Credit Control of Central

Bank
How does the Central Bank control Money
Supply or Flow of Credit in the Economy?
 Central Bank
Unlike Commercial banks, Central Bank
Issues currency
Control interest rates
Lender of last resort for the commercial banks
Clearing agent
Controls credit etc.
 What is Credit Control ?
The activities which ensure the availability of
credit facilities.

Example:-
Relaxing credit laws in times of recession to encourage borrowing
and increase cash flows.
CREDIT CONTROL OF CENTRAL BANK

Bank Creation &

Advances Contraction
of the Credit

Credit Prime
Economy Function of
Central
Bank
Credit
Basis
Business
 Credit control from specialist’s view

“The control of credit “Credit control means checking

means the regulation and that customers pay on time and
control of bank advances’’ do not exceed their credit
K.K. Dewett P.H. Collin limits’’
 Objectives of Credit Control

Stability of Checking Promotion of Stability of Stability in

Internal Booms and Economic the Money Exchange
Price level Depressions Development Market Rates
 Bank rate policy
Quantitative or
General Open market operations

Credit Variation or reserve ratio

Control
Methods Qualitative or Margin Requirements
Regulation of Consumer Credit
Selective Rationing of Credit
Control through Directives
Moral Persuasion
Direct Action
Publicity
 Bank Rate Policy
Official
minimum
lending rate

Also called Rate at

discount Central
rate Bank
advances
Bank
Rate
policy
Now every Earliest
Central instrument
Bank used it

First time in
Bank of
England
 Theory of Bank Rate
“An increase or a decrease in the bank rate leads to a reduction or
an increase in the supply of credit in the economy.”

Bank Supply
of
Rate
Credit

Supply
Bank
of Credit
Rate
 Working of Bank Rate
Bank rate
Bank Bank rate Bank decrease
increase
Rate Rate

Interest rate
Interest rate decrease in
increase in commercial
commercial
Bank Bank

Disagree to
Customer
accept loan encourage to
among accept loan
customer

Decrease the Increase the

amount of amount of
loan in the loan in the
market market
Condition for the Success of the Bank Rate policy

Close relationship between bank

rate & other interest rates

Existence of an elastic economic

system

Existence of short term funds market

Very effective before 1ˢᵗ world war

 Limitations of bank rate policy

Ineffective to Non Banking Decline the use Invention of Less dependence

combat boom & financial of bills of alternative of the
depression intermediaries exchange as instruments of commercial bank
are great threat credit credit control on the Central
instruments is a Bank
threat
 Open Market Operations
Used in the post-war period
First used in Germany

Theory of Open Market operations

’’by the purchase and sale of securities, the central bank is in a
position to increase or decrease the cash reserves of the
commercial bank’’
 Objectives of open market operations

To To impose To To make To
eliminate a check on remove bank rate prevent a
the effects the export the more ’run on
of exports of capital shortage effective the bank’
& imports of money
 Working of Open Market Operations

Selling bond & Money inflow to Decrease the ability of Decrease the amount of
securities in open Central Bank from lending of Commercial loan in the market
market Commercial Bank Bank

Purchase bond & Money outflow from Increase the ability Increase the amount
securities from open Central Bank to of lending of of loan in the market
market Commercial Bank Commercial Bank
Condition for the Success of Open Market Operations

Institutional Framework

Legal Framework

Maintenance of a Definite Cash Reserve Ratio

Non-Operation of Extraneous Factors

Non-existence of Direct Access of Commercial Banks to the Central

Banks
Variable Cash Reserve Ratio

Traditiona
l
Instrumen
t

Federal Populari
Reserve zing by
System Lord
Keynes

First
time
used in
1933
Theory of variable reserve cash ratio

“by varying the reserve requirements of the

banks, the central bank is in a position to
influence the size of credit multiplier of the
commercial banks and therefore the supply of
credit in the economy’’
 Working of Variable Cash Reserve Ratio
Reserve ratio More money inflow Decrease the ability Decrease the
increase to central bank of advancing of amount of loan in
from commercial commercial bank the market
bank

Reserve ratio Less money increase the Increase the

decrease inflow to central ability of amount of loan in
bank from advancing of the market
commercial bank commercial bank
 Limitations of Cash reserve ratio

Considered blunt and Discriminatory in its effect

harsh

Inflexible Create a panic among the

banks and investors

Burden for commercial Ineffective if commercial

bank banks have huge foreign
funds.
 Selective or Qualitative Methods

Special features of qualitative controls

They distinguish between essential and non essential uses of

bank credit.
Only non-essential uses are brought under the scope of central
bank controls.
They affect not only the lenders but also the borrowers.
Objectives
To divert the flow of credit from undesirable uses to
more desirable uses.

To regulate a particular sector

To regulate the supply of consumer credit.

To establish the prices of those goods very much

sensitive to inflation.

To establish the value of securities.

To correct an unfavorable balance of payments.

Measures of Selective Credit Control
Margin Requirements

Regulation of Consumer
Credit
Rationing of Credit

Control through Directives

Moral persuasion

Direct Action

Publicity
 Controls only
commercial
banks

Alternative Difficult to
methods control the
reduced the ultimate use of
importance. credit by the
Limitatio borrowers
ns of
Selective
Credit
Controls

Do not have Difficult to

much scope distinction
under a system between the
of unit productive and
banking. unproductive
uses of credit