AHSEC Class 12 Finance Notes 2024
UNIT -1 : FINANCIAL INSTITUTIONS
CHAPTER-3
CREDIT CONTROL TECHNIQUES OF THE RESERVE BANK OF INDIA
Very Short Question Answer: (1 Mark each)
1) What is the meaning of credit control?
Ans:- Credit control refers to the regulation and management of credit or lending activities of commercial banks by the central bank of a country, such as the Reserve Bank of India (RBI), to achieve specific economic objectives.
2) What is the meaning of credit control techniques?
Ans:- Credit control techniques are the various measures and tools employed by the central bank, like RBI, to control and influence the credit extension or lending activities of commercial banks. These techniques are used to achieve economic goals such as price stability, exchange rate stability, control of cyclical fluctuations, maximization of income and employment, and maintaining balance of payment equilibrium.
B. Short Answer Questions:
2 Marks each
1. Write two objectives of credit control.
Ans:- Two objectives of credit control are:
a) Maintaining stability in the price level.
b) Attaining stability in the exchange rate.
2. What are the two types of credit control techniques?
Ans:- The two types of credit control techniques are:
a) Quantitative credit control techniques.
b) Qualitative/selective credit control techniques.
3. What is Bank Rate?
Ans:- Bank Rate is the rate at which the Reserve Bank of India advances funds to member banks against approved securities or rediscounts eligible bills of exchange and other commercial papers.
4. What is Open Market Operation?
Ans:- Open Market Operation refers to the buying or selling of government securities by the Reserve Bank of India in the open market to regulate liquidity in the banking system.
5. What is Cash Reserve Ratio?
Ans:- Cash Reserve Ratio (CRR) is the percentage of net demand and time liabilities that banks are required to maintain with the Reserve Bank of India as cash reserves.
6. What is Statutory liquidity Ratio?
Ans:- Statutory Liquidity Ratio (SLR) refers to the percentage of net demand and time liabilities that banks are required to maintain as liquid assets, including cash, gold, and government securities.
7.What is Margin requirements?
Ans:- Margin requirements refer to the difference between the loan amount and the market value of assets deposited as security against the loan. It influences the size of the loan.
8.What is Regulation of consumer credit?
Ans:- Regulation of consumer credit is a selective credit control method that aims to control consumer expenditure on non-essential consumer durables by imposing restrictions on bank loans for such purchases.
9. What is credit Rationing?
Ans:- Credit rationing is the fixing of credit quotas to commercial banks for specific categories of loans and advances. It seeks to restrict credit flow to certain sectors and divert it to priority sectors.
10.What is Issue of Directives?
Ans:- Issue of Directives is a qualitative credit control method where the Reserve Bank of India issues oral or written communications, appeals, warnings, etc., to commercial banks to guide their lending policies and operations.
11.What is moral suasion?
Ans:- Moral suasion is a selective credit control technique where the Reserve Bank of India uses persuasion and appeals to commercial banks to align their lending practices with the general monetary policy set by the government.
C.Long Answer Questions (Type-I):
5 Marks each
1) State the various objectives of credit control.
Ans:- Objectives of Credit Control:
The Reserve Bank of India (RBI) implements credit control techniques to achieve various objectives that align with the economic policy of the country. Some of the main objectives of credit control are:
a) Stability in Price Level: The RBI aims to maintain price stability by regulating the money supply. Stable prices promote business activities, investment, consumption, and a balanced foreign exchange rate.
b) Exchange Rate Stability: A stable exchange rate is essential for smooth international trade and economic relations. The RBI strives to minimize fluctuations in foreign exchange rates to encourage trade and reduce speculation.
c) Control of Cyclical Fluctuations: The RBI uses credit control to manage cyclical fluctuations in the economy. During economic booms, it may implement stricter measures to curb excess money supply, while during downturns, it may adopt more liberal measures to stimulate credit creation.
d) Maximization of Income and Employment: Credit control aims to boost income, employment, and output in the country, leading to overall economic growth and prosperity.
e) Meeting Financial Requirements: The RBI ensures that adequate credit is available to meet the financial requirements of various sectors, such as agriculture, industry, infrastructure, and services.
f) Stability in the Money Market: The RBI uses credit control to maintain stability in the money market, ensuring an efficient flow of funds between surplus and deficit units.
g) Balance of Payment Equilibrium: The RBI strives to achieve equilibrium in the balance of payments to ensure stable international economic relations.
2) Briefly state the qualitative credit control techniques applied by the RBI.
