Limitations of credit creation by Commercial banks in developing countries
- Use of restrictive monetary policies by the central bank. The central bank limits the powers of commercial banks to create credit by using the restrictive tools of the monetary policy for example increasing bank rate, selling government securities to the public, increasing minimum legal reserve requirement etc.
- Presence of inadequate credit worthy borrowers. In developing countries, there is lack of enough credit worthy borrowers due to lack collateral securities. This leads to excess liquidity in commercial banks due to limited borrowing hence limiting the process.
- The theory assumes that borrowers deposit cheques they get in the same bank. This is not always true. Therefore one bank keeps on losing deposits to other banks hence limiting the process of credit creation by a single bank.
- The process of credit creation keeps on diminishing towards zero. This limits the amount of credit created.
- High levels of liquidity preference. In developing countries, individuals prefer keeping their money with them instead of depositing it in banks. This results into less bank deposits hence limiting the process of credit creation. .
- Low demand for bank deposits. In developing countries, there is low demand for bank loans because of poor investment climate. This is mainly due to the political instabilities, insecurity, poor infrastructure etc. and this results into less money lend out hence limiting the process.
- High interest rates charged by Commercial banks. These discourage the potential borrowers from demanding for loanable funds for investment hence limiting the process of credit creation.
- Limited number of banking institutions in developing countries. The number of banks is few and they are not widely distributed to mobilize enough savings. This limits the amount of credit created.
- High fractions of Cash ratio in commercial banks. A lot of bank deposits are left in commercial banks in cash form instead of lending it out hence limiting the credit creation process.
- Ignorance of the public about the availability of loanable funds in commercial banks. This leads to a small number of individuals accessing bank loans hence limiting the process of credit creation.
- Corruption of bank officials
- Political instability
CATEGORIES Economics
TAGS Dr. Bbosa Science
