Question

Explain methods of credit control adopted by the 'Central Bank'.

Answer 1

The methods of credit control adopted by the 'Central Bank' are:

1. Quantitative Methods of monetary policy includes those instruments which focus on the overall supply of money. It includes:-

A. Two Policy Rates:-

Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa.

Repo rate is the rate charged on the secured loans offered by the Central bank to the commercial banks that includes collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa.

B. Two Policy Ratio:-

Statutory Liquidity Ratio (SLR) refers to liquid assets that the commercial banks must hold on daily basis as a percentage of their total deposits. SLR is determined by the central bank and is a legal requirement to be fulfilled by commercial banks. It is increased at the time of inflation to reduce the money supply in the economy and vice versa.

Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they must have kept as cash reserves with the central bank. The ratio is fixed by the central bank and is varied from time to time to control the supply of money in the economy depending upon the prevailing situation of inflation or deflation.

C. Open Market Operations:- Open Market Operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities in the open market to control the supply of money in the economy. By selling the securities, the central bank soaks liquidity from the economy and by buying the securities, the central bank releases liquidity.

2. Qualitative Methods of monetary policy includes those instruments which focus on the selected sectors of the economy. It includes:-

A. Margin Requirement:- Margin requirement refers to the difference between the current value of the security offered for loan (called collateral) and the value of loan granted. It is a qualitative method of credit control adopted by the central bank in order to stablise the economy from inflation or deflation.

B. Rationing of Credit:- Rationing of credit refers to fixation of credit quotas for different business activities which is introduced when the flow of credit is to be checked particularly for speculative activities in the economy.

C. Moral Suasion:- The central bank makes the member bank agree through persuasion or pressure to follow its directives which is generally not ignored by the member banks. The banks are advised to restrict the flow of credit during inflation and be liberal in lending during deflation.