Credit Control means the regulation of the creation and contraction of credit in the economy. It is an important function of the central bank of any country. The importance of credit control has increased because of the growth of bank credit and other forms of credit. Commercial banks increase the total amount of money in circulation in the country through the mechanism of credit creation. In addition, businessmen buy and sell goods and services on a credit basis. Because of these developments, most countries of the world are based on a credit economy rather than a money economy. Fluctuations in the volume of credit cause fluctuations in the purchasing power of money. This fact has far-reaching economic and social consequences. That is why credit control has become an important function of any central bank. Credit control weapons used by the Reserve Bank may be either quantitative or qualitative.
1. Bank Rate or Discount Rate Policy: Bank rate is the minimum rate at which the central bank of a country provides loans to commercial banks. The bank rate is also known as a discount rate because in the earlier days central bank use to provide finance to the commercial banks by rediscounting bills of exchange. Bank Rate Policy or the Discount Rate Policy has been the earliest instrument of quantitative credit control. The change in the bank rate generally has an effect on the cost of credit available to the commercial banks from the Reserve Bank. If the bank rate is increased, the cost of the lending rates to the borrower increases, due to which the level of the borrowings of the banks is reduced. In effect, the increased bank rates result in the contraction of bank credit. Therefore, where the Central Bank of the country increases the bank rates, all other rates of interest also increase.
2. Open Market Operations: Open market operations of a central bank consist of the purchase and sale of government and other securities in the open market with a view to regulate the supply of money. It was in Germany perhaps for the first time ‘Open Market Operations’ were conceived as an instrument of quantitative credit control and later adopted in other countries. The Central Bank purchase and sells the Government. Securities, Gold, Foreign Exchange etc., for enlarging or contracting the cash basis of the commercial banks. The Reserve Bank of India can influence the reserves of commercial banks i.e. the cash basis of commercial banks buying or selling Government securities in the Open market. If the Reserve Bank of India buys Government. Securities in the market from commercial Banks, there is a transfer of cash from the Reserve Bank of India to the commercial banks and this increase the cash base of the commercial banks enabling them to expand credit and, conversely, if the Reserve Bank of India sales Government securities to the commercial banks, the commercial banks transfer cash to the Reserve Bank of India, therefore, their cash base is reduced. Thus adversely affecting the capacity of commercial banks to expand their credit.
3. Variable Cash Reserve Ratio: The traditional instruments of quantitative credit control, bank rate policy and open market operations, suffer from certain inherent defects and have been found unsuitable to serve the interests of underdeveloped countries. Hence, an entirely new and unorthodox instrument of quantitative credit control, in the form of variable reserve ratio came into vogue, thanks to the Federal Reserve System of the United States. Variable Reserve Ratio refers to the percentage of the deposits of the commercial banks to be maintained with the central bank, being subject to variations by the central bank. In other words, altering the reserve requirements of the commercial banks is called the variable reserve ratio. It is a well-known fact that all commercial banks are required to keep a certain percentage of their deposits as cash reserves with the Reserve Bank of India. The Reserve Bank of India is legally authorized to raise or lower the minimum reserve that the bank must maintain against the total deposits. This reserve requirement is subject to changes by the central bank depending upon the monetary needs and conditions of the economy.
1. Rationing of Credit: Under this method, the central bank controls credit by rationing it among its various uses. It also seeks to control the allocation of bank credit among the various categories of borrowers. The Reserve Bank has been authorised to secure the distribution of credit in conformity with the national priorities. As required by the Central Government, the Reserve Bank has issued directives to the commercial banks that at least 40% of their credit must be disbursed among the priority sectors of the economy such as agriculture, small industries, artisans, education, housing, etc. Rationing of credit can play a significant role in a planned economy by diverting financial resources into the priority sectors. But it cannot be denied that it curtails the freedom of commercial banks. Commercial banks cannot follow an independent policy because the channels of investment are determined in advance by the Reserve Bank.
2. Varying Margin Requirement: In case of advances against commodities subject to selective control, higher margins are prescribed in order to restrict the borrowing capacity of the borrowers. With a higher margin, a borrower can get less credit from banks against a certain quantity of stock and thus can finance only a smaller part of it through bank finance. Moreover, different margins may be prescribed for different types of borrowers against the security of the same commodity. A higher margin is generally fixed for those borrowers whose need for credit is not so urgent or larger flow of credit to whom is likely to aggravate the price situation.
3. Direct Action: The Central Bank may take action against banks that are pursuing unsound credit policies. This may take the form of charging a penal rate of interest or refusing to grant further rediscounting facilities to the banks who are violating the rules and directives of the Central Bank. The element of force associated with it is not conducive to the attainment of positive results. Direct action would result in a division of responsibility between the Central Bank and the Commercial Bank. The banks constantly feel that the ultimate responsibility rests with the Central Bank and until some action is taken they extend credit. This confusion resulting from the evasion of regulations by some banks and their observance by others is fraught with grave dangers to the financial welfare of the community.
4. Moral suasion: Moral suasion means persuasion of commercial banks to follow certain policies, impressing upon them the necessity to do. There is no legal compulsion in this regard by the Reserve Bank or Government of India and therefore the success of these measures depends upon the cooperation of the commercial banks. The central bank may request and persuade member banks to refrain from increasing their loans for speculative or non-essential activities. Through the instrument of Moral Suasion, the approach is informal rather than formal.