Ans:- Qualitative/Selective Credit Control Techniques:
Qualitative credit control techniques aim to direct the flow of credit to specific sectors while curbing credit to non-essential or speculative activities. Some of the qualitative credit control techniques applied by the RBI are:
a) Issue of Directives: The RBI issues oral or written directives to commercial banks, guiding their lending policies and cautioning against certain types of transactions. It may also request banks to report periodically on their lending activities.
b) Regulation of Consumer Credit: This technique restricts bank loans for the purchase of non-essential consumer durables, such as automobiles, luxury goods, etc., to curb excessive consumer spending.
c) Credit Rationing: The RBI sets credit quotas for banks for specific categories of loans and advances. This ensures that credit is allocated to priority sectors while limiting lending to less desirable areas.
d) Margin Requirements: Margin requirements refer to the difference between the loan amount and the market value of assets pledged as security. By adjusting margin requirements, the RBI influences the size of loans and advances.
e) Moral Suasion: The RBI uses moral persuasion to encourage commercial banks to adhere to monetary policies and lend responsibly. It may advise banks to focus on priority sectors during specific economic situations.
f) Direct Action: Under direct action, the RBI imposes penalties or denies certain facilities to banks that do not comply with its directives. This encourages banks to align with the RBI's credit policies.
These qualitative credit control techniques allow the RBI to influence the direction and purpose of credit flow in the economy, supporting key sectors and promoting economic stability.
D. Long Answer Questions (Type-2):
8 Marks each
1) Discuss the quantitative credit control techniques applied by the RBI.
Ans:- Quantitative Credit Control Techniques applied by the RBI:
Quantitative credit control techniques are designed to regulate the total volume of credit in the economy. These techniques directly impact the money supply and credit creation capacity of commercial banks. The Reserve Bank of India (RBI) uses the following quantitative credit control measures:
a) Bank Rate:
The bank rate is the rate at which the RBI lends money to commercial banks against approved securities. It serves as a benchmark for other interest rates in the economy. By changing the bank rate, the RBI influences the cost and availability of credit in the banking system.
- Credit Expansion: If the RBI wants to increase money supply and encourage borrowing, it lowers the bank rate. This makes borrowing cheaper for banks, leading to increased credit creation and more money circulating in the economy.
- Credit Contraction: If the RBI wants to reduce money supply and curb inflation, it raises the bank rate. Higher bank rates increase the cost of borrowing for banks, leading to decreased credit creation and less money in circulation.
b) Open Market Operations (OMO):
OMO refers to the buying and selling of government securities (bonds) by the RBI in the open market. It is used to influence the liquidity in the banking system.
- Credit Expansion: When the RBI buys government securities from banks, it injects money into the system, increasing liquidity. This stimulates credit creation by banks and boosts money supply in the economy.
- Credit Contraction: When the RBI sells government securities to banks, it absorbs money from the system, reducing liquidity. This restricts credit creation by banks and reduces money supply in the economy.
c) Cash Reserve Ratio (CRR):
The CRR is the portion of deposits that banks are required to keep with the RBI as cash reserves. It affects the lending capacity of banks.
- Credit Expansion: When the CRR is reduced, banks need to keep less money as reserves, which increases their lending capacity. This results in more credit creation and higher money supply.
- Credit Contraction: When the CRR is increased, banks need to keep more money as reserves, reducing their lending capacity. This leads to less credit creation and lower money supply.
d) Statutory Liquidity Ratio (SLR):
The SLR is the portion of deposits that banks must maintain in the form of liquid assets like cash and approved securities.
- Credit Expansion: Lowering the SLR allows banks to have more funds available for lending, leading to increased credit creation and money supply.
- Credit Contraction: Raising the SLR restricts the funds available for lending, leading to decreased credit creation and money supply.
These quantitative credit control techniques help the RBI regulate the money supply and credit availability in the economy, aiming to achieve its monetary policy objectives, such as price stability, exchange rate stability, and economic growth.
2) Discuss the credit control techniques applied by the RBI.
Ans:- Credit Control Techniques applied by the RBI:
The RBI employs both quantitative and qualitative/selective credit control techniques to achieve its credit management objectives. The main credit control techniques applied by the RBI are:
a) Quantitative Credit Control Techniques:
- Bank Rate
- Open Market Operations
- Cash Reserve Ratio (CRR)
- Statutory Liquidity Ratio (SLR)
b) Qualitative/Selective Credit Control Techniques:
- Issue of Directives: The RBI issues oral or written directives to commercial banks, guiding their lending policies and specific actions to be taken to align with the monetary policy objectives.
