Skip to content

IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system

Which of the following is the most accurate description of how a commercial bank creates money when it grants a Rs 10 lakh loan to a business customer?

The bank credits the borrower's account with Rs 10 lakh, creating a new deposit matched by a new loan asset on its balance sheet. Total deposits, which form most of the money supply, therefore rise at the moment the loan is granted.

  1. AIt credits the customer's deposit account with Rs 10 lakh, creating a new deposit alongside a new loan assetCorrect
  2. BIt transfers Rs 10 lakh of other customers' deposits to the borrower, leaving total deposits unchanged
  3. CIt borrows Rs 10 lakh from the central bank and passes the notes to the customer
  4. DIt reduces its reserves by Rs 10 lakh and its deposits by Rs 10 lakh
  5. It sells Rs 10 lakh of government bonds to the public to raise funds before lending

Explanation

A loan creates an asset (the loan) and a matching liability (the deposit credited to the borrower), so the stock of bank deposits rises. It does not require prior savings to be transferred, and it does not require the central bank to supply notes.

Did you get it right without looking?

One question tells you little. A timed set on Role, structure and stability of the financial system shows your real accuracy, how long you take and where you lose marks.

Practise Role, structure and stability of the financial systemFree diagnostic mock

More Role, structure and stability of the financial system questions