Question

Explain step-by-step process by which commercial bank could increase the money supply.

Answer 1

• in general any commercial bank of a country works under the guidance and supervision of Central bank of that country.
• commercial banks are the core at ground level working because they execute the obligations at base and practical level.

increase in money supply is a very crucial step and is undertaken with very cautious step because eventually it can raise the inflation level to a greater extent which is again not so easy to control.

requirement to increase the money supply in the economy is generally necessary when there is a recession in the economy and central bank may instruct the commercial bank to do so.

steps undertaken by commercial banks to increase the money supply-

1. increase in rate of interest on deposit- commercial bank can increase the rate of interest on savings and thus the people holding cash would be encourage to deposit their cash in bank as a result bank would have more cash to lend in the economy. in this way the bank may leads to cash from a unproductive to productive sector.
2. decrease in rate of interest on lendings- business sectors and borrowers can be encouraged to take loans when the rate on lendings are reduced as a result they will be able to take loans and can execute their business works as a result the economic will develop employment would get generated and supply of cash would be increased in this manner also.
3. decrease in margin requirements- margin requirement is a difference between the security pledged and loan provided , let's understand the concept with an example- suppose earlier you went to a bank to take a loan by pledging your house of worth $100000 and bank offered you a loan of $60000 this means bank is reserving $40000 as a security against any default made by you in the future concerned with dealing and you'll have practically only $60000 in your hand to do any dealing. now to increase money supply bank might reduce the margin requirement and by taking the earlier example we can prove it, now again suppose you went to the bank with the security of $100000 but now bank is ready to give you $90000 this means the margin required is reduced from 40000 to 10000 and earlier you would have got 60000 but now you may get 90000 and eventually the supply of money has been increased in the economy.
4. by keeping the Cash reserve at lower level - when bank keeps a less reserve with themselves they have surplus amount to lend and circulate in the economy as a result the supply in the economy is increased.
5. purchasing securities from open market- to increase in the level of supply of cash in the economy the bank may execute the open market operations and purchase the securities from the market and as a result cash will flow from bank to market and the supply of cash in the economy can be increased.

as a result of these steps the earning of the commercial bank may be decline its level of earning but this is required to increase the level of money supply in the economy