- Regulation of Consumer Credit: The RBI may impose restrictions on bank loans for the purchase of non-essential consumer durables to control consumer spending and inflation.
- Credit Rationing: The RBI sets credit quotas for different categories of loans and advances, directing banks to allocate credit to priority sectors and discourage lending to less desirable sectors.
- Margin Requirements: The RBI may change the margin requirement, which is the difference between the loan amount and the market value of assets used as collateral. Higher margins discourage lending, while lower margins encourage borrowing.
- Moral Suasion: This involves persuading or advising banks to follow certain credit policies and lending practices in line with the RBI's monetary policy objectives. It is a non-coercive technique relying on the goodwill of banks.
- Direct Action: The RBI may take direct action against banks that do not comply with its credit policies, such as imposing penalties, denying rediscounting facilities, or restricting credit supply.
By employing these credit control techniques, the RBI aims to achieve its objectives, including price stability, exchange rate stability, control of cyclical fluctuations, maximization of income and employment, and balance of payment equilibrium. The combination of quantitative and qualitative credit control measures allows the RBI to effectively manage the credit supply in the economy and influence economic growth and stability.
Additional Question Answer
Very Short Question Answer:
1) What are the objectives of credit control by the Reserve Bank of India?
Answer: The objectives of credit control by the Reserve Bank of India include maintaining stability in price level, exchange rate stability, controlling cyclical fluctuations, maximizing income and employment, meeting financial requirements, maintaining stability in the money market, and achieving balance of payment equilibrium.
2) Name the two categories of credit control techniques used by the Reserve Bank of India.
Answer: The two categories of credit control techniques used by the Reserve Bank of India are quantitative credit control techniques and qualitative/selective credit control techniques.
3) What is the purpose of the Bank Rate in credit control?
Answer: The Bank Rate is used by the Reserve Bank of India to regulate the cost and availability of refinance to commercial banks, which impacts their lending activities. It is a key tool to influence the overall interest rates in the market.
4) How does the Reserve Bank of India use open market operations for credit control?
Answer: Through open market operations, the Reserve Bank of India buys or sells government securities in the open market to increase or decrease liquidity in the banking system, influencing the capacity of banks to create credit.
5) What is Cash Reserve Ratio (CRR) and how does it impact credit creation?
Answer: Cash Reserve Ratio (CRR) is the percentage of net demand and time liabilities that banks are required to maintain with the Reserve Bank of India. By changing the CRR, RBI can control the amount of money banks can lend, thereby affecting credit creation in the economy.
6) How does Statutory Liquidity Ratio (SLR) influence credit control?
Answer: Statutory Liquidity Ratio (SLR) requires banks to maintain a certain percentage of their liabilities in the form of liquid assets like cash, gold, or approved securities. By changing the SLR, RBI can control the flow of credit by influencing the lending capacity of banks.
7) What are qualitative/selective credit control techniques?
Answer: Qualitative/selective credit control techniques regulate the direction and use of credit by favoring certain sectors and discouraging others. Examples include issuing directives, regulating consumer credit, credit rationing, margin requirements, moral suasion, and direct action.
8) How does credit rationing work as a credit control measure?
Answer: Credit rationing involves fixing credit quotas for specific loan categories to control the flow of credit to certain sectors. By limiting or expanding credit access, RBI can direct funds to priority areas and control credit expansion in non-desirable sectors.
9) What is moral suasion in credit control?
Answer: Moral suasion refers to the informal persuasion or advice given by the Reserve Bank of India to commercial banks to align their lending practices with the monetary policy objectives. It aims to encourage banks to act in line with the central bank's policies.
10) How does the Reserve Bank of India use direct action as a credit control measure?
Answer: Direct action involves imposing penalties, fines, denying rediscounting facilities, or refusing credit supply to commercial banks that do not comply with RBI's directives. It serves as a disciplinary measure to ensure adherence to credit control policies.
Short Question Answer
2 Marks each
1. What is the objective of credit control related to stability in the money market?
Answer: The objective of credit control related to stability in the money market is to ensure smooth and efficient functioning of the money market by regulating the liquidity and interest rates.
2. Explain the purpose of credit control technique "Credit Rationing."
Answer: The purpose of credit rationing is to allocate credit resources to different sectors of the economy based on their priority and importance, thereby restricting the flow of credit to certain sectors and encouraging credit to priority sectors.
