TECHNIQUES OF Definitions of Central Bank Characteristic of Central Bank Difference between Central Bank an Credit Control :Meaning Objectives of Credit Control ‘Techniques of Credit Control Bank Rate Open Market Operations Cash Reserve Ratio ‘Statutory Liquidity Ratio ‘Qualitative/Selective Methods ‘Advantages of Selective Methods Limitations of Selective Methods Difficulties in Credit Control J Commercial Bank | } | | ' | DEFINITIONS OF CENTRAL BANK ‘every Central Bank has one function. It operates to control economy, supply of money an¢ credit”. m ratte Samuelson ‘The primary definition of Central Bank fs a banking system in which asi jther ¢ complete or residuary monopoly of note issue”. which a single bank has elt Vera Smit “Central Bank may be defined insti ent ay be defined as an institution which is charged with the responsibility 0! managing the expansion and contraction ofthe volume : welfare”. of money in the interest of general publi -KentTechniques of Credit Control “Central Bank is the bank in any country to which has been entrusted the duty of regulating the volume of currency and credit in that country”. ~ Bank of International Settlement “A Central Bank is the bank which constitutes the apex of the monetary and banking structure of its country”. De Kock Central Bank is a national financial institution created to operate, not for profit, but for the public purpose of influencing the economy in desirable directions through monetary means”. , - CH. Kreps and 0.5. Pugh ‘A Central Bank as a “lender of the last resort”. —Hawtrey Hence a central bank is known as central wheel of the entire banking system in the country. On the basis of the most important functions it performs, “a Central Bank is one which issues the currency of the country, facilitates, permits and regulates the creation of secondary money (derivate deposits), which acts as the banker of the Government, and as the bankers bank and which is the ‘under of the last resort to the banks”. Central Bank is one which would like to ensure that is neither money lead or money lag as per the requirements of the country. The Central Bank is custodian of the reserves of the governments; it is an agent which collects and disburses funds on behalf of the governments; it handles all securities of internal and external loans of the governments. Central Bank is the apex body of the process of the final settlements between various financial institutions and markets. ‘The above discussed definitions provide the following characteristics of a Central Bank : 1. Apex Institution : Central Bank is the apex financial institution of a country. Central Bank occupies the central place in the monetary and banking system of every country. It is the apex bank of a country through which the economic policies of the country are implemented. 2. No Profit Motive : Central bank has no profit motive. A central banks aims at maximising the public welfare through monetary means. A central bank should act only in the public interest and for the welfare of the country as a whole and without regard to profit as primary consideration. 3. Control the Economy : A central bank influences the economy in desirable directions by controlling and managing the expansion and contraction of the volume of money through various methods of credit control. 4. Use the Monetary Means : A central bank is national financial institution created to operate and influence the economy in desirable directions through monetary means. It controls the money supply through monetary means like bank rate, open market operations, change in CRR and change in SCR ete. :i i ey 7 ANK AND A COMMERCIAL BANK Bi DIFFERENCE BETWEEN A CENTRAL ein C venkat curry sete comme] PED g respects— entral : ‘Commercial Bank Basis of Difference Central Bank : — abies The main objective of @ central bank is The man im ofthe o i ee maximising the public welfare through | is profit motive. Ste | monetary means. deal | A commercial bank can exist only by >. Dealing with public | A Central bank, generally, does not dé a , : by] pores ee (en public directly. It has no direct link | dealing directly with the public | with the public. Commercial banks have close and] direct link with the public. Commercial bank may or may not state Central bank is 2 government owned owned. institution. 4.Note-Issuing Central bank has the monopoly of note- issuing in the country. 5.Competition Central Bank does not compete with | Commercial banks do nat compete with commercial banks, rather it comes to help | central bank. | them asthe lender of last resort Foreign Exchange | Central bank is the custodian of the | Commercial banks are only the foreign exchange of the country. authorised dealers to do foreign exchange business on the approval of the Central bank. 7.Control Central bank controls the entie banking | Commercial banks operate under the system of the country. direct control and supervision of the | Central bank. 3. Ownership ‘(Commercial banks cannot issue notes. CREDIT CONTROL: MEANING = asia nes ie main § fein of the RBI is to manage or control the monetary syste™ of institutions of the country. Credit ul authority to control and regulate the working of the credit Sey Crate cantil terto th is very necessary to achieve and maintain the growth rate of objective of economic growth and eee of credit by the central bank for achieving th® contraction is called credit control. It das ety Hence, the policy of credit expansion oF credit to manage the inflationary and deflationary Fe