Credit control in india

Central bank and credit control
By
Dr. Sunil M Rashinkar and
Dr. Mageshkumar
Presidency University

Meaning of credit control
 The central bank is having the authority to regulate the
amount of money supply in the economy as and when
required.
 Apart form the legal tender money, the credit money is
also plying almost equivalent role in the economic
system and almost affects in the same manner as the
legal money affects.
 Free and unlimited credit creation by the commercial
banks may create a serious threat in the economy, and
therefore, it becomes necessary to regulate the credit
money along with the legal money in the economy.
 Credit control means adjustment of volume credit to suit
the needs of the various sectors of the economy.

Objectives of the credit control:
1. To maintain stability in the internal price level.
2. To maintain stability in the exchange rate.
3. To maintain stability in the money market of the economy.
4. To eliminate or to reduce the vagaries of business cycles
by controlling and regulating the supply of credit.
5. To maximize income, employment and output in the
economy.
6. To meet financial requirements of the economy not only
during normal times but also during the emergency or war.
7. To promote economic growth.

Methods of Credit Control:
A.General Methods / Quantitative methods of Credit
Control
1. Bank rate policy
2. Open Market Operations
3. Variation in Reserve Ratio
B. Selective Methods / Qualitative methods of Credit
Control

A. General or Quantitative methods:
1.Bank Rate Policy:
The rate at which the central bank is willing to discount the
first class bills of exchange of the commercial banks is known
as the Bank Rate.
In some countries it is also known as Discounting Rate.
The rate at which general public is given loans and
advances and the bills of general public is discounted is
known as market rate or Interest rate.

Bank rate:……
 When the commercial banks are continuously granting loans and
advances to the businessmen, then central bank may not treat this
as good for Economy.
 Now to control the lending activities of commercial banks, their
capacity of lending must be reduced.
 In the situation of Inflationary pressures, the RBI tends to increase
the Bank rate.
 This will increase the cost of discounting the bills to commercial
banks.
 The lending activity will be reduced by the commercial banks and
therefore, the total supply of money in the economy will also
reduce.
 The reduction in the supply of money will also reduces the
inflationary pressures.

 On the contrary, reduction in the bank rate will have just the opposite
effect.
 Lowering of the bank rate will imply that co9mmercial banks can borrow
at a cheaper rate from the central bank and therefore, they too will
reduce their lending rates.
 This will make bank credit cheaper and encourages producers and
traders to borrow and invest.
 The level of economic activity will increase resulting in an general price
level.
 This will offset the deflationary pressures.
Bank rate:……

 Conditions for the success of the bank rate policy:
1. close relationship between bank rate and interest rate.
2. Elastic economic structure; effects of changes on the
related factors.
3. Well developed and well organized money market.
Bank rate:……

Bank rate:……
 Limitations of the bank rate policy:
1. Commercial banks may not raise their lending rates due to
heavy surplus cash.
2. In the optimistic atmosphere of inflation, the demand for credit
by businessmen will be interest inelastic.
3. It makes credit costly for productive purposes and speculative
demand may increase.
4. Non existence of well developed and well organized money
market in underdeveloped and developing economies.
5. Insensitivity towards the rate of interest, as it is a very small part
of the cost of production.
6. Non banking financial intermediaries are not affected.
7. Effects of other factors.

2. Open market operations:
 Open market operation simply imply the purchase or sale by
the central bank of any kind of eligible paper like
government securities or any other public securities or trade
bills, etc.
 When the central bank sells securities in the open market,
other thing being equal, the cash reserve of the commercial
banks decreases to the extent that they purchase these
securities.
 By this way the central bank can also reduce the amount of
consumers deposits with commercial banks to the extent
that these consumers acquire the securities sold by the
central bank.

Open market operations:…..
 The sell of securities by the central bank in the open market
ultimately contracts the credit in the economy.
 Conversely, when the central bank purchases the securities
from the commercial banks and general public, the credit
expands up to the extent that they have sold their securities
to the central bank.
 In this way the central bank can either expand or contract
the quantity of money in the economy and can control the
deflationary or Inflationary pressures in the economy.

 Limitations of the open market operation:
1. Lack of well-developed securities market.
2. Contradiction between bank rate and open market
operation.
3. Restricted dealings. (central bank have to be ready to incur
loses, and that’s why this measure is generally adopted for
short run only to avoid the huge loses.)
4. Difficulties in execution. (sale of securities is more difficult as
compared to purchase)
5. Precaution for stabilizing the governments securities market.
6. Assumption of a constant velocity is not true.

 Usefulness of the Open Market Operation Policy:
1. It enhances the efficiency of the bank rate policy as it is
complementary to it.
2. It helps in maintaining the stability in the prices of
government securities by sell and purchase of it at a
suitable time.
3. It also helps in contracting extreme trend in the
business.
4. It helps in increasing the level of exports and indirectly
helps in improving the balance of payment situation.

