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Theory and Practice of Banking - Credit Control

CREDIT CONTROL
Credit Control: Credit Control is an important tool used by the Reserve Bank of India, a major
weapon of the monetary policy used to control the demand and supply of money (liquidity) in the
economy.
Why Credit Control is required: The basic and important needs of Credit Control in the
economy are:

To encourage the overall growth of the priority sector i.e. those sectors of the
economy which is recognized by the government as prioritized.
To keep a check over the channelization of credit so that credit is not delivered for
undesirable purposes.
To achieve the objective of controlling Inflation as well as Deflation.
To boost the economy by facilitating the flow of adequate volume of bank credit to
different sectors.

Broadly there are two measures of Credit Control:


There are two methods that the RBI uses to control the money supply in the economyI. Quantitative credit measures or Selective credit control measures
II. Qualitative credit measures or General credit control measures
I.
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7.

Quantitative credit measures or Selective credit control measures


Bank rate or discount rate
Open market operations
Change in reserve ratio
Repo Rates and Reverse Repo Rates
Cash Reserve Ratio
Statutory Liquidity Ratio
Deployment of Credit

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2.
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Qualitative credit measures or General credit control measures


Regulation of margin requirement
Regulation of consumer credit
Control through directives
Moral suasion
Rationing of credit
Direct action
Publicity

II.

I. Quantitative credit measures or Selective credit control measures:


1. Bank rate or discount rate: It is the official rate at which the central bank of the country
discounts or rediscounts the approved bills or lends against securities brought by the
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Theory and Practice of Banking - Credit Control

commercial bank in either case the central bank provides accommodation to commercial
banks and increase or decreases their cash reserve.
Bank Rate also known as the Discount Rate is the official minimum rate at which
the Central Bank of the country is ready to rediscount approved bills of exchange or lend
on approved securities.
Bank Rate refers to the official interest rate at which RBI will provide loans to the
banking system which includes commercial / cooperative banks, development banks etc.
Such loans are given out either by direct lending or by rediscounting (buying back) the
bills of commercial banks and treasury bills. Thus, bank rate is also known as discount
rate. Bank rate is used as a signal by the RBI to the commercial banks on RBIs thinking
of what the interest rates should be.
When the commercial bank for instance, has lent or invested all its available funds
and has little or no cash over and above the prescribed minimum, it may ask the central
bank for funds. It may either re-discount some of its bills with the central bank or it may
borrow from the central bank against the collateral of its own promissory notes.
In either case, the central bank accommodates the commercial bank and increases
the latters cash reserves. This Rate is increased during the times of inflation when the
money supply in the economy has to be controlled.
2. Open market operation(OMO): Refers to direct buying and selling of securities and
bills in order to expand or contrast the business activity. In the period of inflationary
situation when there is excess of credit and more money with the banks and with the
people the central bank sells securities and bills in its possession. The banks and people
purchase them and therefore money possess to the central bank form them which reduces
the cash required of commercial bank. The decrease of cash reserves forces the
commercial banks to reduce their loan advances and at same time refuses loans further.
This will bring down the level of production employment and prices.
If the central bank desires to control deflation and fall in price and level they will
buy securities in money market and pay cash to the commercial banks and the people.
The commercial banks find that there their cash reserves increased. This enables the bank
to create more credit and thus helps in expanding investment, employment, production
and prices.
3. Change the reserve ratio: By convention or law, every commercial bank is required to
maintain with the central bank a certain percentage of its deposits in the form of
minimum cash reserve. By varying (covering/rising) under inflationary situation the
central rank increases the CRR.