3. How does the Reserve Bank of India use the Cash Reserve Ratio (CRR) as a credit control measure?
Answer: The Reserve Bank of India uses the Cash Reserve Ratio (CRR) to regulate the cash reserves that banks are required to maintain with it. By increasing the CRR, the RBI reduces the lendable funds of banks, thereby controlling credit and money supply. Conversely, by decreasing the CRR, it enhances the lendable funds, promoting credit creation.
4. Differentiate between quantitative credit control techniques and qualitative credit control techniques.
Answer: Quantitative credit control techniques aim to regulate the total volume of credit in the economy and affect all sections of the economy. Examples include Bank Rate, Open Market Operations, Cash Reserve Ratio, and Statutory Liquidity Ratio. On the other hand, qualitative credit control techniques focus on the direction and use of credit, guiding it towards priority sectors and away from non-essential or speculative activities. Examples include credit rationing, margin requirements, moral suasion, and issue of directives.
5. How does the Reserve Bank of India use the Bank Rate to control credit?
Answer: The Reserve Bank of India uses the Bank Rate to influence the cost and availability of credit in the economy. By decreasing the Bank Rate, the RBI reduces the cost of credit, encourages borrowing, and increases money supply. Conversely, by increasing the Bank Rate, it raises the cost of credit, discourages borrowing, and reduces money supply.
6. State one objective of credit control related to foreign trade.
Answer: One objective of credit control related to foreign trade is to maintain equilibrium in the balance of payments. The RBI uses credit control measures to manage the foreign exchange rate and ensure a stable balance of payments.
7. How does the Reserve Bank of India utilize Open Market Operations to achieve credit control?
Answer: The Reserve Bank of India utilizes Open Market Operations by buying or selling government securities in the open market. By purchasing securities, the RBI injects liquidity into the banking system, increasing credit availability. Conversely, by selling securities, it absorbs liquidity, reducing credit availability.
8. Explain the purpose of using "Margin Requirements" as a credit control measure.
Answer: The purpose of using "Margin Requirements" is to control speculative and excessive borrowing. By increasing margin requirements, the Reserve Bank of India reduces the loan size, discouraging excessive borrowing and limiting credit expansion.
9. What is the main objective of credit control concerning cyclical fluctuations in the economy?
Answer: The main objective of credit control concerning cyclical fluctuations is to smooth out the business cycles. During boom periods, credit is controlled to prevent excessive inflation, and during recessionary periods, credit is expanded to stimulate economic activity.
10. Describe the method of "Direct Action" as a credit control measure.
Answer: The method of "Direct Action" involves imposing penalties, fines, or restrictions on commercial banks that do not comply with the prescribed monetary policy of the Reserve Bank of India. It is used to restrict unsound bank advances and loans that go against the country's monetary policy.
11. How does the Reserve Bank of India use the Statutory Liquidity Ratio (SLR) to influence credit?
Answer: The Reserve Bank of India uses the Statutory Liquidity Ratio (SLR) to regulate the proportion of liquid assets that banks must maintain as a percentage of their net demand and time liabilities. By increasing the SLR, the RBI reduces the lendable resources of banks, leading to a contraction in credit and money supply. Conversely, by decreasing the SLR, it enhances lendable resources, promoting credit expansion.
12. What is the purpose of qualitative credit control technique "Regulation of Consumer Credit"?
Answer: The purpose of regulating consumer credit is to control consumer spending on non-essential durable goods such as cars, electronics, etc. By imposing restrictions on bank loans for these purchases, the RBI aims to reduce excessive consumption and focus credit on more productive sectors.
13. How does the Reserve Bank of India use "Moral Suasion" to influence credit behavior?
Answer: Moral suasion involves persuading commercial banks to align their lending practices with the monetary policy objectives set by the RBI. The RBI uses moral suasion to encourage or discourage specific lending activities based on the prevailing economic conditions and policy goals.
14. State one objective of credit control concerning "Maximisation of income, employment, etc."
Answer: One objective of credit control concerning maximization of income and employment is to ensure adequate credit flow to productive sectors that contribute to economic growth and generate employment opportunities.
15. How does credit control impact the balance of payment equilibrium?
Answer: Credit control measures impact the balance of payment equilibrium by influencing the foreign exchange rate and regulating international trade. Through credit control, the RBI aims to maintain a stable balance of payments and avoid adverse currency fluctuations.