a nereopment with sabi 29 well as OBJECTIVES OF CREDIT CONTROL RBI controls credit in order o achieve the following object tives— 1. Exchange Rate Stability : The main objective of rate stability. The fluctuations in foreign exchan affect the foreign trade of the country. Credit rate of the country. the credit control is to maintain exchané® '8¢ rate of the domestic currency adverselY control can help in stabilizing the excha"8® a‘Techniques of Credit Control _) Bachange Rate Stability Prico Stability Economie Stabilly and Growth Osean Ciclo Maintaining a High Level of Employment Control Over Trade Cycles Stablisation of Money Market 2. Price Stability : Another important objective of credit control isto stabilise internal price- level, The frequent fluctuations in intemal prices bring economic dislocation and loss of economic welfare and ultimately affect the social, political and moral structure of society. ‘The price stabilisation is the ultimate end of central banking policy. Central bank tries to stabilize the internal prices through credit control. 4, Economic Stability and Growth : Economic stability and economic growth is another important objective of credit control. Central bank through credit control tres to accelerate the rate of economic growth of the country. Central bank checks the cyclical fluctuations with the help of credit control which are main hinderence inthe way of economic growth. 4, Maintaining a High Level of Employment : ‘Another objective of credit control is to maintain a high level of employment. In recent times, emphasis has been on stability in income and employment through credit control. Unemployment is economically wasteful and socially undesirable. 5, Control over Trade Cycles : Credit control is also helpful in controlling the trade cycles. These trade cycles not only cause economic instability but also harmful to the economic interests of the countries concemed. Trade cycles can be controlled by increasing or decreasing the volume of credit as per requirement. 6. Stabilisation of the Money Market : Another objective of the credit policy is to provide stabilisation of the money market so as to minimise the interest rate fluctuations due to temporary factors. EDIT CONTRO! : RBI is the main body to control the credit. It can control credit through its monetary policy. Under its monetary policy there are various methods of credit control. ‘These methods can be broadly classified into two categories— (A) Quantitative or General Methods (8) Qualitative or Selective Methods56 Techniques of Cretconu! A. Quantitative or General Technique : {ral bank to determine the total money supply of the counin, thods are used by the cent mony PY of hc, ‘am aie of quantitative contol is to control the total volum credit and inte, i tral bank controls the quantity of credit in the rds, those methods by which cent ls | a are coil quantitative methods of credit control. The quantitative credit control methods are count as follow— Meet 1 2b ji Bank || Open martet’ |] Change in | | Change in Rate Operations CAR SLR e Hees eee Regulation of ange in ‘Consumer's eae oe _ofloan ‘exchange presented by the commercial In other words, the price which the cen commercial bank or member bank is the ban} banks to get financial i tral bank chanson oe emodation from the central bank- k rate, "BS for rediscounting. the securities ofTechniques of Credit Control a DEFINITIONS OF BANK RATE spank rate is the minimum rate at which the central bank rediscounts the approved securities or advances loans to other banks”. “Spalding is the publicly announced charge applied by the central bank on discounts of -R.A. Young “Bank rate securities or advances to member banks”. Bank rate is the standard rate at which it is prepared to buy or discounts bills of exchange or other comuncrcial papers eligible for purchase under this Act”. Section 49 of the Reserve Bank of India, Act 1934 Difference and relation between Bank Rate and Rate of Interest ‘There is difference between Bank rate and Rate of interest. Rate of interest is the rate at which commercial banks advance loans to public whereas bank rate is the rate at which central bank sdvances loans to other banks. There is direct ink between bank rate and rate of interest. An increase in bank rate leads to an increase in the rate of interest and a fall in the bank rate will result in the reduction of the rate of interest. Bank Rate Policy Bank rate policy is that policy by which the central bank controls the credit creation of the banks: ‘The manipulation of the bank rate to influence the credit situation is called the Bank Rate Policy. Contraction of Credit Fein Policy, Expansion of Credit (a) Contraction of Credit : When a central bank wants to contract the credit in the country it increases the bank rate. The main aim of raising the bank rate is to provide central bank oan to commercial banks more expensive. As a result, the commercial banks also increase the rate of interest. The effect of increase in rate of interest will be that the traders and investors ete. will borrow less amount from the banks. Thus, there will be contraction of credit. (b) Expansion of Credit : When the central bank wants to expand credit in the country, it lowers the bank rate. Low bank rate means central bank's loans to the commercial banks ‘become cheap. As a result of which the rate of interest will also go down, Traders and ee etc. will now borrow more from the banks. Thus, there will be expansion of the credit. Assumptions of Bank