Page 49 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes 3.5 Techniques of Credit Control

Several tools and techniques of credit control used by the Reserve Bank of India can be broadly
categorized as quantitative or general methods and qualitative or selective methods.

3.5.1 Quantitative or General Methods

The tools used by the central bank to influence the volume of credit in totality in the banking
system, without any regard for the use to which it is put, are called quantitative or general
methods of credit control. These methods govern the lending power of the financial sector of the
whole economy and do not discriminate among the several spheres of the economy. The crucial
quantitative methods of credit control are:
Bank Rate Policy: The standard rate at which the central bank is ready to buy or rediscount
bills of exchange or other commercial papers eligible for purchase under the provisions of
the Act of RBI. Thus, the Reserve Bank of India rediscounts the first class bills in the hands
of commercial banks to furnish them with liquidity in case of need.

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Caution Bank rate is subjected to change from time to time in accordance with the economic
stability and its credibility of the nation.

The bank rate indicates the central bank’s long-term outlook on interest rates. If the bank
rate moves up, long-term interest rates also tend to move up, and vice-versa.
Banks make a profit by borrowing at a lower rate and lending the same money at a higher
rate of interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that
a bank pays for borrowing money (banks borrow money either from each other or from
the RBI) increases. It, in turn, raises its own lending rates to ensure it continues to make a
profit.

· Open Market Operations: It means of enforcing monetary policy by which RBI controls
the short term rate of interest and the supply of base money in an economy, and thus
indirectly the total supply of money. In times of inflation, RBI sells securities to finish off
the excess money in the market. Similarly, to increase the money supply, RBI purchases
securities.
Adjusting with CRR and SLR: By adjusting the CRR (Cash Reserve Ratio) and SLR
(Statutory Liquidity Ratio) which are short term tools to be used to shortly govern the
cash and fund flows in the hands of the banks, people and government, the central bank of
India regularly make necessary alterations in these rates. These variations in the rates will
easily have a larger control over the cash flow of the country.
(i) CRR (Cash Reserve Ratio): All commercial banks are required to retain a certain
amount of its deposits in cash with RBI. This percentage is called the cash reserve
ratio. The present CRR requirement is 4 per cent. This serves two purposes. Firstly,
it ensures that a part of bank deposits is totally risk-free and secondly it enables RBI
to control liquidity in the system, and thereby, inflation by tying their hands in
lending money
(ii) SLR (Statutory Liquidity Ratio): Indian banks are required to maintain 25 per cent of
their time and demand liabilities in government securities and certain approved
securities. What SLR does is again restrict the bank’s leverage in lifting more money
into the economy by investing a part of their deposits in government securities as a
part of their statutory liquidity ratio requirements.

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