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Credit control is absignificant tool used by Reserve Bank of India. It is an important weapon of the monetary policy used to control demand and supply of money which is also termed as liquidity in the economy. Administers of the Central Bank control over the credit that the commercial banks grant. Main purpose of credit control is to bring “economic development with stability”. It means that banks will not only control inflationary trends in the economy but also boost economic growth which would ultimately lead to increase in real national income stability. As we know RBI have functions like issuing notes and custodian services, if credit control is not controlled by RBI it would lead to social and economic stability in the country.
There are several reasons for which credit control is needed. Some of them are:
Frequent price fluctuations cause disturbances and maladjustments in the economic system and have serious social consequences. So, important objective of credit control policy is stabilisation of price. Credit supply is regulated by Central Bank with respect to needs of people which can bring about price stability in the country.
Instability in a capitalist economy is generally brought by operation of business cycle. To ensure economic stability in the economy credit control policy of central bank eliminates cyclic fluctuations.
Unemployment is economically wasteful and socially undesirable. So economic stability with maximum employment and high per capita income has been considered as one of the important objective of credit control policy of a country.
The main objective of credit control policy in the not so developed countries should be economic growth promotion within the shortest possible time. Underdeveloped countries generally suffer from deficiency of financial resources. So, planned expansion of bank credit can be one of the ways to solve the problem of financial scarcity in these countries.
To reduce the fluctuations in the interest rates to the minimum central bank’s credit policy control stabilises the money market. Credit control should be practised in such a way that demand and supply of money should be achieved mostly.
One of the objective of credit control is exchange rate stability. Difference in the exchange rate is harmful for the foreign trade of the country. So, the central bank, in the countries largely dependent upon foreign trade, should attempt to eliminate the fluctuations in the foreign exchange rates through its credit control policy.
To control credit creation RBI generally employs two methods
It is also known as traditional method. It uses bank rate policy, open market operations and variable reserve ratio. It includes margin requirement, credit rationing, consumer credit regulation and direct action. It is one of the methods used by RBI to control credit creation. Quantitative controls are designed to regulate the volume of credit created by qualitative measures of banking system. It is designed to regulate the flow of credit in specific uses.
It is defined as the rate prescribed by the central bank. It is nothing but the minimum rate at which the central bank will discount first class bills of exchange or will advance loans against approved securities. It is also known as discount rate. Between bank rate and other money market interest rates there is a direct and organic type relationship such that whenever there is a change in bank rates it will directly reflect in change in interest rate of commercial banks for short term money and bank loans and advances.
There is also another rate known as market rate which is slightly different from the bank rate. It is rate of discount at which lending institutions in the country where as rate of interest is the rate at which banks pay to depositors. Bank rate is one of the important instrument of credit control. Suppose credit expansion is required, central bank will lower the bank rate making the credit cheaper followed by commercial banks who lower their interest rates. Under inflationary conditions to discourage credit creation the central bank will raise the bank rate. Consequences of raise in bank rate will be raise in cost of borrowing making it dearer, discouraging businessman, entrepreneurs, speculators and traders borrow more thus reducing bank credit volume.
Businesses which primarily depend upon borrowed funds such as production of investment goods and business or construction activities will be slowed down and which ensures unemployment. Dealers who keep goods stock with the money they borrowed will reduce their stock as cost of borrowing will increase and there is a possibility of decline in price. Producers of goods will receive reduced orders from dealers which will result in decrease of productive activities and unemployment increase which will lead to decline in prices and money incomes. When the bank rate is lowered, opposite action happens such as expand in business activity and rise in employment as cost of borrowing decreases.
Rise in bank rate will also set right an adverse balance of trade. This will result in export of gold. Increase in bank rate will also result in increase in other money rates as a result on deposit goes up in money market. Foreigners, who now obtain higher rates on their investments, will not withdraw any money. As a result, capital will move into the country due to better returns and money outflow will stop. Domestic currency demand will rise, raising its value and making the exchange rates more valuable. Moreover, funds which were borrowed have become costly which will result in decrease in spent of goods which were purchased leading to a decline in volume of imports. Thus, trade balance will become favourable with increase in interest rate.
However, it should be clear that to make bank rate mechanism successful the money market must be an integral whole, that is, there must be a direct relationship between bank rate and other market interest rates. Elasticity of economic structure of the company is also required so that changes made in money and credit conditions will result in change in other variables like costs, wage, price, production and employment.
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