Rate Policy ‘Ther i i a bens certain conditions which must be satisfied for the proper functioning of the bank rate58 The successful functioning of the ‘bank rate (a) Relationship between Different Rates + The interest rates of commercial banks are closely volated to bank tate. Bank rate policy will be successful if change in it causes corresponding change in other rates in the money market. In other words, increase in bank rate should result in increase in rate of interest and decrease in bank rate should result in decrease in rate of interest. (b) Elasticity in the Economy : The economic structure should be elastic which means that every increase or decrease in Bank rate should have suitable effect on investment, output, employment, wages, prices ete. policy is based on the following assumptions . ~ era peu Relationship between dierent Ras, Elasticity in the Economy | Psychology of Investors Cash Reserve of Bank (6) Psychology of Investors : Psychology of the investors also determines the success of Bank rate policy. An increase in the bank rate will generate a feeling that now the accommodation from the central bank will not be easily available and that it will be costlier. ‘The commercial banks will become cautious in their lendings. (@)_ Commercial banks keep cash reserves which are adequate for their day-to-day activities For additional cash resources, they freely approach the central bank. {e) The demand of bank credit is dependent upon the prevailing interest rates. Limitations of Bank Rate Policy 1. Long Term Effect : The change in bank rate does not make any instant effect on other rates of interest in the markt in most ofthe underdeveloped countries, I has long term effect. Therefore, bank rate poli achieve its objective. Cae 2. Less Elastic : There is lack of clasti elasticity i underdeveloped countries. During the boom patel ie prevailing optimism makes the demand for credi interest inelastic. On the other hand, during depresaye the business morale is so low that decline in ther oon rate fails to encourage borrowings. Therefore, chars bank rate do not have full impact on prices, gurney ‘employment etc. "output and 3, Unorganised Money Market: There is la tronay of bil marie tn moa of teen seeepsd countries. As a result, change in the bank rea yo Ped : ik have any considerable effect onthe rate of incre does not st. 4, International Flow of Capital : The effect of bank rate has di limini Pane an gale Long Term Effect Less Elastic il [+] Unorganised Money Market International Flow of Capit! 1 Less Dependence Ignores the Rate of Proft ann ished these days becaus? °‘pechniques of Credit Control = control over international flow of capital. Bank rate was more effective during the days of Gold Standard. 5. Less Dependence : Dependence of commercial banks on Central bank as lender of the last resort has also diminished considerably. -¢ the Rate of Profit : During the period of boom, when profits are rising, increase bank rate neither contracts nor the volume of investment. Fall in bank rate during, re ineffective. During this period, demand for loans for despite fall in the rate of interest because marginal efficiency 6. Ignores in the depression proves: still mor investment does not look up of capital is very low. It is also very imps being used increasingly as an instrument securities by the central bank of the count ortant method of credit control. In recent times, open market operations are of credit control. The purchases and sales of government ‘ry is known as open market operations. In other words, open market operation refers to the sale and purchase of government securities by the central bank in the open market. Open market operations attempt to increase or decrease the credit in the system by directly influencing the cash reserves with the banking system. This is done by selling or buying the government securities from the open market. Definitions of OMO “Open market operations imply the purchase and sale of securities by central bank in the open market”. De Kock “Open market operations consist of central bank’s purchases or sales of securities in the open market”. -R.A. Young Open Market Operations Policy : The open market operation policy is that policy by which the central bank contracts or expands the credit by sale or purchase of securities in the open market. (a) Contraction of Credit : When credit is to be contracted in the country, the central bank begins to sell securities in the open market. People have more confidence in the central bank than the other banks. They buy the securities issued by the central bank either by withdrawing their money from the commercial banks or by their cash hoardings. In this way, while money starts to flow into the central bank, cash reserves of the commercial banks begin to fall. Therefore, commercial banks are obliged to contract credit creation. Contraction of credit brings down the volume of investment. As a result, there is fall in income, employment and general price-level. : If the central bank wants to expand credit, it begins to purchase in the open market. It causes increase in the volume of money. People deposits more money in banks. With rise in the cash reserves of the bank they are able to © credit te morei Y Techniques of Creda 7 60 Assumptions for Open Market Operations ‘The successful operations of market operations as a method of monetary manageme, uy TU Fs ay dependent upon certain assumptions. These are as follows : (i) There should be a well-organised capital market