16. Explain the difference between "Quantitative Credit Control Techniques" and "Qualitative Credit Control Techniques."
Answer: Quantitative credit control techniques focus on regulating the overall volume of credit in the economy and include measures like Bank Rate, Open Market Operations, Cash Reserve Ratio, and Statutory Liquidity Ratio. On the other hand, qualitative credit control techniques target the direction and use of credit and include methods such as credit rationing, margin requirements, moral suasion, and issuing directives to banks.
17. How does the Reserve Bank of India use "Direct Action" to enforce credit discipline?
Answer: Direct action involves penalizing commercial banks that do not comply with the prescribed monetary policy. The RBI may impose fines, restrict rediscounting facilities, or deny credit supply to enforce credit discipline and align bank lending practices with the RBI's objectives.
18. What is the main objective of credit control related to "Control of Cyclical Fluctuations"?
Answer: The main objective of credit control related to control of cyclical fluctuations is to mitigate the impact of business cycles and stabilize the economy. During periods of economic expansion, credit is controlled to prevent overheating and inflation, while during economic downturns, credit is expanded to boost economic activity and investment.
19. How does the Reserve Bank of India use "Issue of Directives" to guide commercial banks?
Answer: The Reserve Bank of India issues directives in the form of oral or written communications to guide commercial banks' lending policies and operations. These directives may include instructions on lending to specific sectors, reporting requirements, and adherence to the RBI's monetary policy.
20. State one objective of credit control related to "Meeting Financial Requirements."
Answer: One objective of credit control related to meeting financial requirements is to ensure that the economy has sufficient credit resources to support productive activities, investment, and economic development while avoiding excessive inflationary pressures.
Long Question Answer
1) What is the objective of credit control by the Reserve Bank of India?
Ans:- Objective: The main objective of credit control by the Reserve Bank of India is to achieve "Economic Development with Stability." This involves maintaining stability in the price level, exchange rate stability, control of cyclical fluctuations, maximization of income and employment, meeting financial requirements, ensuring stability in the money market, and maintaining equilibrium in the balance of payments.
2) Explain the quantitative credit control techniques employed by the Reserve Bank of India.
Quantitative Credit Control Techniques:
a) Bank Rate: The bank rate is the rate at which the RBI lends to commercial banks. By increasing the bank rate, the RBI makes borrowing more expensive, reducing credit expansion. Conversely, lowering the bank rate encourages borrowing and credit expansion.
b) Open Market Operations: The RBI buys or sells government securities in the open market. Purchasing securities injects money into the economy, while selling them absorbs excess money, thus controlling liquidity.
c) Cash Reserve Ratio (CRR): CRR is the percentage of net demand and time liabilities that banks must keep as cash reserves with the RBI. By adjusting the CRR, the RBI can control the amount of lendable funds in the banking system.
d) Statutory Liquidity Ratio (SLR): SLR requires banks to maintain a certain percentage of their assets in the form of liquid assets like cash and government securities. By changing the SLR, the RBI influences credit expansion or contraction.
3) How does the RBI use qualitative credit control techniques to regulate credit flow?
Ans:- Qualitative Credit Control Techniques:
a) Issue of Directives: The RBI issues oral or written directives to banks, guiding their lending policies and cautioning against specific transactions or sectors.
b) Regulation of Consumer Credit: This technique restricts bank loans for non-essential consumer durables to control excessive consumer spending.
c) Credit Rationing: The RBI sets credit quotas for banks for specific categories of loans to prioritize lending to certain sectors.
d) Margin Requirements: The RBI adjusts margin requirements to influence the size of loans and advances.
e) Moral Suasion: The RBI uses moral persuasion to encourage banks to adhere to its monetary policies and lending priorities.
f) Direct Action: The RBI imposes penalties or denies facilities to non-compliant banks, encouraging them to align with credit policies.
4) What is the role of credit control in achieving economic stability?
Answer: Credit control plays a crucial role in achieving economic stability by regulating the flow of credit in the economy. It helps in controlling inflationary pressures, promoting sustainable economic growth, ensuring financial stability, and maintaining a stable balance of payments. By managing the availability and cost of credit, the RBI can influence investment, consumption, and overall economic activity, thus achieving a balanced and stable economy.
5) How do credit control techniques impact the overall business cycle?
Answer: Credit control techniques have a significant impact on the business cycle. During economic booms, the RBI may use credit tightening measures to curb excessive lending and investment, controlling inflation and preventing asset bubbles. In contrast, during economic downturns, the RBI may adopt credit easing measures to encourage borrowing, stimulate investment, and promote economic recovery. These measures help smooth out the peaks and troughs in the business cycle, contributing to overall economic stability.
