Credit Control System by RBI


What is credit control by Reserve Bank of India?

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Law Anupam Shukla 1 year 1 Answer 635 views 0

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  1. Credit Control by Reserve Bank of 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 with 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-

    1.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.

    2.To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes.

    3.To achieve the objective of controlling inflation as well as deflation.

    4.To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors.

    5.To develop the economy.

    Objectives of credit control: Credit control policy is just an arm of economic policy which comes under the purview of Reserve Bank of India, hence, its main objective being attainment of high growth rate while maintaining reasonable stability of the internal purchasing power of money. The broad objectives of credit control policy in India have been –

    1.Ensure an adequate level of liquidity enough to attain high economic growth rate along with maximum utilization of resource but without generating high inflationary pressure.

    2.Attain stability in exchange rate and money market of the country.

    3..Meeting the financial requirement during slump in the economy and in the normal times as well.

    4.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. 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 loan – 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. e.g.- a person mortgages his property worth Rs. 100,000 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. Reserve Bank of India has been using this method since 1956.

    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, 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. 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.

    Moral persuasion- 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. RBI puts a pressure on the commercial banks to put a ceiling on credit flow during inflation and be liberal in lending during deflation.

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