for government or eligible securities, Gi) There must be sufficient quantum of government securities. Gi) Commercial banks should consistently Keeps reserves just adequate 10 satisty the jy requirements, Ifthe banks are already maintaining a reserve ratio much higher than fe egal requirements, open market operations will fail to make the desired impact, (iv) There should not be excessive volume of government debt. (¥) The central bank should not be under the pressure of weightier considerations of mone control and policy. tary Objectives of Open Market Operations Open market operations are executed to achieve the following objectives : 1, Credit Control : The primary objective of open market operations is to influence the volume of credit in the economy. Credit Control Stabilization of Prices of Government Securities Objectives of ane Fulfils Government Credit Needs Cet Complementary of Bank Rate Policy Absorbing the Seasonal Changes . Stabilization of Prices of Government Securities may be used to stabilise the securities market. It securities should remain fairly stable to win over ensured ifthe central bank is ready to sell or buy a The open market operation foals is essential that the market price © the confidence of investors. This can be NY amount of securities, 3. Fulfills Government Credit Needs : The open mark ‘i edit 0 m" t the credit fulfill the financial needs of government, peer, Sree 4. Complementary of Bank Rate Policy : The open mark, e used 1 et operations may be supplement the bank rate policy. If the banks are having excess eh reserves, oe increase i" the bank sate will prove ineffective, Commercial banks will eogiies ene ing the lending rate as a consequence of an increase in the bank rate only if they have to avail credit fr of bills. However, if they have their own re for rediscounting. In such a situation, open m2 excess cash resources from the bank. This, in tu" they will not approach the central bank operations can be resorted to take away eee ajeune 61 will force them to depend upon the central b: te wil © will become an effect fective So oee nk and the bank rat 5, Absorbing the Seasonal Changes : The open market operations t absorbing the seasonal changes in the cash reserves withthe bankine ; achieved by resorting to open market sales when there B pyeter. This can be is excess cash purchases when there is scarcity of eash with the banking, system, and open market 6. Open market operations may be used to remove the effect of inflow under gold standard, technique may be used for and outflow of gold 7. Open market operations technique is also used to check the export of capital to other countries, . Open market operation technique helps in removing the shortage of money in the money market. Limitations of Open Market Operations The poli ‘These are as follows— (i) Influence on the Cash Reserve of the Banks : The extent to which the cash reserves of the commercial banks are influenced measures the success of open market operations. If the central bank sells securities it should reduce seats de occ But many a time it does not happen because y of open-market operations to control credit has also limitations. people buy be cies aes Influence on Cash Reserve of Bank payments not by withdrawing their funds from the banks but out of their cash ae hoardings or out of the foreign exchange [~[_Shangein Credit Foley eared due to favourable balance of payments. On the other hand, when the Demand and Supply of Securities central bank purchases the securities, it is not necessary that cash reserves of the ‘No Change in Credit Policy of Customers commercial bank may increase because people may keep cash with themselves or |_| Powerot Contra Bank to Exchange Securities spend it on domestic durable products or spend on foreign imports. |] Well organised Money Markot (i) Change in the Credit Policy of Banks : Open market operations will be successful if Nai aos there is no change in the credit policy of the ‘commercial banks. For example, if Central Bank buys securities in order to expand credit but commercial banks do not want to create credit then central bank cannot succeed in its Policy of credit control. (ii) Demand and Supply of Securities : There should always be demand and supply of securities. If in order to expand credit central bank wants to purchase securities but no one wants to sell then central bank’s policy of credit control cannot succeed. Similarly, if theTechniques of Credit Contre, central bank wants to sell securities but there is no demand for the same by the public, then credit cannot be contracted. ; iv) No Change in Credit Policy of the Customers : There should be fe Sane the credit policy of the borrowers. For example, in order to expand credit ae ank wants t purchase securities, but the traders and industrialists due to economic and political reasons fare reluctant to borrow from the banks then there will be no expansion of credit () Power of Central Bank to Exchange Securities : Open market operations can be effective only if Central Bank has large quantity of securities and large funds to purchase the securities. If central bank has limited quantity of securities, it cannot contract credit by selling securities. On the other hand, if central bank has limited funds to buy securities, it cannot expand credit. (vi) Well Organised Money Market : Successful open market operations are possible only in developed and well organised money market. (vii) Normal Conditions : Successful open market operations are only