Methods of Credit Control by Central Bank | Banking
Credit control is one of the most powerful functions of a Central Bank. By regulating the supply of money and credit, central banks ensure stability in the economy, control inflation, and promote sustainable growth. Broadly, these methods are divided into Quantitative (general) and Qualitative (selective) techniques.
1. Quantitative Methods of Credit Control
Quantitative methods influence the overall volume of credit in the economy. They do not target specific sectors but affect money supply as a whole.
1.1 Changes in the Bank Rate
The bank rate is the minimum interest rate at which the central bank lends to commercial banks. By raising or lowering the rate, the central bank affects borrowing and lending in the market. For example:
- During inflation → Bank rate is increased → Borrowing falls → Credit contracts.
- During deflation → Bank rate is lowered → Borrowing rises → Credit expands.
Limitation: Less effective in countries with weak money markets or underdeveloped bill markets.
1.2 Open Market Operations (OMO)
OMOs involve the buying and selling of government securities by the central bank.
- Sale of securities → Banks’ reserves fall → Lending decreases → Credit contracts.
- Purchase of securities → Banks’ reserves rise → Lending increases → Credit expands.
Limitation: Requires a strong securities market, otherwise less effective.
1.3 Variable Reserve Ratio (CRR)
The Cash Reserve Ratio (CRR) is the portion of deposits commercial banks must keep with the central bank. By adjusting CRR:
- Higher CRR → Less lending → Credit contracts.
- Lower CRR → More lending → Credit expands.
Limitation: Smaller banks are hit harder compared to larger banks.
2. Qualitative or Selective Methods of Credit Control
These methods target specific sectors or types of credit rather than the whole economy.
2.1 Minimum Margin Requirements
The central bank sets a minimum margin for loans against specific commodities like rice, wheat, sugar, or cotton. This prevents excessive speculation and controls inflation in essential goods.
2.2 Regulation of Consumer Credit
Banks’ lending for durable goods (cars, refrigerators, furniture) is regulated by setting down payments, installment periods, and repayment terms. This was first applied in the USA during World War II.
3. Additional Methods of Credit Control
- Credit Rationing: Setting lending quotas for banks.
- Direct Instructions: Central bank issues directives to banks (e.g., Credit Authorization Scheme in India).
- Moral Persuasion: Informal advice or circulars issued to banks to regulate credit.
Real-World Examples of Credit Control
- Fed (USA) 2022: Raised interest rates to control inflation.
- RBI (India) 2020: Cut CRR to boost lending during COVID-19.
- China 2021: Increased margin requirements to curb risky trading.
- Bank of England 2014: Tightened mortgage rules to avoid housing crisis.
Conclusion
The success of credit control methods depends on the structure of the country’s money market. In developed economies, quantitative tools are highly effective, whereas in developing countries like India, selective and supplementary methods are often more practical. Ultimately, the goal remains the same: maintaining price stability and ensuring smooth economic growth.