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    Question

    If an individual deposits a sum of money in a bank, then

    the amount of additional credit that the banking system can be create is
    A a fraction of that sum defined by the cash reserve ratio Correct Answer Incorrect Answer
    B a fraction of that sum defined by the statutory liquidity ratio Correct Answer Incorrect Answer
    C a multiplier of that sum defined by the cash reserve ratio Correct Answer Incorrect Answer
    D a multiplier of that sum defined by the statutory liquidity ratio Correct Answer Incorrect Answer

    Solution

    When an individual deposits a sum of money in a bank, the banking system can create additional credit based on this deposit. This process is governed by the reserve requirements set by the central bank. There are two main ratios to consider: 1.      Cash Reserve Ratio (CRR) : This is the fraction of deposits that banks are required to hold as reserves with the central bank. 2.      Statutory Liquidity Ratio (SLR) : This is the fraction of deposits that banks are required to maintain in the form of liquid assets such as cash, gold, or government securities. Credit Creation Multiplier: The amount of additional credit that the banking system can create is determined by the reserve requirements, specifically the Cash Reserve Ratio (CRR). The multiplier effect in credit creation is derived from the CRR.   ·         Cash Reserve Ratio (CRR) : When a bank receives a deposit, it is required to keep a portion of it as reserves (CRR) and can lend out the rest. The amount that can be lent out is thus a function of the CRR. This process of lending and re-depositing continues, creating a multiplier effect in the money supply. The credit creation process can be summarized by the formula: Credit Multiplier=1/CRR Therefore, the additional credit that the banking system can create is a multiplier of the initial deposit , defined by the Cash Reserve Ratio (CRR).

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