possible in the normal conditions in the country. Bank Rate Versus Open Market Operations There are some disputes regarding whether the bank rate is a superior technique for credit control or open market operations. According to Keynes, the policy of open market operation is sufficient to control credit as it can be practised independently. But according to Hawtrey, open market operation policy cannot operate independently. It can succeed only when supported by bank rate policy. Another opinion of Clark is that from the stand point of credit, open market operations are complementary to bank rate policy: ‘These two policies are complementary to each other. One must back up the other for the desired effect. In isolation none of these can be very effective. In modern times open market operations are more direct, potent and effective technique of credit control as compared to the bank rate due to following reasons— (@) Independent Use : Open market operations are used independently for effective credit control without the help of other methods whereas bank rate does not use 5? independently, i Gi) Direct Effect : Open market operations effect the long-term rate of interest directly whereas change in bank rate effect long term rate of interest indirectly. ii) Quick Effect : Bank rate has quick effect on short- term interest rate but slow effect on Jong term interest rate whereas open market operations have quick or immediate effect on bot i Jong term and short term rates of interest. (iv) Flexible : Open market operations are flexible an possible during a day, i again. Ps \d can be changed to as many time @ ‘week and month but itis not possible to change bank rate again and (0) Biffect on Bank : Change in bank rate has its great effect on all commercial banks However, central bank cannot pressurize any commercial bank wrongfully through ope? market operations.Techniques of Credit Control 3, VARIABLE CASH RESERVE RATION The maintenance of a minimum cash reserve b important instrument of credit control. In every cour certain percentage of their deposits in the form of raising of this ratio improves or restricts the power of commercial banks This method was first of all used by Federal Reserve 5; Minimum Reserve. This method was suggested by Keynes, to create credit. 'ystem in 1933. It is also known as Statutory “Variation in cash reserve ratio implies changes in the minimum percentage of the deposits to b keptas reserve funds by the banks with the central bank’. eae -RA. Young Policy of Varying Cash Reserve Ratio The Varying Cash Reserve Ratio is that policy by which the central bank contracts or expands the credit by increasing or reducing in the cash reserve ratio. fa) Contraction of Credit : When the central bank is to contract credit it increases the ratio of the cash reserve. As a result, cash balances of the banks are reduced and their capacity to create credit is also reduced to the same extent. (b) Expansion of Credit : When the central bank is to expand credit it reduces the cash reserve ratio. As a result, cash balances of the banks are increased and their power to create credit is also increased to the same extent. Difficulties of Variable Reserves Ratio Variable reserves ratio as an instrument of credit control suffers the following limitations— 1. This method proves ineffective when commercial banks happen to possess large excess reserves. Even if the minimum cash reserve ratio is raised they will continue to carry on credit creation with such excess cash held by them. 2. Demand for credit is a fundamental factor. Even though the minimum cash reserve ratio is lowered, the investors may not be coming forward to borrow funds. This happens usally in the situation of depression. 3. Too frequent changes in the ratio may have a disturbing effect on the economy. 4. This method involves discrimination against commercial banks. The non-banking financial intermediaries over which the central bank has no control, remain untouched. ‘STATUTORY LIOUIDITY RATIO This new method of credit control was developed during Second World War. According to Statutory Liquidity Ratio, the commercial banks have to keep a certain percentage of their assets in liquid form compulsorily. It involves cash and government securities. It also curtails the power of the ‘commercial banks create credit. This method was first adopted by Belgium in 1946 and later followed by Italy (1947) and France (1948). Other countries also adopted it from time to time, Central banks in Europe have taken much advantage of it. This system can prove useful to developing countr as well.| «64 + Liquidity Ratio is Reserve Ratio and Statutory Liquidity Ratio is that ¢ ‘The difference between Gs . tio is maintained by the comer sh Tat are to be kept with the Central Bank whereas statutory . concerned. Policy of Changing Statutory Liquid : When the “The banks have to keep @ ig credit. bank has to expand credit it reduces the statutyy proportion of their deposits in the par ity Ratio (a) Contsaction of Credit central bank has to rae credit it increases 4, statutory liquidity ratio. large part of their deposits in the for. cash. It reduces their ‘capacity of creatin; Credit : When the central ‘The banks have to maintain less of creating credit. (b) Expansion of liquidity ratio. cash, Itincreases their capacity 5, Reverse Repo Rate Reverse Repo Rate is the rate at whi always in a hurry to lend money tothe RBI ‘An increase in reverse repo rate can prompt returns on idle cash. It is also a significant