Credit Control Methods of RBI

It is important to know about the Credit Control measures of RBI for those who are preparing for competitive exams. It’s a very popular topic of competitive exams, interviews, group discussions and of general discussion. Those interested to know about it in simple language can go through this post.

You will also understand about the definitions of CRR, Bank Rate, SLR, Repo Rate, Reverse Repo Rate and other credit control methods.

What is Credit Control: Credit Control is an important tool used by the Reserve Bank ofIndia, 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.

What are the methods of Credit Control?

There are two methods that the RBI uses to control the money supply in the economy-

(1) Qualitative Method: By qualitative methods means the control or management of the uses of bank credit or manner of channelizing of cash and credit in the economy. Tools used under this method are:

Marginal 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.

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.

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.

Direct Action: Under the banking regulation Act, 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 ofIndia.

Moral Suasion: This method is also known as “Moral Persuasion” as the method that the Reserve Bank of India, being the apex bank uses here, is that of persuading the commercial banks to follow its directions/orders on the flow of credit.

(2) Quantitative Method: By Quantitative Credit Control we mean the control of the total quantity of credit. Different tools used under this method are:

Bank Rate: 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.

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 latter’s cash reserves. This Rate is increased during the times of inflation when the money supply in the economy has to be controlled.

Open Market Operations: Open Market Operations indicate the buying/selling of government securities in the open market to balance the money supply in the economy. During inflation, RBI sells the government securities to the commercial banks and other financial institution. This reduces their cash lending and credit creation capacities. Thus, Inflation can be controlled. During recessions, RBI purchases government securities from commercial banks and other financial institution. This leaves them with more cash balances for lending and increases their credit creation capacities. Thus, recession can be overcome.

Repo Rates and Reverse Repo Rates: 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.

Cash Reserve Ratio: The money supply in the economy is influenced by the cash reserve ratio. It is the ratio of a bank’s 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.

Statutory Liquidity Ratio: 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.

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.

If you have any question on this topic, you can ask us by posting below.

Comments

  1. Shabin says:

    What is the difference between bank rate and repo rate?
    And what is the re-discounting of bills?

    • Administrator says:

      The only difference between the two are,in REPO RATE, there is sale of security to RBI on an agreement to” repurchase” it at a future date at predetermined price.That is why the term REPO means “REPURCHASE AGREEMENT”.Whereas in BANK RATE, there is no such sale or repurchase agreement.It takes place as mere
      lending of money to commercial banks at fixed rate ,i.e the bank rate.

  2. love kumar says:

    WE TAKE THE LOAN BY BANK,SO WHT DOES THE BANK GIVEN THE RATE ?

  3. palak says:

    which method is better? and why?

  4. suhani says:

    explain the sources of credit control used by R.B.I

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