Process of Credit Creation by Commercial Banks:
A central bank is the primary source of money supply in an economy of a nation through the circulation of currency. It ensures the availability of the currency for meeting the transaction needs of an economy. It also facilitates various economic activities such as production, distribution as well as consumption. For this purpose, the central bank needs to depend upon the reserves of the commercial banks which are the secondary source of money supply in an economy.
The most crucial purpose of a commercial bank is the creation of credit. This is the reason why the money supplied by commercial banks is called credit money. All commercial banks create credit by advancing loans and purchasing securities. They lend money to the individuals as well as to the businesses out of deposits accepted from the public.
Commercial banks are not allowed to use the entire amount of public deposits for lending purposes. They are accepted to keep a certain amount as a reserve with the central bank. This is for serving the cash needs of the depositors.
The commercial banks can lend the remaining portion of the public deposits after keeping the expected amount of reserves.