technique which can out of the banking system. ch RBI borrow money from commercial banks. Banks x since their money are in safe hands with a good infers. banks to park more funds with RBI to eam highs be used by RBI to drain excess monty 3h ove}, 6. Repo Rate ia lends money # Repo rate is defined asthe rte of intrest at which Reserve Bank of Indi commercial banks. Repo stands for Repurchase Agreement or Repurchasing option. Banks Joans from RBI by selling eligible securities. An agreement between RBI and the commercial bith will ie ate to sen fe au a pric that is predetermined, It is done when banks a a shortage of funds or need to maintain liquidity in volatil ot conditi ¢ repor 2 Snr lation rates. Curren Repo cnlae latile market condition. RBI uses the FP? 7. Marginal Standing Facility signi) MSF enables banks to borrow funds from RBI in eme i i : : re i ir absolutely dries up. This shor term borowing scheme fc eae slurs whe ie ei from RDI overightin ase of stron cash shartge by ofering thir cecal nt i DS rate differs from the Reporte. RBI can vary the ae of bor approved governinet owist tunder MSF to maintain sibility in Indian economy. Current owing and the percent of POPE which is 25 basis point or 0.25% higher than Repo rate, In ae 1 MSF rate of borrowin& “i led venercial banks can take money rom RBI by sling thir imple terms, at present tee meet of 5.15% p-a. when they are no more eligible to get money un erent Se ye pa ‘epo rate wi is 4.90% 8. Standing Deposit Facility (SDF) rat introduced te Sanding Depst Fst Dyan ai ait an interest rate of 3.75%. ‘The main purpose of SDF ieee tol fe abe oo \ ation. SDF isa liquidity management instrument which ce he excess guilty ge repo. SDF has the following features: replace the fixed rate over™!techniques of Credit Control 7 (1) It is the floor of the LAF (Liquidity Adjustment Facility) corridor replacing the fixed rate reverse repo. (2) Itisa monetary policy instrument to absorb liquidity without any collateral with an interest rate of 3.75%. @) Ibis operated on the overnight basis with the flexibility to absorb liquidity for longer tenor with appropriate pricing. (&) Deposits under SDF shall not be reckoned as balances eligible for the maintenance of the CRR under Section 42 of RBI Act, 1934 but shall be eligible asset for maintenance of SLR under Section 24 of the Banking Regulation Act, 1949. (5) SDF is designed to absorb surplus liquidity which is transient in nature reflected in the increase in deposits of the government with RBI. (© Absorbing surplus liquidity is primarily on account of an increase in advance tax receipts, sudden increase in public provident funds and small savings receipts and temporary postponement of certain expenditure. B. QUALITATIVE OR SELECTIVE METHODS Qualitative or selective techniques or methods are meant to give the central bank as ability to affect particular segments ofthe economy on selective basis. These methods try to direct the flow of ‘credit into desired channels for a particular segments of the economy. The main selective methods are discussed as follows— 1. Varying Margin Requirement Method : Its an important qualitative method of credit control. ‘This method was initially used in America in 1929. Under this method credit given for specific purposes is controlled. The margin requirement is the different between the market value of the security and its ‘maximum loan value. Marginal requirement = Value of Security — Amount advanced The banks keep a certain margin while lending money against securities. Banks do not advance ‘money to the full value of the security pledged for the loan. “Marginal requirement is the difference between the value of the security and the amount of the Joan sanctioned against that security”. Ritter In other words, when a commercial bank advances loan on the security of some assets then the amount of loan advanced is less than the value of the asset pledged. Supposing, Ms Alice pledges ‘00ds worth % 1000 with a bank and gets loan amounting to 800, then the difference between the asset pledged and loan amounted, that is, % 200 is the marginal requirement. If this marginal Lape is increased, then Ms Alice will have to pledge goods of greater value in order to get leat the same amount. As a result, there will be contration of credit. For example if marginal ideenent {s increased to 40%, then on a security worth € 1000 the bank will grant a oan of & 600 ERY. On the other and i marginal requirement is reduced to 10%, then on a security worth & 1000 rank will grant a loan of € 900. There will be expansion of credit.cee 66 oor i ate. 1. This method of it control is very simple and easy t0 ee ne i way 2, The method controls the credit in the speculative area. yy demand for seltgd * edit is contralled- : ; credit is cont 1 diversifies the credit and directs its flow into the desing 3, This method of credit contre! channels. Oe oe 4, The technique is contributed to stabilise the economy and minimise cyclical disturbance, Limitations L Inpractce thismethod imposes a big responsibility om Central Bank. 2. There ate leakages of credit f0 finance security speculation through non purpose loan speculators ‘and to unscrupulous money lenders. 