Methods Of Credit Control

What Is Meant By Credit Control?

Credit control refers to the function of the central bank (Reserve Bank of India) in managing the amount and distribution of money, or liquidity, in the economy. A central bank’s role is to supervise the credit extended by commercial banks to their customers.

This kind of activity of Central Bank is known as credit control. As a result, economic development within a framework of stability will be achieved, and inflationary and deflationary pressures will be managed.

Therefore, there is a need to limit the volume of credit lent by the commercial banks, regulate the amount of credit lent, direct the credit to productive uses, and implement measures that strengthen the structure of banks.

Methods Of Credit Control

Central Banks employ various methods to control credit, which can be broadly classified into two categories:

Quantitative Methods Or General Methods

Quantitative methods of credit control focus on the quantity or volume of money and are used to regulate the total amount of credit extended by banks. As indirect tools, these instruments tend to influence the loanable funds of commercial banks.

These methods are expected to control and adjust the amount of deposits created by commercial banks. As a result, these methods ensure that savings and investments remain in balance.

1. Bank Rate Policy:

It is also known as a discount rate policy. A standard rate of discount set by the central bank at which eligible instruments such as government-approved bills and commercial papers can be purchased or rediscounted is commonly referred to as the repurchase rate. The availability and cost of credit are strongly influenced by it.

The rising bank rate of the central bank may result in commercial banks borrowing less from the RBI. But, conversely, when the bank rate is reduced, the commercial banks can borrow more, and credit expansion occurs.

2. Open Market Operations (OMO):

The RBI trades eligible securities in both the capital and money markets on behalf of the country’s apex bank. By purchasing or selling short-term or long-term securities, the central bank is increasing or decreasing the financial resources of the commercial bank. In turn, this will have an impact on the creation of credit.

3. Variations In The Reserve Ratio:

Commercial banks must maintain Cash Reserves with the Reserve Bank of India following a specified percentage of their net demand and time liabilities. As well as maintaining a certain proportion of their liquid assets to meet their net demand and time liabilities.

They are known as the Cash Reserve Ratio or (CRR) and the Statutory Liquidity Ratio or (SLR). In the event that any one of these ratios changed slightly, the reserve position of commercial banks could be adversely affected.

4. Repo:

The central bank makes repurchase transactions to maintain the stability of the money market. Repo rate is the rate in which the central bank provides loans to commercial banks against government-approved securities for a specified period at a specified rate, called the Repo Rate. As part of this process, the central bank absorbs or drains liquidity from the system.

Also Read: Credit Rating Process

Qualitative Methods Or Selective Methods

Besides general credit control methods, qualitative methods are also utilized. There are several circumstances in which quantitative methods may not function effectively and may harm particular sectors.

In a quantitative sense, credit control involves controlling the volume of credit as a whole. Thus, there is the possibility that it may affect legitimate productive purposes.

Consequently, the qualitative methods of credit control come into play, whereby a credit facility is available for productive and priority sectors while all other sectors are restricted.

1. Fixation Of Margin Requirement

Through the provision of margin requirements, the central bank establishes the minimum margin that banks and financial institutions must maintain on all loans secured by commodities, stocks, and shares.

In addition, a central bank may also prescribe margin requirements for the underlying securities to reduce speculative trading on stock exchanges.

2. Credit Rationing

Credit rationing is a situation in which the banks limit the amount of credit they extend to consumers. The process is referred to as credit rationing. The central bank uses this method to restrict the amount of loans and advances to a specific sector.

It may be necessary for the central bank to set a ceiling for certain categories of loans or advances in particular cases. It is also expected that commercial banks adhere to the ceiling set by the central bank. This reduces the exposure of the banks to undesirable sectors.

3. Regulation Of Consumer Credit

To regulate consumer credit, the apex bank sets the down payment amount and the length of time over which installments will be spread. In an inflationary period, more restrictions are imposed to prevent prices from rising by reducing demand, while during a depression, relaxation is provided to encourage demand for goods.

4. Control Through Directives

The central bank uses this technique to regulate the amount of credit created by commercial banks. These may take the form of written orders, warnings, notices, or appeals.

For example, it may be helpful to regulate commercial banks’ lending policies, set a maximum credit limit for specific purposes, and restrict the flow of bank credit into non-essential areas. The credit may be diverted to productive uses as a result.

5. Moral Suasion

Moral suasion is the method of coercing private economic activity by the government into participating in ways that are not already defined or regulated by law. The method is known as moral suasion.

Using this method, the Reserve Bank of India exerts moral influence on commercial banks in recommendations, suggestions, guidelines, directives, requests, and persuasion. To achieve this, the central bank must cooperate. Commercial banks,

however, are not liable for any financial penalties if they do not comply with the RBI’s advice. The cooperation between the two banks, i.e., the central bank and the commercial bank, constitutes the success of this method. When the economy is experiencing inflation, this helps limit credit.

6. Publicity

This method specifies that the central bank issues numerous reports in the form of bulletins to give an overview of the good and the bad aspects of the system and inform the public about its perspective on credit expansion and contraction.

A commercial bank can use this information to guide the supply of credit in a particular direction. Thus, the Central Bank will be able to guide the commercial banks, which will enable them to make modifications to their lending policies.

7. Direct Action

In addition to its use as an adjunct to other methods, this technique can be utilized by the central bank for enforcing both quantitative and qualitative methods.

Further, the central bank has the power to take action against banks who fail to follow instructions or directives and refuse to rediscount their bills of exchange and commercial papers.

The Reserve Bank may also refuse to grant credit to banks whose borrowings exceed their capital. Even the central bank has the authority to ban a particular bank if it fails to follow instructions.

Also Read: What is Cash Credit & How does Cash Credit Work?

What Is Credit Control By RBI?

Reserve Bank of India implements credit control as a key part of its monetary policy to regulate the flow of credit and demand for money in an economy. The RBI controls the credit that commercial banks issue.

Which Bank Does Credit Control?

The Reserve Bank of India Act, 1934, and the Banking Regulation Act, 1949 provide the legal framework under which RBI has control over the credit structure in India. To maintain a proper level of credit supply in the market, quantitative credit controls are employed.

Need For Credit Control

The Reserve Bank of India has among its most important functions the control of credit in the economy. There are several primary and important needs to manage credit in the economy.

• The purpose of this initiative is to facilitate the more rapid growth of the “priority sector,” i.e., those sectors of the economy that are deemed “prioritized” by the government based on their economic condition or public interest.
• Keeping a check on the channelization of credit so that it is not used for inappropriate purposes.
• Controlling inflation and deflation is an important objective.
• To increase economic activity by facilitating the flow of adequate bank credit to various sectors.
•  Economic development.

Also Read: How to Remove Inquiries From Credit Report?

Final Thoughts

Despite these limitations, selective credit controls are among the most important tools in the central bank’s arsenal and are widely used as a credit control method.

It is important to combine quantitative and qualitative credit control methods judiciously to achieve successful and efficient monetary management. The two types of credit control are complementary rather than competitive.

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