Theory and Practice of Banking - Credit Control

The reserve ratio the central bank is in position to contract or expand the volume
of credit in country. When there is excess credit and money. The central bank raises the
reserve ratio as a result more money flows to the central bank from commercial banks
and therefore the focus of commercial banks to create more gets reduced. Conversely in
order to enable the banks to create more credit in times of deflation the central bank
lower the reserve ratio.
4. Repo Rates and Reverse Repo Rates: Repo rate is the rate at which the central bank of
a country lends money to commercial banks in the event of any shortfall of funds. Repo
rate is used by monetary authorities to control inflation.
Repo is a swap deal involving immediate sale of securities and a simultaneous re
purchase of those securities at a future date at a predetermined price. Commercial banks
and financial institution also park their funds with RBI at a certain rate, this rate is called
the Reverse Repo Rate. Repo rates and Reverse repo rate used by RBI to make liquidity
adjustments in the market.
Reverse Repo rate is the short term borrowing rate at which RBI borrows money
from banks. The Reserve bank uses this tool when it feels there is too much money
floating in the banking system. An increase in the reverse repo rate means that the banks
will get a higher rate of interest from RBI.
5. Cash Reserve Ratio: A specified minimum fraction of the total deposits of customers,
which commercial banks have to hold as reserves either in cash or as deposits with the
central bank. CRR is set according to the guidelines of the central bank of a country.
The money supply in the economy is influenced by the cash reserve ratio. It is the
ratio of a banks time and demand liabilities to be kept in reserve with the RBI. A high
CRR reduces the flow of money in the economy and is used to control inflation. A low
CRR increases the flow of money and is used to overcome recession.
6. Statutory Liquidity Ratio: Reserve requirement that the commercial banks in India
require to maintain in the form of gold, government approved securities before providing
credit to the customers.
Under SLR, banks have to invest a certain percentage of its time and demand
liabilities in Government approved securities. The reduction in SLR enhances the
liquidity of commercial banks.
7. Deployment of Credit: The RBI has taken various measures to deploy credit in different
of the economy. The certain percentage of bank credit has been fixed for various sectors
like agriculture, export, etc.
II. Qualitative credit measures or general credit control measures:
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Theory and Practice of Banking - Credit Control

The Qualitative Credit control affect indiscriminately all the section of the economy
depending upon the bank credit, they affect the borrowers without making any distinction
between essential and non-essential users. Selective credit controls on the other hands show
distinction between essential and non-essential users to which credit is put and discriminate in
favour of essential users.
1. Margin requirement: Marginal Requirement of loan can be increased or decreased to
control the flow of credit for e.g. a person mortgages his property worth Rs. 1,00,000
against loan. The bank will give loan of Rs. 80,000 only. The marginal requirement here
is 20%. In case the flow of credit has to be increased, the marginal requirement will be
lowered.
While lending money against securities commercial bank do not lend full amount of
the value of the security but keep certain amount of margin. The central bank will raises
or Lowes this margin to control the flow of credit during the periods of inflation and
deflation and also for various purposes.
2. Regulation of consumer credit: Credit given to the consumers to buy certain goods in
called consumer credit. The central bank may lay down restrictions on such credit in
order to control credit or may liberalise the rules on such credit to expand the volume of
credit.
3. Control through directives: Central bank may also give directives to the commercial
banks regarding expansion or contraction of credit and the commercial banks have to
follow them accordingly.
4. Rationing of credit: Under this method there is a maximum limit to loans and advances
that can be made, which the commercial banks cannot exceed.
It is the method of controlling and regulating the purpose for which the credit id
granted by the commercial bank it may arise in two forms
a. Variable portfolio ceiling
b. Variable capital asset ratio
a. Variable portfolio ceiling: refers to a system by which central bank fixes a
ceiling on maximum amount of loans and advances for each commercial
banks.
b. Variable capital asset ratio: refers to the system by which the central bank
fixes the ratio which the capital of the commercial banks should have been
used for loans and advances of the total assets.
5. Direct action: Under the banking regulation Act-1949, the central bank has the authority
to take strict action against any of the commercial banks that refuses to obey the
directions given by Reserve Bank of India.
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Theory and Practice of Banking - Credit Control

Implies direct measures to control credit it may take various forms the central bank
may refuses to rediscount the bills or advances loans against securities to those bank
which are not following its policy or directives. The central bank may charge a panel rate
of interest on money borrowed beyond the prescribed limit.
6. Moral suasion: Implies persuasion and request made by the central bank to the
commercial banks to follow the monetary policies of the commercial bank in times of
deprecation the central bank may persuade the commercial banks to expand their loans
and advances against inferior type of securities as fix lower margins and thus stimulate
expansion of bank credit the reverse is true during the period of inflation. However the
effectiveness of moral suasion is doubtful.
7. Publicity: RBI uses media for the publicity of its views on the current market condition
and its directions that will be required to be implemented by the commercial banks to
control the unrest.

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