2, Regulation of Consumer's Credit : The Federal Reserve System of the United States inventel this method of selective credit contol ‘This method is suitable for that segment of economy whee consumer credit in form of instalment payment is popular. The regulation of consumer's credit s Gone by the control of the hre-purchase finance and instalment purchase and sales of durable consumer goods. “The central bank cn conrl the consumer credit by (@) varying the cash down payment required for the purchase of such goods; and /or (&) by varying the maximum maturities period of instalment credit for the purchase a specified durable consumers’ goods arelsid down. ‘sigher cash down payment requixement will place the goods be and the reach of 0" consumers I the istalment period is Teduce, the monthly taal sal me op and eee oe SS ae to prs te gods. This il esl in reduction of demand nie weal read of ee ey Srranced counties where instalment POY ‘useful in developing Ba ae a very common on the part of consumers: This method is work to apply this method whi ee eschew ube a tof ley ony te method which i main dificuly with ths method. Its enor compliance is also a tough work especialy d smrngcessary restrictions on ts freedom to Riser mal times, forthe public would hard # Limitations 4. This method of credi of credit control affects the middle class people only whose decisions 4° make great differences in the credit pattern ofthe: 2, This method doesnot affect the higher incom ae group. 43, In this method, there is @ problem of admin 8 central bank. stration, compliance and cenforcem™ 4, Rationing of Credit: The conta regulate the vie erat thl calees can also adopt th rol agulate the purpr ehalangs credits granted bythe »pt the rationing of credit to.” sl? this method, the central bank con fix a limit for the credit roms banks to its cust nk facilities available to commer!Techniques of Credit Control - central bank allows only limited accommodation to commercial banks by way of rediscount facilities ‘Asa lender of last resort, central bank can introduce rationing of credit in four ways— {i Itcan decline to give loans to a particular bank. {ii) It can scale down the amount of loans to be given to different banks. (iii) It caXn fix quota of the credit to be given to different banks. (iv) It can fix the limits of loans to be given to different industries and traders. Credit can be also controlled through the mechanism of rationing. The introduction of rationing, makes commercial banks cautious in matter of advancing loans. Hence, credit is contracted. The problem with this method is that the commercial banks dislike such restrictions being imposed on them. They cannot follow an independent policy according to their own inclinations. Under this method, they are compelled to make investments in pre- determined sectors. Besides, it tends to be discriminatory between different banks. Some banks may be patronised and other penalised by the central bank for granting credit. 4, Direct Action ; Direct action includes all types of restrictions imposed upon the commercial banks by central bank concerning lending and investment. Hence, direct action refers to direct dealings with individual bank which adopt policies against the policies of the central bank. Under this method, the central bank may be obliged to take action against the defaulting banks, if they do not follow the policy laid down by the central bank. The central bank does not give any financial accommodation to the defaulting bank. ‘The action may take many form: (i) Rediscounts facilities may be refused. (i) The central bank may’not grant further accommodation by way of lending its funds to defaulting banks. (iii) Imposition of monetary penalty on them. The following are the difficulties in the way of successful implementation of this method— (@) The commercial bank may not be in a position to check effectively the purposes for which they advance credit to their borrowers, who may misuse the funds. (b) It is difficult to distinguish between the legitimate activities for the advance of loans and illegitimate ones or between essential or non-essential enterprises. 5. Moral Persuasion : Moral persuasion is not a statutory obligation. It is merely a request to ‘commercial banks not to apply fund for speculative activities. In recent times, central bank has used moral persuasion over other banks to get them agree to his credit control policy as an instrument of credit control. Moral persuasion is a general term describing a variety of informal or non-legal ‘methods used by the central bank to persuade commercial banks to behave in a particular manner, Central bank has its influence on almost all banks. Through this technique the central bank persuades and seeks the co-operation from commercial banks in checking and restricting non-essential activities. ‘The central bank may issue directives to commercial banks to refrain from certain types of lendings. The success of moral persuasion depends on the prestige enjoyed by the central bank. ate Peblicity and Propaganda : 8 another technique used by central bank to control the credit. lodern age is an age of publicity. This media is made excessive use of to implement credit controlTechniques of Credit Contre, ~ policy. Central bank gives wide publicity to its credit policy through media publicity. The main purpose isto bring the banking community under the pressure of public opinion enforcing them ty "follow only that credit policy which is in the interest of the economy of the country. According to experts, the principal factor in credit is the state of mind and you cannot control credit until you can control public opinion. The publicity generally takes the form of periodicals and journals. The success of this technique of credit control depends upon the extent to which central bank is able to build up ‘The selective credit control methods have gained popularity as a technique of credit control. 