Methods of Credit Control

What is meant by credit control?

The central bank’s (Reserve Bank of India) role in managing the amount and distribution of money, or liquidity, in the economy is known as credit control. The role of a central bank is to oversee the credit that commercial banks extend to their customers.

Credit control is the term for this type of central bank activity. As a result, economic progress will take place within a stable framework, with inflationary and deflationary forces handled.

As a result, commercial banks must limit the amount of credit they lend, regulate the amount of credit they lend, steer credit to productive uses, and apply bank-strengthening measures.

Methods of credit control

Central banks use a variety of strategies to regulate credit, which can be divided into two categories:

Quantitative Methods or General Methods

Quantitative credit control methods regulate the total amount of credit extended by banks by focusing on the quantity or volume of money. These instruments tend to impact commercial banks’ loanable funds as indirect tools.

Commercial banks are expected to use these approaches to control and adjust the number of deposits they make. As a result, these techniques help to keep savings and investments in check.

1. Bank Rate Policy:

A discount rate policy is another name for it. The repurchase rate is a standard rate of discount set by the central bank at which qualifying instruments such as government-approved bills and commercial papers can be acquired or rediscounted. It has a significant impact on lending availability and pricing.

The rising bank rate of the central bank may result in commercial banks borrowing less from the RBI. But, conversely, when the bank rate is reduced, the commercial banks can borrow more, and credit expansion occurs.

2. Open Market Operations (OMO):

The RBI trades eligible securities in both the capital and money markets on behalf of the country’s apex bank. By purchasing or selling short-term or long-term securities, the central bank is increasing or decreasing the financial resources of the commercial bank. In turn, this will have an impact on the creation of credit.

3. Variations in the Reserve Ratio:

Commercial banks are required to deposit a certain percentage of their net demand and time obligations with the Reserve Bank of India. In addition, they must keep a specific amount of liquid assets on hand to cover their net demand and time liabilities.

The Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) are the two ratios. The reserve position of commercial banks could be negatively impacted if any of these ratios changed slightly.

4. Repo:

To keep the money market stable, the central bank conducts repurchase transactions. The repo rate is the rate at which the central bank lends money to commercial banks in exchange for government-approved assets for a set length of time at a set rate. The central bank absorbs or drains liquidity from the system as part of this process.

Also Read: Credit Rating Process

Qualitative Methods or Selective Methods

Qualitative methods are used in addition to general credit control methods. Quantitative methods may not be effective in a variety of situations, causing harm to specific industries.

Credit control, in a quantitative sense, refers to the overall volume of credit. As a result, it may have an impact on genuine productive reasons.

As a result, qualitative credit control methods are used, in which a credit facility is offered for productive and priority industries while all other sectors are prohibited.

1. Fixation of margin requirement

The central bank establishes the minimum margin that banks and financial institutions must hold on all loans backed by commodities, stocks, and shares through margin requirements.

In addition, to reduce speculative trading on stock exchanges, a central bank may impose margin requirements for the underlying securities.

2. Credit Rationing

Credit rationing occurs when banks restrict the quantity of credit they issue to customers. Credit rationing is the term for this process. This strategy is used by the central bank to limit the quantity of loans and advances to a given sector.

In some situations, the central bank may be required to impose a ceiling for specific types of loans or advances. Commercial banks are likewise expected to adhere to the central bank’s ceiling. This decreases the banks’ exposure to risky industries.

3. Regulation of Consumer Credit

The apex bank sets the down payment amount and the length of time over which installments will be distributed to manage consumer borrowing. More limitations are placed during an inflationary time to prevent prices from rising by limiting demand, while relaxation is offered during a depression to increase demand for commodities.

4. Control through directives

This method is used by the central bank to control the quantity of credit created by commercial banks. Written orders, cautions, notices, and appeals are some examples.

Regulating commercial bank lending policies, setting a maximum credit limit for specified objectives, and restricting the flow of bank credit into non-essential areas, for example, may be beneficial. As a result, the credit could be redirected to other productive applications.

