EconomicsICSE Class 10 · Commercial Banks

Credit Creation by Commercial Banks: Primary and Derivative Deposits (ICSE Class 10)

Updated 17 October 2026 · Fact-checked

Credit creation is the process by which commercial banks increase total deposits (and money) by lending. A primary deposit is a deposit made by a customer in cash or cheque; a derivative deposit is created when the bank lends and credits the loan to the borrower's account. If a bank keeps a fraction r of deposits as reserve, total deposits can rise to primary deposit × (1 ÷ r).

Each loan is spent and redeposited, so the bank keeps 10% and lends the rest again; ₹1,000 grows into ₹10,000, mostly derivative deposits.

Illustration drawn for QuestionBuddy.

Understand Credit Creation: Primary and Derivative Deposits

Primary deposits. Customers bring cash or cheques; the bank only receives (passive deposits).

Derivative deposits. When the bank gives a loan, it opens or credits an account for the borrower; this deposit arises from lending (active deposits).

Process (brief). A bank knows that not all depositors will withdraw together, so it keeps a fraction as reserve and lends the rest. The borrower spends the loan; the receiver deposits it in a bank, which again keeps a part and lends the rest, and so on.

Illustration. Primary deposit ₹1,000, reserve ratio 10%.

Round	New deposit (₹)	Reserve kept (₹)	Loan given (₹)
1	1,000	100	900
2	900	90	810
3	810	81	729
...	...	...	...

Total deposits = 1,000 × (1 ÷ 0.10) = ₹10,000. Of this, ₹1,000 is primary and ₹9,000 is derivative. Total loans = ₹9,000 and total reserves = ₹1,000.

Credit multiplier. 1 ÷ reserve ratio. With a 20% ratio it is 5; with 10% it is 10.

Limits to credit creation.
1. The reserve ratio (set by the central bank).
2. People's habit of holding cash and not depositing everything.
3. Availability of good borrowers and securities.
4. Central bank policy and credit controls.
5. Business conditions: in a depression, people borrow less.

Why it matters. Credit creation expands the money supply; the central bank therefore controls it.

Credit Creation: Primary and Derivative Deposits: key facts

Credit multiplier: 1 ÷ reserve ratio; Reserve ratio as a fraction.
Total deposits: Primary deposit × (1 ÷ reserve ratio)
Derivative deposits: Total deposits − Primary deposit
Each round: Loan = Deposit × (1 − reserve ratio)

How to answer Credit Creation: Primary and Derivative Deposits questions

Convert the reserve percentage into a fraction, find the multiplier, and then total and derivative deposits.

1Reserve ratio r = percentage ÷ 100.
2Multiplier = 1 ÷ r.
3Total deposits = primary × multiplier.
4Derivative deposits = total − primary.
5For rounds: loan = deposit × (1 − r); next deposit = that loan.

Credit Creation: Primary and Derivative Deposits in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

A neighbourhood bank

Suppose Asha deposits ₹50,000 in cash in a bank which must keep 20% as reserve. The bank lends ₹40,000 to a builder who pays it to a supplier who deposits it in another bank.

How much can total deposits finally become, and how much is derivative?

Try it first, then show the solutionSolution

r = 0.20; multiplier = 1 ÷ 0.20 = 5.
Total deposits = 50,000 × 5 = ₹2,50,000.
Derivative = 2,50,000 − 50,000 = ₹2,00,000.

Answer: Total deposits up to ₹2,50,000; derivative deposits ₹2,00,000.

Memory hook: Deposit, keep a part, lend the rest, and it comes back.

Tricks to remember Credit Creation: Primary and Derivative Deposits

Short memory aids. Say each one aloud once, then use it on a question the same day.

Primary = Passive, Derivative = Doing
Primary deposit is received; derivative is created by lending.
Use it when: Meaning.
1 over r
Multiplier is 1 divided by the reserve ratio.
Use it when: Formula.
Lower reserve, larger credit
A smaller r gives a larger multiplier.
Use it when: Reasoning questions.

Credit Creation: Primary and Derivative Deposits: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Which deposit · 1 mark · MCQBoard level

A deposit created when a bank grants a loan is called:
(a) primary deposit
(b) derivative deposit
(c) fixed deposit
(d) passive deposit

Try it first, then show the solutionSolution

Created by lending: derivative (active).

Answer: (b)

Example 2: Total deposits · 2 marks · Short answerBoard level

A bank receives a primary deposit of ₹2,000 and keeps a reserve ratio of 10%. Find the maximum total deposits. (2 marks)

Try it first, then show the solutionSolution

Multiplier = 1 ÷ 0.10 = 10.
Total = 2,000 × 10 = ₹20,000.
Check: 10% of 20,000 = 2,000 = primary deposit.

Answer: ₹20,000.