5. Publicity: Under this method, the central bank gives wide publicity regarding the probable credit control policy it may resort to by publishing facts and figures about the various economic and monetary conditions of the economy. The central bank brings out this publicity in its bulletin, periodicals, report etc.
Quantitative Methods:
Quantitative methods aim at controlling the total volume of credit in the country. They relate to the volume and cost of bank credit in general, without regard to the particular field of enterprise or economic activity in which the credit is used or utilised. The important quantitative or the general methods of credit control are as follows:1. Bank Rate or Discount Rate Policy: Bank rate is the minimum rate at which the central bank of a country provides loans to commercial banks. The bank rate is also known as a discount rate because in the earlier days central bank use to provide finance to the commercial banks by rediscounting bills of exchange. Bank Rate Policy or the Discount Rate Policy has been the earliest instrument of quantitative credit control. The change in the bank rate generally has an effect on the cost of credit available to the commercial banks from the Reserve Bank. If the bank rate is increased, the cost of the lending rates to the borrower increases, due to which the level of the borrowings of the banks is reduced. In effect, the increased bank rates result in the contraction of bank credit. Therefore, where the Central Bank of the country increases the bank rates, all other rates of interest also increase.
2. Open Market Operations: Open market operations of a central bank consist of the purchase and sale of government and other securities in the open market with a view to regulate the supply of money. It was in Germany perhaps for the first time ‘Open Market Operations’ were conceived as an instrument of quantitative credit control and later adopted in other countries. The Central Bank purchase and sells the Government. Securities, Gold, Foreign Exchange etc., for enlarging or contracting the cash basis of the commercial banks. The Reserve Bank of India can influence the reserves of commercial banks i.e. the cash basis of commercial banks buying or selling Government securities in the Open market. If the Reserve Bank of India buys Government. Securities in the market from commercial Banks, there is a transfer of cash from the Reserve Bank of India to the commercial banks and this increase the cash base of the commercial banks enabling them to expand credit and, conversely, if the Reserve Bank of India sales Government securities to the commercial banks, the commercial banks transfer cash to the Reserve Bank of India, therefore, their cash base is reduced. Thus adversely affecting the capacity of commercial banks to expand their credit.
3. Variable Cash Reserve Ratio: The traditional instruments of quantitative credit control, bank rate policy and open market operations, suffer from certain inherent defects and have been found unsuitable to serve the interests of underdeveloped countries. Hence, an entirely new and unorthodox instrument of quantitative credit control, in the form of variable reserve ratio came into vogue, thanks to the Federal Reserve System of the United States. Variable Reserve Ratio refers to the percentage of the deposits of the commercial banks to be maintained with the central bank, being subject to variations by the central bank. In other words, altering the reserve requirements of the commercial banks is called the variable reserve ratio. It is a well-known fact that all commercial banks are required to keep a certain percentage of their deposits as cash reserves with the Reserve Bank of India. The Reserve Bank of India is legally authorized to raise or lower the minimum reserve that the bank must maintain against the total deposits. This reserve requirement is subject to changes by the central bank depending upon the monetary needs and conditions of the economy.
Qualitative or Selective Credit Controls
The main instruments of selective credit control in India are:1. Rationing of Credit: Under this method, the central bank controls credit by rationing it among its various uses. It also seeks to control the allocation of bank credit among the various categories of borrowers. The Reserve Bank has been authorised to secure the distribution of credit in conformity with the national priorities. As required by the Central Government, the Reserve Bank has issued directives to the commercial banks that at least 40% of their credit must be disbursed among the priority sectors of the economy such as agriculture, small industries, artisans, education, housing, etc. Rationing of credit can play a significant role in a planned economy by diverting financial resources into the priority sectors. But it cannot be denied that it curtails the freedom of commercial banks. Commercial banks cannot follow an independent policy because the channels of investment are determined in advance by the Reserve Bank.
2. Varying Margin Requirement: In case of advances against commodities subject to selective control, higher margins are prescribed in order to restrict the borrowing capacity of the borrowers. With a higher margin, a borrower can get less credit from banks against a certain quantity of stock and thus can finance only a smaller part of it through bank finance. Moreover, different margins may be prescribed for different types of borrowers against the security of the same commodity. A higher margin is generally fixed for those borrowers whose need for credit is not so urgent or larger flow of credit to whom is likely to aggravate the price situation.
3. Direct Action: The Central Bank may take action against banks that are pursuing unsound credit policies. This may take the form of charging a penal rate of interest or refusing to grant further rediscounting facilities to the banks who are violating the rules and directives of the Central Bank. The element of force associated with it is not conducive to the attainment of positive results. Direct action would result in a division of responsibility between the Central Bank and the Commercial Bank. The banks constantly feel that the ultimate responsibility rests with the Central Bank and until some action is taken they extend credit. This confusion resulting from the evasion of regulations by some banks and their observance by others is fraught with grave dangers to the financial welfare of the community.
4. Moral suasion: Moral suasion means persuasion of commercial banks to follow certain policies, impressing upon them the necessity to do. There is no legal compulsion in this regard by the Reserve Bank or Government of India and therefore the success of these measures depends upon the cooperation of the commercial banks. The central bank may request and persuade member banks to refrain from increasing their loans for speculative or non-essential activities. Through the instrument of Moral Suasion, the approach is informal rather than formal.
5. Publicity: Under this method, the central bank gives wide publicity regarding the probable credit control policy it may resort to by publishing facts and figures about the various economic and monetary conditions of the economy. The central bank brings out this publicity in its bulletin, periodicals, report etc.
No comments:
Post a Comment