5. Moral Suasion

The government uses moral suasion to coerce private economic activity into engaging in ways that are not already defined or regulated by law. Moral suasion is the term for this technique.

The Reserve Bank of India uses this strategy to impose moral pressure on commercial banks through recommendations, proposals, guidelines, orders, requests, and persuasion. The central bank must work together to achieve this. Banks, commercial

If they do not follow the RBI’s advice, they will not face any financial penalties. The success of this method is due to cooperation between the two banks, namely the central bank and the commercial bank. This helps limit credit while the economy is facing inflation.

6. Publicity

This strategy stipulates that the central bank publishes numerous reports in the form of bulletins to provide an overview of the system’s positive and negative characteristics, as well as to tell the public about its views on credit expansion and contraction.

This information can be used by a commercial bank to direct credit supply in a specific direction. As a result, the Central Bank will be allowed to provide guidance to commercial banks, allowing them to make changes to their lending practices.

7. Direct Action

This strategy can be used by the central bank to enforce both quantitative and qualitative procedures, in addition to being used as an adjunct to other methods.

Furthermore, the central bank has the authority to take action against banks that refuse to rediscount their bills of exchange and commercial papers after failing to follow instructions or directives.

Banks whose borrowings exceed their capital may also be denied credit by the Reserve Bank. If a bank fails to follow instructions, even the central bank has the authority to ban it.

Also Read: What is Cash Credit and How Does It Function?

What is credit control by RBI?

To govern the flow of credit and demand for money in an economy, the Reserve Bank of India uses credit control as a crucial aspect of its monetary policy. Commercial banks’ credit is regulated by the RBI.

Which bank does credit control?

The Reserve Bank of India Act of 1934 and the Banking Regulation Act of 1949 establish the legal framework within which RBI exercises control over India’s credit system. Quantitative credit restrictions are used to maintain a suitable amount of credit supply in the market.

Need for credit control

Controlling credit in the economy is one of the most important tasks of the Reserve Bank of India. In order to manage credit in the economy, there are various fundamental and significant requirements.

  • The goal of this effort is to help the priority sector, or those areas of the economy that the government considers important because of their economic status or public interest, grow faster.
  • Keeping an eye on credit channelization to ensure that it isn’t being misappropriated.
  • Inflation and deflation are key goals to achieve.
  • Increase economic activity by allowing appropriate bank credit to flow to various sectors.
  •  Economic development.

Also Read: How to Delete Credit Report Queries?

Final Thoughts

Notwithstanding these drawbacks, selective credit controls remain an essential instrument in the arsenal of central banks and are commonly utilized as a credit control mechanism.

To achieve successful and efficient monetary management, it is critical to use a combination of quantitative and qualitative credit control methods. The two methods of credit control work together rather than against each other.

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Frequently Asked Questions

What is the purpose of the RBI as a credit controller?

The RBI regulates the entire quantity of money and bank credit in the national interest. The RBI also holds bank credit to ensure currency and price stability. The RBI accomplishes this goal by employing a number of quantitative, qualitative, and selective credit control tools.

How does credit control work?

Extending credit to consumers to stimulate the purchase of products or services is referred to as credit control. To ensure prompt payment of their goods or services, many businesses extend credit to customers with a good credit history.

Is there anything that the RBI can do to control credit in the economy?

The ratio can be changed to a limit in the event of a central bank. A high CRR implies banks have more minor to lend, reducing liquidity; on the other hand, a low CRR indicates banks have more minor to lend, increasing liquidity. The RBI can adjust the CRR to restrict or loosen liquidity depending on the scenario. CRR is now at 4%.

What is the full form of CRR?

The percentage of total deposits kept as liquid cash is known as the cash reserve ratio (CRR). The RBI requires it, and the cash reserves are stored with the RBI. The liquidity that banks hold with the RBI does not earn interest and cannot be used for investing or lending.

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