6) Explain the role of credit control in managing inflation and deflation in the economy.
Answer: Credit control plays a crucial role in managing inflation and deflation in the economy. Inflation refers to a sustained increase in the general price level, while deflation refers to a sustained decrease in the general price level.
During periods of inflation, when prices are rising rapidly, the Reserve Bank of India (RBI) implements credit tightening measures. It increases the bank rate, which raises the cost of borrowing for commercial banks, thereby reducing credit availability. Additionally, the RBI may increase the cash reserve ratio (CRR) and statutory liquidity ratio (SLR), forcing banks to keep higher reserves and limiting their lending capacity. These measures reduce the money supply in the economy, leading to lower consumer spending and investment, and thus helping to control inflationary pressures.
Conversely, during deflationary periods when prices are falling, the RBI adopts credit easing measures. It lowers the bank rate to reduce the cost of borrowing, encourages banks to lower CRR and SLR, and may conduct open market operations to inject liquidity into the system. These actions increase the money supply, making credit more accessible, and stimulating consumer spending and investment, thus countering deflationary pressures.
By employing these credit control measures, the RBI can regulate the money supply, influence interest rates, and steer the economy towards price stability, ensuring that inflation and deflation are kept in check.
7) Describe the impact of credit control on different sectors of the economy.
Answer: Credit control measures implemented by the Reserve Bank of India have varying impacts on different sectors of the economy. The sectors primarily affected include agriculture, industry, services, housing, and infrastructure.
a) Agriculture: Credit control can influence the availability of credit to the agricultural sector, which is crucial for rural development and food production. During periods of economic expansion, the RBI may encourage lending to agriculture by lowering interest rates and easing credit conditions. This stimulates agricultural activities and boosts production. Conversely, during inflationary periods, the RBI may tighten credit availability to curb excess spending, which can also affect credit availability to farmers.
b) Industry: The industrial sector heavily relies on credit for investment and expansion. During economic booms, the RBI may use credit tightening measures to prevent overheating in the economy and control inflation. This could lead to higher interest rates and reduced credit availability, impacting industrial investment and expansion. On the other hand, during economic downturns, the RBI may adopt credit easing measures to boost industrial activities and revive economic growth.
c) Services: The services sector encompasses various activities, including banking, finance, retail, and education. The availability of credit impacts the expansion and growth of these activities. Credit control measures can influence the cost and availability of credit for service-based businesses, thus affecting their investment and expansion decisions.
d) Housing: The housing sector heavily relies on credit for home purchases and real estate development. During periods of economic expansion, the RBI may encourage lending to the housing sector to boost construction and meet the demand for housing. Conversely, during inflationary periods, credit tightening measures can lead to higher interest rates, making borrowing more expensive and potentially impacting the housing market.
e) Infrastructure: Infrastructure development requires substantial investment and financing. Credit control measures can impact the availability of funds for infrastructure projects. During economic downturns, the RBI may use credit easing measures to stimulate infrastructure investment as part of fiscal stimulus efforts.
Overall, credit control measures influence the cost and availability of credit, impacting investment decisions and economic activities in different sectors, and play a critical role in shaping the overall economic landscape.
3) Discuss the challenges faced by the Reserve Bank of India in implementing effective credit control.
Answer: The Reserve Bank of India faces several challenges in implementing effective credit control measures:
a) Data Accuracy: One of the significant challenges is obtaining accurate and up-to-date data on credit flows, money supply, and economic indicators. Without reliable data, it becomes difficult to assess the current economic situation accurately and implement appropriate credit control measures.
b) Time Lag: There is often a time lag between the implementation of credit control measures and their impact on the economy. Monetary policy actions may take some time to show their full effects, making it challenging to fine-tune the measures precisely.
c) Uncertain Economic Environment: The economy operates in a dynamic and uncertain environment. External factors such as global economic conditions, geopolitical events, and natural disasters can influence the effectiveness of credit control measures.
d) Transmission Mechanism: The effectiveness of credit control measures depends on the transmission mechanism of monetary policy. The impact of changes in interest rates and credit availability on the overall economy can be complex and may not work as expected in all situations.
e) Inflation-Output Tradeoff: The RBI faces the challenge of striking a balance between controlling inflation and promoting economic growth. Tightening credit to control inflation may lead to reduced economic output, while easing credit to stimulate growth may risk higher inflation.
f) Non-Bank Financial Institutions: Credit control measures by the RBI primarily target commercial banks. However, non-bank financial institutions and shadow banking entities also play a significant role in credit intermediation, and regulating their activities can be challenging.
g) Political Pressures: The RBI operates independently, but political pressures to ease credit conditions during elections or challenging economic situations can hinder effective credit control.
