Credit Creation

Presented By:

Alveena Qayyum 3003

Rabia Qayyum 3037

Ayesha Munir 3013

Sidra Sajjad 3049

Qurat-ul-ain Aziz 3035

Noureen Nasir 3034

Nimra Shahid 3033

CREDIT CREATION:

In simple words credit creation means the multiple loaning by commercial banks. A single bank cant create credit. But banks in multi banking system can grant several loans out of a single deposit.

LIMITATIONS OF CREDIT CREATION:

The credit creation process just discussed

is very simplified one. Infect there are

many restrictions and constraints over

this. This process is guided and affected

by variety of factors like:

Currency Drains

Excess Reserves

Primary Depositor

Cash Reserve Ratio

Economic circumstances

Monetary Policy

Different Types of Deposit

1.CURRENCY DRAINS:

An assumption of our credit creation process is that all receipts and payments are made by cheques. In reality this may not go like this. A borrower may wish to take cash instead of cheques.

In our simplified model we have said that banks

hold only 20 percent reserves and rest of the

amount is lent out. However in reality no

commercial bank works like that.

2 . EXCESS RESERVES:

3. PRIMARY DEPOSIT:

The credit creation process depends on the

availability of primary deposit. If banks have

adequate primary deposit only then they can

create credit. There is a direct relation between

primary deposit and credit creation.

4. CASH RESERVE RATIO:

Another constraint on the lending potential of

the commercial banks is the reserve ratio.

Our banks are required to hold some percentage of

their demand deposits as reserve with the central

Bank.

5. ECONOMIC CIRCUMSTANCES:

Commercial banks can’t create credit on their own oraccording to their own will and wish. They can onlymake it when borrowers demand loans. The economiccircumstances and monetary situation effect the creditcreation.

6. MONETARY POLICY:

The extra ordinary or unnecessary credit expansion

may prove harmful for the economy in all countries

central banks are vested with power to influence

lending powers of commercial banks.

7. DIFFERENT TYPES OF DEPOSITS:

Commercial banks accept three main different

Types of deposits which are: Demand Deposits Saving Deposit Fixed Deposit

DEMAND DEPOSITS:

All deposit received by banks are demand deposit.

Funds held in an account from which deposited funds

can be withdrawn at any time without any advance

notice to the Depository institution. Demand deposits

can be "demanded" by an account holder at any time.

SAVING DEPOSIT:

A deposit account held at a bank or other financial institution that

provides principal security and a modest interest rate. Depending on

the specific type of savings account, the account holder may not be

able to write checks from the account (without incurring extra fees

or expenses) and the account is likely to have a limited number of

free transfers/transactions.

FIXED DEPOSIT: Fixed Deposit refers to a savings account or certificate of deposit that pays a fixed rate of interest until a given maturity date. Funds placed in a Fixed Deposit usually cannot be withdrawn prior to maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty assessed.

CREDIT ANALYSIS:

According to some bankers “credit” is an

evolution of Latin word “creditium” which means

“trust”. Basically it is element of trust that runs

the whole mechanism of credit. The first relation

between lender and borrower is that of trust.

TRADITIONAL FACTORS:There are certain policy guidance and factors which

have been followed since long by the bankers while

making a lending decision.

These factors are:

Credit worthiness of the borrower Record of Bank Dealings Size of Business

CREDIT WORTHINESS OF THE BORROWER:

This was dependent on the information that lending

officer “possessed” about the borrower.

RECORD OF BANK DEALINGS:

SIZE OF BUSINESS:

The borrower record of bank dealing was next to examine. A normal record of dealing with bank was considered positive sign to grant credit.

If the size of business was found comparable with the amount of loan applied, the lending officer gave approval of credit.

DIFFERENTIATING RETAIL AND CORPORATE CREDIT:

RETAIL CREDIT:Retail credit is the usual

business credit. Such

Credit requirements are

not extraordinary huge

and the business

structure is also simple.

CORPORATE CREDIT:

Corporate credit deals

with corporate business

houses, industries,

concern etc.

Banks have differentiated modern retail and corporatecredit.

3CS WHICH ARE NORMALLY FOLLOWED FOR GRANTING CREDIT ARE:

CHARACTER:The character is established by the information like conduct the

borrower, background, means of earnings, mode of living etc.

CAPACITY:Capacity means the ability to repay the loan.

CAPITAL:Capital means the assets owned by the borrower. If the borrower is

sound in respect of the assets and properties held by them, then the

lending officer approves the credit.

OTHER MODERN & IMPORTED FACTORS ARE:

Financial statement analysis:

Financial statement have gained importance in

modern world.

There are three financial statement.

1) Profit and loss account

2) Balance sheet

3) Cash flow statement

PROFIT AND LOSS ACCOUNT:

It is a summary of revenues earned and

expenditures incurred by an enterprises in a

given year.

BALANCE SHEET:

It is a snapshot of the financial position of the

business at a particular date.

CASH FLOW STATEMENT:

These statements disclose the liquid cash available

and the net increase and decrease in cash equivalents

during a year.

RATIO ANALYSIS:

Ratios are various types. They may be financial,

managerial, commercial, or operational.

What all the ratios do is that they may help in the

understanding of a complex, diversified and vast

data in an easy way. They express complex

information in an understandable manner.

Ratio analysis are also important while making a

lending decision.

PROFIT PROJECTION ANALYSIS:

Such analysis help in determining the future trend of business and anticipated revenues.

SOURCES & APPLICATION OF FUNDS:

This involves the visualising of funds received by the business from sources and the applications andutilisation of these funds. Such analysis helps the lending officer to determines the credit worthiness of the borrower.

EXCHANGE TRANSLATION ANALYSIS:

Where the loans are to be given to the business

which is being operated from abroad or which is

export oriented, exchange translation analysis is

made.

INFLATION ACCOUNTING:A statement is prepared that shows the real worth

of the business according to the prevailing general

price level.