3. Variations in cash reserve ratio:
 The countries where the money market is disorganized or less
developed, they can adopt this method of quantitative credit control.
 The central bank is having the power to acquire a part of reserves of
commercial banks as being a bank of the bankers.
 The central bank is also having a power to alter the quantum of this
reserve according to the needs of the economy.
 The increase in the customary reserve ration contracts the liquidity with
commercial banks and lending power of the same.
 On the other hand, decrease in the reserve ration increases the lending
power of the commercial banks by increasing their liquidity.
 The central bank changes the reserve amount according to the
inflationary or deflationary situations of the economy.

Variations in cash reserve ratio…….
 Limitations of the Variations in the cash reserve ration:
1. Large excess reserves are available with the commercial
banks.
2. Determination of bank credit policy: other things are
considered at the time of deciding credit policies by the
commercial banks.
3. Demand for bank credit: if demand does not changes,
there may not be a desired effect on the bank credits.
4. Distortions caused by frequent use: can only be used when
the large changes are to be made in the credit capacity.
5. Discriminatory effect: non banking financial institutions
remains outside its purview.

B. Selective or Qualitative methods:
 Objectives of the Selective methods:
1. To diversify the credits towards the more productive uses.
2. To tackle only the sensitive spot of the economy.
3. To discourage excessive consumer demand for certain
goods, induced by hire-purchase and installment schemes.
4. Discrimination can be made in favour of exporting industries,
and to influence the balance of payment situation.
5. To eliminate the limitations of the quantitative methods and
to control all types of credits.

Measures of selective credit control:
1. Fixation of Margin Requirements:
 The practice of margin requirement is generally followed by all the
financial institutions dealing in the loans and advances against the
securities to the borrowers.
 The loan value of the security = the market value of the security –The
margin.
 The central bank is empowered to fix the “margin” and thereby fix
the maximum amount which the purchaser of security may borrow
against that security.
 Effective enough without affecting actual credit capacity.
 To check the effect of inflation in certain spots of the economy
without affecting the Macro economic phenomenon.
 Diversified margins can be set for different loans.
 Easily administered.

2. Consumer Credit Regulation:
 This includes the laying down of rules regarding;
 Minimum down payments
 Minimum amount of installment
 Maximum period of payment, etc
 For certain type of consumer durable goods.
 This tool is extremely useful supplementary tool for controlling
inflation and maintaining economic stability.
 There is a problem of administration in developing countries
like India.

3. Issue of Directives:
 The central bank is having the authority to issue some directions
related to the credit facilities provided by the commercial
banks in the economy.
 The directives can be oral or written, statements, appeals or
warnings, to the financial institutions.
 The effectiveness of the “Directives” depends on the prestige
of the central bank.
 More successful in Branch banking as compared to Unit
Banking System.
 But it is difficult to examine the effects of these Directives.

4. Rationing of Credit:
 The central bank may control or regulate the purposes for
which the credit is to be granted or not and up to which limit.
 It secure the diversion of financial resources in to the desired
channels of public authority in furtherance of the objectives
of planning.
 Credit rationing can be done in two ways:
a) Variable portfolio ceiling
b) Variable capital asset ratio.
 This method is justifiable in totalitarian economy as it
expands the responsibilities of the central bank.

5. Moral Suasion and Publicity:
 This includes request made by the central banks to the
commercial banks to co-operate with the general monetary
policies of the central bank.
 Central bank can also request the commercial banks for not
to involve herself in any speculative finance of non essential
activities.
 This can secure good results only I the case of good
cooperation by the commercial banks as there is no
compulsion or threat on punitive actions.
 This method is more suitable in expansion of credits rather
contraction of credits.

6. Direct Action:
 This is the most extensively used selective method for credit
control by the central bank.
 These direct actions may be:
a) Refusing to rediscounting of bills to commercial banks.
b) Refusal of more credits to the banks who have alreadyborrowed
in excess to their reserves.
c) Charging penal interest rates on the credit demand over and
above the prescribed limit.
 It may affect the positive activities of the commercial banks.
 It is difficult to channelize the credits by the commercial banks.
 Its is not easy to demarcate the essential and non essential
uses of the credits.

Limitations of the Selective methods:
1. The selective methods too excludes the non financial institutions which
indirectly making the credits .
2. The qualitative credit control can not be materialized in the real sense
as the commercial banks can not watch over the utilization of the loans
it has granted.
3. The velocity of bank money makes the measure ineffective.
4. Commercial banks are having the profit motives at the centre, and that
is why they may mischief by manipulating the accounts and
sanctioning loans for forbidden uses.

Credit control in india

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