creation · discuss destruction of the deposit by bank’s credits creation.
How Banks Create Credits
The main activities of banks are creation of credits out of the deposits received from customers. Banks serve as intermediary between the surplus and deficit economic agents.The most basic commodity being traded in financial markets is credit. Borrowers of funds can switch from one market to another, seeking the most favourable credit terms wherever they can be found.
Loans
The principal business of commercial banks is to make loans to qualified borrowers, or at least, make it easier for their customers to find credit from some sources with a bank perhaps agreeing to underwrite a customer’s security issue or guarantee a loan from a third party lender. Banks make loan of reserves to other banks though the federal funds market and to securities dealer through repurchased agreements.Banks make credit available to commercial and industrial customers in the form of direct loans formally banks prefer to give out short term loans to businesses, but recently, however, banks have lengthened the maturity of their business loans to include term loan, which have maturities over one year, to finance the purchase of buildings, machinery, and equipment.
Deposits
For banks to widen or expand their credit creation, they draw on a wide variety of deposit and non-deposit sources of funds. It is not uncommon knowledge that the bulk of commercial bank funds, about two-third of the total funds come from deposits. This deposit comprises of demand, savings, and time deposits. The demand deposit (is the commonly used) uses cheques to transact on the account, while the savings deposit is generally bear a relatively low interest rate but may be withdrawn by the depositor with no notice. The time deposit carries a fixed maturity, a penalty for early withdrawal and usually offers the highest interest rates a bank will pay.Non-Deposit Sources Of Funds
One of the most significant trends in banking in recent years is the greater use of non-deposit funds (borrowings), especially as competition or deposits increases in banks. Banks resort to purchasing of reserves (Federal funds) from other banks.In recent time, banks have turned to the new style of depending on the non-deposit sources, including floating rate commercial deposits (CDS) and notes sold in international markets, sales of loans, securitisation of selected assets and standby credit guarantees.
These and so many other ways the banks can create credit in the economy, which helps to expand economic activities as it leads to growth.
SELF-ASSESSMENT EXERCISE
- Mention and discuss ways by which banks can create credits.
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