CREDIT CONTROL

 Means the regulation of the creation and contraction of credit in the economy
 Is an important function of central bank of any country
 The importance of credit control has increased because of the groth of bank credit and
other forms of credit.
 Commercial banks increase the total amount of money in circulation in the country
through the mechanism of credit creation.
 Fluctuations in the volume of credit cause fluctuations in the purchasing power of
money.
 This fact has far reaching economic and social consequences
 That is why, credit control has become an important function of any central bank

OBJECTIVES AND METHODS OF CREDIT CONTROL:

Objectives of Credit Control

The central bank is usually given many weapons to control the volume of credit in the
country. The use of these weapons are guided by the following objectives.

(i) Stability of Internal Price-Level

The commercial bank can create credit because their main task is borrowing and lending.
They creates credit without any increase in cash with them. This leads to increase in the
purchasing power of many people which may lead to an increase in the prices. The central
bank applies its credit control to bring about a proper adjustment between the supply of credit
and measures required to that effect in the country concerned. This helps in keeping the
prices stable under control.

(ii) Checking Booms and Depressions The operation of trade cycles causes instability in the
country, so the objective of the credit control should be to reduce the uncertainties caused by
these cycles. The central bank adjusts the operation of the trade cycles by increasing and
decreasing the volume of credit.
(iii) Promotion of Economic Growth

The objective of credit Control policy in backward and underdeveloped countries should be
to promote economic growth within the shortest possible time. Generally speaking, the
economic development in these countries is retarded on account of lack of financial
resources. Hence, the Central Banks in these countries often try to solve the problems of
financial stringency through planned expansion of bank credit

(iv) To Regulate and Expand Banking RBI regulates the banking system of the economy.
RBI has expanded banking to all parts of country. Through monetary policy, RBI issues
directives to different banks for setting up rural branches for promoting agricultural credit.
Besides it, government has also set up cooperative banks and regional rural banks. All this
has expanded banking in all parts of country

(v) Stabilisation of the Money Market

According to some economists the credit control policy of the Central Bank should aim at the
stabilisation of the money market in the country. To achieve this objective, the Central Bank
should neutralize seasonal variations in the demand for funds. It should for example, provide
extra credit in times of emergencies. In fact, the control on credit should be exercised by the
Central Bank in such a manner as to bring about an equilibrium in the demand and supply of
money at all times.

(vi) Stability in Exchange Rates

This is also an important objective of credit control. Credit control measures certainly
influence the price level in the country. The internal price level affects the volume of exports
and imports of the county which may bring fluctuations in the foreign exchange rates. While
using any measure of credit control, it should be ensured that there will be no violent
fluctuation in the exchange rates.

(vii) Preparation for war and other Emergencies

Sometimes the objective of the Central bank is to prepare the country for war through
expansion of credit to enable the Government to meet its financial requirement. Modem wars
 are so expensive that it is not possible to meet their costs without adequate expansion of bank
credit. During the second world war almost every country resorted to expansion of credit on a
large scale to meet the rising war expenditure

Methods of Credit Control:

The methods of credit control are also called the central banking techniques. There are broadly
speaking two types of controls used by the Central Banks in modern times for regulating bank
advances:

(a) Quantitative or General Credit Controls, and

(b) Qualitative Controls or the Selective Credit Controls.

The aim of the quantitative controls is to regulate the amount of bank advances, i.e., to make the
banks lend more or lend less.

The object of the selective credit controls, on the other hand, is to divert bank advances into
certain channels or to discourage them from lending for certain purposes. These selective credit
controls have of late assumed great importance, especially in under-developed economies.

Quantitative or General Credit Controls may take the form of:

(i) Manipulation of the Bank Rate;

(ii) Open market operations;

(iii) Varying reserve requirements; and

(iv) Credit rationing.

Qualitative or Selective Credit Controls Consist in:

(i) Varying margin requirements for certain bank advances;

(iii) Direct Action

(iv) Moral Suasion

(v) Publicity

Quantitative or Central Controls:

Manipulation of the Bank Rate:

 If the Central Bank wants to control credit, it will raise the Bank Rate. As a result, the
market rates and the other lending rates in the money market will go up. Borrowing will
consequently be discouraged. Those who hold stocks of commodities with borrowed
money will also unload their stocks, since as a result of theories in interest rates; the cost
of carrying stocks becomes higher.
 They will repay their loans. Thus, the raising of Bank Rate will lead to contraction of
credit. Conversely, a fall in Bank Rate will lower the lending rates in the money market,
which in turn will stimulate commercial and industrial activity, for which larger credit
will be sought from banks. There will thus be expansion of the volume of bank credit.
 This method of credit control will, however, succeed only if the other rates in the money
market follow the Bank Rate in its movement. In underdeveloped money markets, like
that of India, there is no such close relationship between the Bank Rate and the other
rates.

