Instruments of credit control by C.B.
Central Bank controls credit in two ways:- Quantitative Credit Control and Qualitative credit Control
(A) QUANTITATIVE CREDIT CONTROL:- The main objective of quantitative credit control is to control the total volume of bank credit and rate of interest. In other words, those methods by which Central Bank controls the quantity of credit in a country are called Quantitative methods.
These methods include:- bank rate, open Market Operations, Change in CRR and Change in SLR.
(1) BANK RATE
It is the rate at which the Central Bank rediscounts the first class securities of other banks. With the help of Bank Rate policy the Central Bank controls the credit creation of other banks.
Whenever Central Bank wants to control credit in the country it raises the Bank Rate. As a consequence the commercial banks would have to increase it's market rate of interest for providing loans. As rate of interest increases traders and investors reduce their borrowings thus contracting the credit supply in market.
When the Central Bank wants to expand credit it lowers the Bank Rate. As a result market rate of interest also goes down. Traders and investors will now borrow more from the banks and there will be expansion of credit.
(2) OPEN MARKET OPERATIONS
It refers to sale and purchase of securities by the Central Bank in the open market. It is a monetary instrument used by the Central Bank to contract or expand the credit by way of sale or purchase of securities respectively in open market.
When credit is to be contracted in the country, the Central Bank begins to sell securities in the open market. People buy this by either withdrawing money from commercial banks or by their cash hoardings. In this way, money with commercial bank decreases and they are forced to contract their lendings and thus credit contracts.
If the Central Bank wants to expand credit, it begins to buy securities in the open market. It causes increase in the quantity of money. People deposit more money in banks. With this cash reserves increases with commercial bank and they create more credit.
(3) VARIATION IN CASH RESERVE RATIO
Central Bank can control credit by varying the minimum cash reserves of commercial banks. It is known as the method of STATUTORY MINIMUM RESERVE. According to it, all banks must keep a certain percentage of their deposits with the Central Bank as reserve fund.
When the Central Bank is to contract credit it raises the ratio of the cash reserves. As a result, cash balances of the banks are reduced and their capacity to create credit is correspondingly reduced.
On the contrary, if the Central Bank is to expand credit it lowers the Cash Reserve Ratio. Consequently, cash balances of the banks are increased and also their power to create credit.
(4) CHANGE IN STATUTORY LIQUIDITY RATIO
According to this method, the banks have to keep compulsory a certain portion of their assets in liquid form. This curtails the power of commercial banks to create credit.
When the central Bank has to contract credit it increases the SLR. The banks have to keep a large portion of their deposits in the form of cash. It reduces their capacity of creating credit.
On the other hand, when the Central Bank has to expand credit it reduces the SLR. Consequently, the banks have to maintain less proportion of their deposits in the form of cash. It enhances their capacity to create credit.
**NOTE:- The major difference between CRR and SLR is that the former is kept with Central Bank and the latter is maintained by the Commercial banks itself.****
(B) QUALITATIVE CREDIT CONTROL:- It aims at regulating the volume of credit given for specific purposes. It is also called SELECTIVE CREDIT CONTROL. Its different forms are as under:-
(1) REGULATION OF CONSUMER'S CREDIT
Central Bank controls credit given to the consumers at the time of inflation. Some restrictions are made on installment facilities granted to the consumers. Whenever installment facilities are extended there is expansion of credit. On the contrary, reduction of these facilities helps contract credit.
(2) RATIONING OF CREDIT
As we know Central bank acts as the lender of the last resort. It can ration credit in 4 ways:- (i) It can decline to give loans to a particular bank; (ii) It can scale down the amount of loans to be given to different banks; (iii) It can fix quota of the credit to be given to different banks; (iv) It can fix the limits of loans to be given to different industries and traders.
Introduction of credit rationing makes commercial banks cautious in matter of advancing loans.
(3) MORAL PERSUASION
Sometimes Central Bank by exercising moral persuasion over other banks get them agree to its credit control policy. It has influence on almost all banks. No pressure is implied, only morally advises are given.
(4) PUBLICITY AND PROPAGANDA
Modern age is an age of publicity. This media is made use of to implement credit control policy. Central bank gives wide publicity to its credit policy. It serves as a brief for other banks and they act accordingly. This policy is pursued on a large scale by the Central Bank of America and Germany.
