Credit creation refers to the process of expanding the availability of money through the advancement of loans and credit by banks and financial institutions. In most modern economies, money is created by both central banks and commercial banks. Central banks can increase the quantity of base money directly, while the majority of the money supply is created by the commercial banking system in the form of bank deposits.

In the process of credit creation, banks use their demand deposits to provide loans to their customers, giving borrowers higher purchasing power and competitive interest rates. Banks keep some share of their deposits as minimum reserves to meet the demand of their depositors. Thus, banks lend out the excess reserves for loans and investment purposes, and the interest earned becomes income for the banks.

The credit creation process is driven by the liquidity and profitability of the banks. The factors that determine the amount of credit that can be created include the amount of cash in the deposits, the reserve ratio, and default risk. The central bank of a country is responsible for ensuring the supply of money in the economy and regulates credit creation by ensuring the maintenance of adequate reserves within the banking system. The cash reserve ratio (CRR) defines legal reserves that banks shall maintain as a part of demand deposits while advancing loans and credit of the excess reserves.

The following formula can be used to determine the total credit creation: Total credit creation = Original deposit x Credit multiplier coefficient, where the credit multiplier coefficient is 1/r, and r is the cash reserve requirement, also known as the cash reserve ratio (CRR) .

In summary, credit creation is the process by which banks and financial institutions expand the availability of money through the advancement of loans and credit. The process is driven by the liquidity and profitability of the banks, and the central bank of a country regulates credit creation by ensuring the maintenance of adequate reserves within the banking system.