Open Market Operations:

 The term ‘Open Market Operations’ in the wider sense means purchase or sale by a
Central Bank of any kind of paper in which it deals, like government securities Or any
other public securities or trade bills etc. In practice, however, the term is applied to
purchase or sale of government securities, short-term as well as long-term, at the
initiative of the Central Bank, as a deliberate credit policy. This method of credit control
has attained great importance since the thirties.
  The theory of open market operations is like this: The sale of securities leads to
contraction of credit and the purchase thereof to credit expansion. When the Central Bank
sells securities in the open market, it receives payment in the form of a cheque on one of
the commercial banks. If the purchaser is a bank, the cheque is drawn against the
purchasing bank. In both cases the result is the same.
 The cash balance of the bank in question, which it keeps with the Central Bank, is to that
extent reduced. With the reduction of its cash, the commercial bank has to reduce its
landings. Thus credit contracts. Conversely, when the central bank purchases securities, it
pays through cheques drawn on it-self. This increases the cash balances of the
commercial banks and enables them to expand credit. ‘Take care of the legal tender
money and credit will take care of itself is the maxim.

Varying Reserve Requirements:

 When it is sought to restrict credit, the Central Bank may raise the reserve ratio. In 1960,
for instance, the Reserve Bank of India required the scheduled banks to maintain with it
additional reserve equivalent to 25% of the increase in their bank deposits (later raised to
50%).
 The Reserve Bank has also the power to vary the cash reserve ratio (CRR) which the
banks have to maintain with it from the minimum requirement of 3% up-to 15% of the
aggregate liabilities (7% since June 1982) raised in stages to 8.5% effective from August
27, 1983.
 Variations of reserve requirements affect the liquidity position of the banks and hence
their ability to lend. The raising of reserve requirements is an anti-inflationary measure
inasmuch as it reduces the excess reserves of member-banks for potential credit
expansion. The lowering of the reserve ratios has the opposite effect.

There are, however, limitations to the success of this weapon of credit control:

(a) The banks may have very large excess reserves with them, which may nullify the rise in
reserve requirements;

(b) A large net inflow of gold in payment of persistent export surplus may increase the banks’
power to lend; and
(c) The government policy of keeping interest rate low and stable may discourage too drastic
increases in reserve requirements.

Credit Rationing:

Credit rationing means restrictions placed by the Central Bank on demands for accommodation
made upon it during times of monetary stringency and declining gold reserves. The credit is
rationed by limiting the amount available to each applicant. Further, the Central Bank restricts its
discounts to bills maturing after short periods. This method of controlling credit can be justified
only as a measure to meet exceptional emergencies, because it is open to serious abuses

2. Selective Credit Controls:

Varying Margin Requirements:

Another weapon in the hands of the Central Bank for controlling credit is to vary the margin
requirements. While lending money against securities, the banks keep a certain margin. They do
not advance money to the full value of the security pledged for the loan. In case it is desired to
curtail bank advances, the Central Bank may issue directions that a higher margin be kept. For
instance, in I960, the Reserve Bank of India raised to 50% the minimum margin requirement for
bank advances against equity shares.

The raising of margin requirements is designed to check speculation in the stock markets and to
prevent the typical ‘boom-bust’ pattern, in the stock markets. In this way, demand for speculative
credit is controlled. The higher the margin required the less credit one would obtain for the
purchase of stocks and shares.

Regulation of Consumer Credit:

Apart from credit for trade and industry, a great deal of credit, ill developed countries at any
time, may be for durable consumer. Goods like houses, motor cars, refrigerators, furniture, TV
and radio-sets when these are sold on hire-purchase or installment credit system. Central Banks
seek to Control such credit in several ways, e.g.,

(a) By regulating the minimum down payments on specified goods,

(c) By regulating the maximum maturities (payment period) on $11 installment credits, and

(d) By fixing the maximum exemption costs of installment purchases of specified goods

Direct Action:

Direct action implies coercive measures like refusal on the part of the Central Bank to rediscount
for banks whose credit policy is not in accordance with the wishes of the Central Bank, or whose
borrowings from the Central Bank are excessive in relation to their capital and reserve.

Moral Suasion:

The Central Bank may, on the other hand, request and persuade member-banks to refrain from
increasing their loans for speculation or non-essential activities.

Publicity:

The method of publicity is also used. This means issuing of weekly statistics, periodical review
of the money market conditions, public finances, trade and industry, the issue of weekly
statement of assets and liabilities in the form of balance sheets, etc.