(A) QUANTITATIVE CREDIT CONTROL:- The main objective of quantitative credit control is to control the total volume of bank credit and rate of interest. In other words, those methods by which Central Bank controls the quantity of credit in a country are called Quantitative methods.
These methods include:- bank rate, open Market Operations, Change in CRR and Change in SLR.
(1) BANK RATE
It is the rate at which the Central Bank rediscounts the first class securities of other banks. With the help of Bank Rate policy the Central Bank controls the credit creation of other banks.
Whenever Central Bank wants to control credit in the country it raises the Bank Rate. As a consequence the commercial banks would have to increase it's market rate of interest for providing loans. As rate of interest increases traders and investors reduce their borrowings thus contracting the credit supply in market.
When the Central Bank wants to expand credit it lowers the Bank Rate. As a result market rate of interest also goes down. Traders and investors will now borrow more from the banks and there will be expansion of credit.
(2) OPEN MARKET OPERATIONS
It refers to sale and purchase of securities by the Central Bank in the open market. It is a monetary instrument used by the Central Bank to contract or expand the credit by way of sale or purchase of securities respectively in open market.
When credit is to be contracted in the country, the Central Bank begins to sell securities in the open market. People buy this by either withdrawing money from commercial banks or by their cash hoardings. In this way, money with commercial bank decreases and they are forced to contract their lendings and thus credit contracts.
If the Central Bank wants to expand credit, it begins to buy securities in the open market. It causes increase in the quantity of money. People deposit more money in banks. With this cash reserves increases with commercial bank and they create more credit.
(3) VARIATION IN CASH RESERVE RATIO
Central Bank can control credit by varying the minimum cash reserves of commercial banks. It is known as the method of STATUTORY MINIMUM RESERVE. According to it, all banks must keep a certain percentage of their deposits with the Central Bank as reserve fund.
When the Central Bank is to contract credit it raises the ratio of the cash reserves. As a result, cash balances of the banks are reduced and their capacity to create credit is correspondingly reduced.
On the contrary, if the Central Bank is to expand credit it lowers the Cash Reserve Ratio. Consequently, cash balances of the banks are increased and also their power to create credit.
(4) CHANGE IN STATUTORY LIQUIDITY RATIO
According to this method, the banks have to keep compulsory a certain portion of their assets in liquid form. This curtails the power of commercial banks to create credit.
When the central Bank has to contract credit it increases the SLR. The banks have to keep a large portion of their deposits in the form of cash. It reduces their capacity of creating credit.
On the other hand, when the Central Bank has to expand credit it reduces the SLR. Consequently, the banks have to maintain less proportion of their deposits in the form of cash. It enhances their capacity to create credit.
**NOTE:- The major difference between CRR and SLR is that the former is kept with Central Bank and the latter is maintained by the Commercial banks itself.****
(B) QUALITATIVE CREDIT CONTROL:- It aims at regulating the volume of credit given for specific purposes. It is also called SELECTIVE CREDIT CONTROL. Its different forms are as under:-
(1) REGULATION OF CONSUMER'S CREDIT
Central Bank controls credit given to the consumers at the time of inflation. Some restrictions are made on installment facilities granted to the consumers. Whenever installment facilities are extended there is expansion of credit. On the contrary, reduction of these facilities helps contract credit.
(2) RATIONING OF CREDIT
As we know Central bank acts as the lender of the last resort. It can ration credit in 4 ways:- (i) It can decline to give loans to a particular bank; (ii) It can scale down the amount of loans to be given to different banks; (iii) It can fix quota of the credit to be given to different banks; (iv) It can fix the limits of loans to be given to different industries and traders.
Introduction of credit rationing makes commercial banks cautious in matter of advancing loans.
(3) MORAL PERSUASION
Sometimes Central Bank by exercising moral persuasion over other banks get them agree to its credit control policy. It has influence on almost all banks. No pressure is implied, only morally advises are given.
(4) PUBLICITY AND PROPAGANDA
Modern age is an age of publicity. This media is made use of to implement credit control policy. Central bank gives wide publicity to its credit policy. It serves as a brief for other banks and they act accordingly. This policy is pursued on a large scale by the Central Bank of America and Germany.
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