1. Directive and Effective : Selective credit control methods are more direct and effective than ‘quantitative credit control technique in controlling, the external factors effecting credit control. + Directive and Effective 2, Flexible : Selective methods of credit control are Wide Etfect Balanced Growth [erence] more flexible and changeable according to the changing economic conditions of the economy than quantitative measures. 3. Wide Effect : Quantitative methods influence the working of commercial banks alone whereas selective methods influence both the commercial banks and their customers. 4, Balanced Growth : The selective credit controls ensure a balanced economic growth and ‘Strength to Monetary Policy. development. Central bank can correct the unbalanced regional growth through selective methods of credit control. Romoval of Soctorial imbalances Procise Control 5. Removal of Sectorial Imbalances : The selective measures of credit control can also play @? important role in the removal of sectorial imbalances between primary sector, secondary sector and tertiary sectors of the economy. Si 6, Precise Control : Qualitative methods control the use of credit for particular purpose and particular sectors whereas quantitative methods control the total volume or quantity of credit, which is not very effective. a 7. Strength to Monetary Policy : Selective credit control method: 5 is have given more strength the monetary policy of central bank. Quantitative methods do not make any distinction between essential and non-essential activities of the economy. This can lead to certai" difficulties and problems. On the other hand, selective measures take care of suc! situations. i ‘Therefore, selective methods of credit control have been used effectively by developing countvi® like India, :Techniques of Credit Control . " 69 a HITAT! C} LIME OF SELEC! Selective methods of credit control suffers from certain limitations which are as below— (i) The total use of credit is not under the control of commercial banks, There may be leakage of credit from an essential area to non-essential area such as speculative area. (ii) The effectiveness of these techniques has been reduced by the growing popularity of company form of organisation which can raise finance directly from market by issuing shares and debentures. (ii) These methods are not useful in the unorganised sector of banking such as indigenous banking or money lenders. (iv) Itis difficult to ensure that, the borrowers use the loan amount for that purpose for which it istaken. () Commercial banks may lend money for the purpose other than laid down by central bank to earn large profits. (i) Selective credit control are applicable only to commercial banks. Other method of financing like issue of shares & debenture ploughing back of profits and borrowing from non- banking financial institutions are not covered by selective credit control. ‘The following are the main difficulties in the way of credit control— (@ Problem in controlling all types of credit : Central bank can only control the bank credit. Other types of credit such as book credit, trade credit etc. cannot be control by the central bank. These types of credits have the similar affect on economy. (Gi) Uncontrolled Banking sector : Central bank does not succeed in controlling all types of banks. The indigenous bankers are not under the control of central bank. (ii) Unorganised Banking System : In developing countries neither the banking system has been properly developed nor the banks co-operative the central bank to control credit. (iv) Lack of Banking Traditions : Banking traditions in U.K. are such that the central bank has simply to hint at its credit policy and all banks carry it out instantly. But in most of the countries these banking traditions are not present. Itis very difficult to control the credit in those countries. mercial banks (v) Lack of Co-operation : These is lack of co-operation to central bank from co! and other non-financial institutions to control the credit. So that central bank does not succeed in its credit control function. $roreennescnseensnen nena senna SS a] SS SSSTechniques of Credit Cont 2. Detine a central bank 2 What important ol it can playin a developing economy 2 iscuss the Bank Rate policy as an instrum, 3. What are the objectives of credit control ? Discuss the icy nt Of crag control, ee ons, objectives and limitations 4. What are open market operations ? Discuss assumptions, obje Of open mathe, ‘operations. 5.‘ What are selective methods of credit contol ? Discuss their significance and limitations, \ . 8. Distinguish between central bank and commercial banks. Enumerate the main functions of a Central a Bank. f 7. What are the objectives of monetary polcy in RBI ? Also discuss the quantitative credit conta used by RBI? (PU 2018 Nov) (Mark 5 Short Answer Questions 1. Define the feature of Central Bank. 2. Explain the difference between Central Bank and Commercial Bank. 3. What is Lender of Last Resort 2 4. Define controller of credit, 5. Explain Credit Control, 6. What is Bank Rate ? 7. Explain Bank Rate Policy. 8. What is Open Market Operation ? 8. (PU 2021) (Marks) Explain variable Cash Reserve Ratio, Discuss Statutory Liquidity Ratio, Explain Regulation of Consumer Credit, What is Rationing of Credit? 10. 1. 2 13. Write Note on Direct Action, 14. What is Moral persuation 2 2900