Example 3: Derivative deposits · 3 marks · Short answerHarder board level

A primary deposit of ₹5,000 is made when the reserve ratio is 20%. Find total deposits and derivative deposits. (3 marks)

Try it first, then show the solutionSolution

Multiplier = 1 ÷ 0.20 = 5.
Total = 5,000 × 5 = ₹25,000.
Derivative = 25,000 − 5,000 = ₹20,000.

Answer: Total ₹25,000; derivative ₹20,000.

Example 4: Rounds · 4 marks · Short answerHarder board level

A primary deposit of ₹1,000 and 10% reserve ratio: show three rounds of lending and the total loans at the end. (4 marks)

Try it first, then show the solutionSolution

Round 1: lend 900 (reserve 100).
Round 2: lend 810 (reserve 90).
Round 3: lend 729 (reserve 81).
Total deposits = 10,000; total loans = 10,000 − 1,000 = ₹9,000.

Answer: 900, 810, 729; total loans ₹9,000.

Example 5: Change in ratio · 4 marks · Short answerHOTS / competency

A bank has a primary deposit of ₹4,000. Compare total deposits when the reserve ratio is 10% and when it is raised to 25%. What does it show about the central bank's control? (4 marks)

Try it first, then show the solutionSolution

10%: multiplier 10, total ₹40,000.
25%: multiplier 4, total ₹16,000.
The fall is ₹24,000; raising the ratio reduces credit creation, so the central bank can control credit through the ratio.

Answer: ₹40,000 versus ₹16,000; higher ratio, smaller credit.

Where students lose marks in Credit Creation: Primary and Derivative Deposits

The slips examiners see most often, and what to write instead.

Mistake: Treating the multiplier as the reserve ratio
Inverted.
Wrong working
Total = 5,000 × 0.20.
Right working
Total = 5,000 × (1 ÷ 0.20) = 25,000.
Do this: Divide 1 by the ratio.
Usually costs: 1-2 marks.
Mistake: Calling total deposits derivative
No subtraction.
Wrong working
Derivative deposits = ₹25,000.
Right working
Derivative = total − primary = ₹20,000.
Do this: Subtract the primary.
Usually costs: 1 mark.
Mistake: Percentage not converted
20 used as 20.
Wrong working
1 ÷ 20.
Right working
1 ÷ 0.20.
Do this: Convert to a fraction.
Usually costs: 1 mark.

Exam tips

Syllabus asks for a brief understanding; one rounds table is enough.
Define both deposit types in two lines each.
State the limits in a short list.

Practice questions on Credit Creation: Primary and Derivative Deposits

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
Primary deposits are also called:
(a) active deposits
(b) passive deposits
(c) derivative deposits
(d) time deposits
Hint
Bank only receives.
Answer
(b)
Q2 · 1 mark · Very short answerBoard level
Define credit creation. (1 mark)
Hint
Lending creates deposits.
Answer
The process by which commercial banks increase total deposits by lending a part of the deposits they receive.
Q3 · 3 marks · Short answerHarder board level
A bank receives a primary deposit of ₹3,000 with a reserve ratio of 20%. Find the credit multiplier, total deposits and derivative deposits. (3 marks)
Hint
1 ÷ 0.2 = 5.
Answer
Multiplier = 5; total = 3,000 × 5 = ₹15,000; derivative = 15,000 − 3,000 = ₹12,000.
Q4 · 3 marks · Short answerHarder board level
Explain any three limits to credit creation. (3 marks)
Hint
Reserve ratio, cash habit, borrowers.
Answer
The reserve ratio fixed by the central bank; people holding cash instead of depositing; shortage of good borrowers; central bank policy.
Q5 · 4 marks · Long answerHOTS / competency
A bank has a primary deposit of ₹6,000 and a reserve ratio of 15%. Find the maximum total deposits (to the nearest rupee) and explain why the actual amount of credit created is usually lower. (4 marks)
Hint
1 ÷ 0.15 = 6.67.
Answer
Multiplier = 1 ÷ 0.15 = 6.67 (recurring); total = 6,000 ÷ 0.15 = ₹40,000. Actual credit is lower because people hold some cash, borrowers may be scarce and the central bank may limit credit.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Deposits made by customers?Show answer
Primary deposits.
2.Deposits created by loans?Show answer
Derivative deposits.
3.Multiplier?Show answer
1 ÷ reserve ratio.
4.Reserve ratio 25%, multiplier?Show answer
4.
5.Who controls credit creation?Show answer
The central bank.

Credit Creation: Primary and Derivative Deposits: frequently asked questions

What is credit creation?

Creation of deposits by banks through lending.

What are primary and derivative deposits?

Primary deposits come from customers; derivative deposits are created when loans are credited.

What limits credit creation?

Reserve ratio, cash-holding habits, borrowers' availability and central bank policy.