Despite these challenges, the Reserve Bank of India continuously evaluates the economic conditions and adjusts its credit control measures to achieve its objectives of economic development with stability. It also collaborates with the government and other financial regulators to address systemic challenges and promote overall economic stability.
Additional Question Answer
1. What do you mean by credit control? What are the objectives of credit control?
Ans: Credit control refers to the measures and strategies employed by central bank of a country, such as the Reserve Bank of India, to regulate and manage the extent and nature of credit extended by commercial banks. These controls are crucial for maintaining economic stability. Through various monetary policy tools, the central bank influences the availability and cost of credit, thereby affecting borrowing and spending behavior in the economy. By adjusting interest rates, reserve requirements and open market operations, the central bank can either stimulate or curb lending activities. The goal is to strike a balance between promoting economic growth and preventing inflation, ensuring that credit flows to productive sectors without destabilizing the overall financial health of the nation.
Credit control, managed by the Reserve Bank of India (RBI), aims to achieve economic stability and growth. Its objectives are:
i. Price Stability: RBI uses credit control techniques to stabilize consumer prices. This boosts consumer confidence, encourages business activities and promotes trade by ensuring consistent prices for goods.
ii. Exchange Rate Stability: Maintaining a steady exchange rate is crucial for smooth international trade and relations. Stable rates discourage speculation, ensuring reliable foreign trade.
iii. Cyclical Fluctuation Control: To manage economic cycles, RBI adjusts credit supply. During booms, it tightens credit to limit excessive money supply, while in recovery periods, it eases credit to boost money flow.
iv. Income and Employment Maximisation: Credit control supports income, employment and economic growth, contributing to overall prosperity. Financial Requirements: One crucial goal of the Reserve Bank of India's credit control is to fulfil the financial needs of the nation.
vi. Money Market Stability: Credit control maintains stability in the money market, ensuring efficient financial operations.
vii. Balance of Payment Equilibrium: Credit control helps maintain a balanced international trade situation, preventing trade imbalances.
2. What are the Quantitative Credit Control Techniques by Reserve Bank of India?
Ans: Quantitative Credit Control Techniques by Reserve Bank of India
1. Bank Rate: The bank rate is the interest rate at which the central bank lends money to commercial banks. It affects the overall cost of borrowing in the economy. When the central bank adjusts the bank rate:
i. Credit Expansion: Lowering the bank rate encourages borrowing by making loans more affordable. This boosts economic activity as businesses and individuals take advantage of cheaper credit, leading to increased money supply.
ii. Credit Contraction: Raising the bank rate makes borrowing more expensive. This discourages borrowing, reduces the demand for loans and subsequently decreases the money supply, helping manage inflation.
2. Open Market Operation: Open market operations involve the buying and selling of government securities by the central bank. These transactions impact the liquidity of the banking system. When the central bank engages in open market operations:
i. Credit Expansion: Purchasing government securities injects money into the banking system. Banks have more funds to lend at lower rates, stimulating credit creation and fostering economic growth.
ii. Credit Contraction: Selling government securities withdraws money from the banking system. With reduced liquidity, banks lend less, leading to reduced credit availability and moderating inflation.
3. Cash Reserve Ratio (CRR): The cash reserve ratio is the percentage of deposits that banks are required to hold in reserve with the central bank. The CRR can be varied by the RBI from 3% to 15% of banks' net demand and time liabilities (NDTL). Adjusting the CRR affects the amount of money banks can lend out:
i) Credit Expansion: Lowering the CRR allows banks to keep a smaller portion of their deposits as reserves, giving them more funds to lend. This encourages credit expansion and supports economic activity.
ii). Credit Contraction: Raising the CRR mandates banks to hold a larger portion of their deposits as reserves. This limits their lending capacity, curbing excessive credit growth and managing inflation.
4. Statutory Liquidity Ratio (SLR): The statutory liquidity ratio mandates the percentage of certain liquid assets that banks must maintain. These assets include cash, gold and government securities:
i). Credit Expansion: Reducing the SLR increases the funds available for lending, promoting credit expansion. Banks have greater liquidity to extend loans, supporting economic activities.
ii). Credit Contraction: Increasing the SLR compels banks to hold a larger portion of their assets in liquid form, limiting their lending capacity. This helps manage credit growth and control inflation.
