Credit control in

India

Credit control is an important tool used

by Reserve Bank of India, a major
weapon of the monetary policy used to
control the demand and supply of money
(liquidity) in the economy. Central Bank
administers control over the credit that
the commercial banks grant. Such a
method is used by RBI to bring
"Economic Development with Stability". It
means that banks will not only control
inflationary trends in the economy but
also boost economic growth which
would ultimately lead to increase in real
national income stability. In view of its
functions such as issuing notes and
custodian of cash reserves, credit not
being controlled by RBI would lead to
Social and Economic instability in the
country.

Need for credit control

Controlling credit in the economy is
amongst the most important functions of
the Reserve Bank of India. 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" depending
upon their economic condition or
government interest. These sectors
broadly totals to around 15 in
number.[1]
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.
To develop the economy.

Objectives of credit control

The broad objectives of credit control
policy in India have been-

Ensure an adequate level of liquidity

enough to attain high economic growth
rate along with maximum utilisation of
resource but without generating high
inflationary pressure.
Attain stability in the exchange rate
and money market of the country.
 Meeting the financial requirement
during a slump in the economy and in
the normal times as well.
Control business cycle and meet
business needs.

Methods of credit control

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

Qualitative method
Quantitative method

During the period of inflation Reserve

Bank of India tightens its policies to
restrict the money supply, whereas
during deflation it allows the commercial
bank to pump money in the economy.

Qualitative method

By Quality we mean the uses to which

bank credit is directed.

For example- the bank may feel that

spectators or the big capitalists are
getting a disproportionately large share
in the total credit, causing various
disturbances and inequality in the
economy, while the small-scale
industries, consumer goods industries
and agriculture are starved of credit.
Correcting this type of discrepancy is a
matter of qualitative credit control.

Qualitative method controls the manner

of channelizing of cash and credit in the
economy. It is a 'selective method' of
control as it restricts credit for certain
section where as expands for the other
known as the 'priority sector' depending
on the situation.

Tools used under this method are-

Marginal requirement

Marginal requirement of loan current

value of security offered for ban-value of
loans granted. The marginal requirement
is increased for those business activities,
the flow of whose credit is to be
restricted in the economy.

For Example:- A person mortgages his

property worth ₹ 1,00,000 against loan.
The bank will give loan of ₹ 80,000. The
marginal requirement here is 20%

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. RBI fixes ceiling for
specific categories. Such rationing is
used for situations when credit flow is to
be checked, particularly for speculative
activities. Minimum of "capital: total
assets" (ratio between capital and total
asset) can also be prescribed by Reserve
Bank of India

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. Though this
method is not very successful in
developing nations due to high illiteracy
existing making it difficult for people to
understand such policies and its
implications.
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 of
India. There can be a restriction on
advancing of loans imposed by Reserve
Bank of India on such banks. e.g. – RBI
had put up certain restrictions on the
working of the Metropolitan co-operative
banks. Also the 'Bank of Karad' had to
come to an end in 1992.[2]

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. It
also be part of meetings between RBI
and Commercial Banks. RBI persuades
the commercial bank to follow their
policies. RBI puts a pressure on the
commercial banks to put a ceiling on
credit flow during inflation and be liberal
in lending during deflation.

Quantitative method
Graph showing variations in the Bank Rate from

1935–2011 (current year)[3]

xsBy quantitative credit control we mean

the control of the total quantity of credit.

For Example- consider that the Central

Bank, on the basis of its calculations,
considers that Rs. 50,000 is the
maximum safe limit for the expansion of
credit. But the actual credit at that given
point of time is Rs. 55,000(say).Thus it
then becomes necessary for the central
bank to bring it down to 50,000 by
tightening its policies. Similarly if the
actual credit is less, say 45,000, then the
apex bank regulates its policies in favor
of pumping credit into the economy.

Different tools used under this method

are-

Chart showing effect of increase in bank rate

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
re discount approved bills of exchange or
lend on approved securities.

Section 49 of the Reserve Bank of India

Act 1934, defines Bank Rate as "the
standard rate at which it (RBI) is prepared
to buy or re-discount bills of exchange or
other commercial paper eligible for
purchase under this Act".

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.

At any time there are various rates of

interest ruling at the market, like the
deposit rate, lending rate of commercial
banks, market discount rate and so on.
But, since the central bank is the leader
of the money market and the lender of
the last resort, all other rates are closely
related to the bank rate. The changes in
the bank rate are, therefore, followed by
changes in all other rates as the money
market.

The graph on the right hand side shows

variations in the bank rate since 1935–
2011.

Working of the bank rate

This section will answer how Bank Rate

policy operates to control the level of
prices and business activity in the
country.

Changes in bank rate are introduced with

a view to controlling the price levels and
business activity, by changing the
demand for loans. Its working is based
upon the principle that changes in the
bank rate results in changed interest rate
in the market.

Suppose a country is facing inflationary

pressure. The central bank, in such
situations, will increase the bank rate
thereby resulting to a hiked lending rate.
This increase will discourage borrowing.
It will also lead to a fall in the business
activity due to following reasons.
 Employment of some factors of
production will have to be reduced by
the business people.
The manufacturers and stock
exchange dealers will have to liquidate
their stocks, which they held through
bank loans, to pay off their loans.

The effect of Rise in bank rate by the

central bank . Hence, we can conclude
that hike in Bank Rate leads to fall in
price level and a fall in the Bank Rate
leads to an increase in price level i.e. they
share an inverse relationship.

References
 1. "Priority Sector Lending – FAQs" .
Retrieved 30 September 2011.
2. Nanda, Sachin. "Role of RBI in Indian
Economy" . Retrieved 30 September
2011.
3. "Chronology of Bankrate" . Retrieved
12 October 2011.

External links

Look up deflation in Wiktionary, the

free dictionary.

Look up inflation in Wiktionary, the

free dictionary.

RBI home page

 Book: Economics and Banking

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