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CREATION OF CREDIT IN MERCHANT ACCOUNT
Creation of credit is one of the
important functions of a modern bank. A
bank has sometimes been called a factory
for the manufacture of credits. Banks
create credit in two ways for merchant
accounts. One of the ways is by
purchasing advance loans and the other
way is by purchasing securities. A bank
deposit is created entirely by the
banking system. Every advance made by
the bank creates a corresponding
deposit. In fact the two things happen
simultaneously. In order to start a
business, a merchant has to depend upon
the bank for applying loans.
The granting of loan results in creation
of deposit. It is an open secret that
the banks do not keep any reserve
against deposits in order to meet the
demands of the merchants. The bank is
not a cloak room where you can keep your
currency notes or coins and claim those
very notes or coins back when you
desire. It is generally understood that
deposits received by the banks are meant
to be advanced to others.
A depositor has to be satisfied with the
bank’s promises or undertaking to pay
him whenever he makes a demand. Thus the
banks are able to do with a very small
reserve, because all the merchants do
not come to withdraw money
simultaneously; some withdraw, while
others deposit at the same time. Thus
the bank is enabled to erect a vast
super structure of credit on the basis
of small cash reserves. The bank is able
to lend money and charge interest
without parting with cash. The bank loan
creates a deposit, as we have seen above
or it creates a credit for the borrower.
Similarly the bank buys securities and
pays the seller with its own cheque
which again is no cash; it is just a
promise to pay cash. A merchant requires
loans and advances to run his business.
In the same manner he also has to
deposit cash into the merchant account
in whichever bank he holds an account.
It is also like a give and take policy.
The cheque is deposited in some bank and
a deposit is created or credit is
created for the seller of the
securities. This is credit creation.
Also, when bank discounts a bill of
exchange, it is seldom that the amount
is paid in cash; instead the customer’s
account is credited with the amount.
This is creating credit. Thus every time
the bank acquires an earning asset
whether by advance or investment, it
creates a deposit (or credit) in the
name of the merchant or his firm from
whom the asset has been acquired. The
term “credit creation” implies a
situation, to use Ben ham’s word, when
“a bank may receive interest simply by
permitting customers to overdraw their
accounts or by purchasing securities and
paying for them with its own cheques,
thus increasing the total bank
deposits”. All merchant accounts are
governed by a set of rules made by the
bank. The creation of credit in merchant
account is done with the help of the
bank. |