5. What are the Qualitative or selective credit control techniques of RBI?
Ans: Qualitative or selective credit control techniques are designed to direct the flow of credit toward priority sectors and productive uses while curbing non-essential consumption and speculative activities. These measures provide the central bank with tools to guide banks' lending behavior in ways that contribute to economic stability and growth.
These techniques are Qualitative/Selective Credit Control Techniques
1. Issue of Directives: The Reserve Bank of India (RBI) has the authority to issue directives to commercial banks through written or oral communication. These directives guide banks on their lending policies, restricting specific types of transactions and urging caution against certain activities. The RBI can also call for periodical reports, inspect banks' books, grant or deny permission for opening new branches and require banks to submit annual progress reports. This method influences banks to align their lending practices with the central bank's monetary policy goals.
2. Regulation of Consumer Credit: This technique aims to regulate consumer spending on non-essential consumer durables. The RBI places restrictions on bank loans used to finance installment sales of items like automobiles, electronics and appliances. By controlling consumer credit, the RBI can manage excessive consumer spending and ensure that credit flows to more productive sectors of the economy .
3. Credit Rationing: Credit rationing involves setting credit quotas for specific categories of loans and advances to commercial banks. This approach restricts credit flow to undesirable sectors while channeling it towards priority sectors. By controlling the allocation of credit, the RBI can encourage lending to sectors that contribute to economic growth and development.
4. Margin Requirements: Margin requirements refer to the difference between the loan amount and the market value of assets pledged as collateral. The RBI adjusts margin requirements to influence the size of loans. It can raise margins for non-desirable sectors to discourage lending and lower margins for priority sectors to encourage lending. This technique directly affects the borrowing capacity of businesses and individuals.
5. Moral Suasion: Moral suasion involves the RBI using informal persuasion to influence o mmercial banks' lending practices. During periods of inflation, the RBI advises banks to reduce financing for speculative or non-essential activities, Conversely, during deflationary periods, the RBI encourages banks to ease their lending criteria, lower margins and stimulate credit flow to counter economic downturns.
6. Direct Action: Under direct action, the RBI takes punitive measures against banks that fail to comply with its directives. These measures can include penalties, fines, denial of rediscounting facilities, or refusal of credit supply. This technique compels banks to align their activities with the RBI's policy goals, ensuring that lending practices support the broader economic objectives of the country.
7. Write a short note on :
a. Cash Reserve Ratio (CRR)
B. Statutory Liquidity Ratio (SLR)
Ans: a. Cash Reserve Ratio (CRR): Cash Reserve Ratio (CRR) is a crucial monetary policy tool used by the Reserve Bank of India (RBI) to regulate the amount of funds that banks must maintain with the central bank as a percentage of their total deposits. The CRR can be varied by the RBI from 3% to 15% of banks' net demand and time liabilities (NDTL). By adjusting the CRR, the RBI can influence the liquidity levels of banks and the overall money supply in the economy. A reduction in CRR boosts the funds available for lending, encouraging credit expansion and economic growth. Conversely, an increase in CRR limits the lending capacity of banks, curbing excessive credit growth and helping control inflation. CRR plays a significant role in maintaining the stability of the financial system while steering economic growth.
b. Statutory Liquidity Ratio (SLR): The Statutory Liquidity Ratio (SLR) mandates that banks maintain a certain percentage of their assets in the form of liquid assets like cash, gold and government securities. The SLR serves as a safeguard to ensure banks have readily available resources to meet their obligations and maintain stability. Adjusting the SLR directly impacts the amount of funds available for lending. Lowering the SLR provides banks with more liquidity, enabling increased lending and stimulating economic activity. Conversely, raising the SLR restricts lending capacity, contributing to credit moderation and aiding in controlling inflation.
The SLR, along with other tools, helps the RBI shape credit flows to align with economic priorities. (add from long asn, as per the marks given)
6. What are the differences between CRR and SLR?
6. What are the similarities between Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)?
Ans: The similarities between Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) :-
(a) Frequency: Both the CRR and SLR need to be maintained on a daily basis.
(b) Penalty: Banks face penalties if they fail to maintain the required CRR or SLR.
(c) Applicability: Similar to CRR, it's applicable to Scheduled Commercial Banks, Small Finance Banks, Payments Banks, Local Area Banks, Co-operative Banks.
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