Ways of Creating Money:

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  1. By advancing loans
  2. By allowing overdrafts
  3. By providing cash credits
  4. By discounting bills of exchange

 1.    Creation of Money by Advancing Loans:

 

When a bank grants a loan to a borrower, it does not usually pay the amount to the borrower in cash. Instead, it opens a deposit account in the name of the borrower and credits the loan amount to that deposit account. The borrower can make use of the deposit in payments of goods and services are in settlement of debts through cheques.

 

The loan amount in the bank as a deposit and issue cheques against the deposite in settlement of business obligations.

 

Thus, when a loan is granted by a bank, there arise a deposite and an increase in the supply of money or purchasing power in the country. We are justified in saving that banks create money by granting loans.

 

2.    Creation of Money by Allowing Overdrafts:

 

When a bank grant an overdraft to a current account holder, there arise additional bank deposits in the name of the customer. The customer can use those deposits for meeting his obligations by issuing cheques. Thus, when an overdraft is allowed by a bank, there results in some additional supply of money or purchasing power which did not exist before. So, we can rightly say that banks create money by allowing overdrafts.

 

3.    Creation of Money by Providing Cash Credits:

 

When a bank grants a cash credit to a borrower, it does not pay the amount to the borrower in cash. It simply opens a cash credit account in the name of the borrower and credits the amounts of cash credit to the cash credit account. The borrower is allowed to issue cheques against his cash credited account and make his payments.

 

4.    Creation of Money by discounting Bills:

 

When a bank discount a bill of exchange, the net proceeds of the bill are, generally, not paid to the discounter in cash.

 

Of course, the discounter can make use of the deposits by issuing cheques. Thus when a bill is discounted additional supply of money arise in the country.

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