Which of the following are the limitations in the creation of credit of commercial banks?
(A) The amount of cash that commercial banks possess
(B) Supply of collateral security
(C) Monetary policy of the central bank
(D) Allied deposits scheme
(E) Deposits linked with special benefits
Choose the correct answer from the options given below:

Correct option is D

The creation of credit by commercial banks is influenced by various factors, including regulatory constraints, monetary policies, and the nature of bank deposits. Among the given options, the following factors act as limitations on credit creation:

1. Allied Deposits Scheme (D):

   • These are specialized deposit schemes that banks introduce for specific purposes (e.g., pension schemes, recurring deposits, and government-mandated savings schemes).
   • Such deposits cannot be freely used for lending, restricting the ability of banks to create credit.

2. Deposits Linked with Special Benefits (E):

   • Some bank deposits, such as fixed deposits with tax benefits, provident fund deposits, or government-subsidized schemes, have withdrawal restrictions and cannot be used for extensive lending.
   • Since these deposits are locked for a fixed duration, they reduce the availability of funds that banks can use to extend credit.

Information Booster:

(a) Allied Deposits Scheme (D)

These include specialized savings and fixed deposit schemes that have specific withdrawal conditions. Since a portion of bank funds is locked in these schemes, it restricts banks from using them for credit expansion.

(b) Deposits Linked with Special Benefits (E)

Certain deposits are linked to government benefits, tax exemptions, or employee savings schemes and cannot be used as loanable funds. The more deposits banks hold in such schemes, the less credit they can create.

Additional Knowledge:

Amount of Cash That Commercial Banks Possess (A)

• While reserves impact lending, banks can still create credit through the fractional reserve system.
• The cash reserve ratio (CRR) plays a role, but it does not completely limit credit creation.

Monetary Policy of the Central Bank (C)

• While monetary policy affects credit expansion, it is more of a regulatory measure rather than an inherent limitation on credit creation.
• Banks can adjust their strategies in response to monetary policies.

Supply of Collateral Security (B)

• Collateral is important for securing loans, but it does not directly restrict credit creation.
• Banks can still lend based on their available reserves, regardless of collateral availability.​