Credit Control by RBI in India

8/9/2019 Credit Control by RBI in India

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Central banking – methods of creditcontrol – an overview

Dr. Prashant S. Desai,Assistant Professor,

NLSIU


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Central bank – quick recap

• They are different from commercial banks

• It does not aim at profit – although it may actually

earn good amount of profit• It aims at controlling the banking system and

supporting the economic policy of the government

•

It is empowered with special powers to control andregulate the working of the commercial bankingsystems of the country

• It is rather popularly known for its action to control

credit in the economy


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Background

• Set up on the basis of the recommendations of theHilton Young Commission in 1926.

• Report of the Chamberlain Commission of 1914recommended that the three Presidency Banksshould be merged into one central bank.

• The RBI Act, 1934 provides for the statutory basis ofthe functioning of the Bank, which commencedoperations on April 1, 1935.


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• RBI was started originally as a shareholders’ bankand its paid up capital was Rs.5 Crores.

• It took over the function of currency issue from theGovt. of India and the power of credit control fromthe then Imperial Bank of India.

• It was nationalized w.e.f. 1-1-1949 on the basis of theRBI (Transfer to Public Ownership) Act, 1948.

• All shares in the capital of the bank were deemedtransferred to the Central Govt. on payment of a

suitable compensation.


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Functions of RBI

• Regulate the issue of banknotes

• Maintain reserves with a view to securing monetary

stability• Operate the credit and currency system of the

country to its advantage

•

Monetary Policy, Bank Supervision and Regulationand Overseeing the Payments System anddeveloping the financial markets.


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• Issuer of currency in India

• Banker to the Government

• Banker to Commercial Banks• Organizer of commercial Banking System

• Regulator and supervisor of the Financial System

• Financial supervision• Monetary Authority

• Monetary and credit policies

• Controls the volume of credit


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• Authority to regulate and supervise PaymentSystems

•Manager of Foreign Exchange

• Maintains the value of currency

• Development of Rural Banking

•Money and Capital Market

• Promotion of financial Institutions

• Developmental role of RBI


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Organization of RBI

• Central Board of Directors of RBI (Sec.8)

• Local Boards of RBI – Mumbai, Kolkata, Chennai

and New Delhi – 5 members each for a term of 4years to represent territorial and economic interests,the interest of cooperatives and indigenous banks.

• Board for Financial Supervision (Sec.58)


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RBI and Commercial Banks

• Commercial Banks maintain accounts with RBI

• RBI as Banker to Scheduled Commercial Banks

• RBI controls the activities of Commercial Banks• RBI issues Licence to Banks

• Power to inspect the Commercial Banks (Sec.35 of

BR Act)• Overall Control over management of Banks (Sec.

35B of BR Act)

•

Power to control the volume of credit


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Two methods of credit control

1. Quantitative credit control methods

1. Bank rate or discount policy

2. Open market operation & reserve requirements2. Qualitative or selective credit control methods

1. Regulations or margin requirements

2. Regulation of consumer credit

3. Control through directives

4. Moral persuasion

5. Rationing of credit

6. Direct action


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Quantitative methods

• Bank Rate Policy

– Commercial banks when in additional need of cash –obtain from the Central Bank either

• By rediscounting some of the securities; or

• Borrow from the Central Bank against the securities

• For this Central Bank charges interest at the rate,

which is known as Bank Rate or Discount Rate


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BANK

RATE

GOING

UP

• LENDING RATES

OF

THE

COMMERCIAL

BANKS

WILL

GO

UP

• PEOPLE ARE

DISCOURAGED

TO

TAKE

LOANS

• MERCHANTS

LIQUIDATE

THEIR

STOCKS

• DEALERS

IN STOCK

EXCHANGE

MAY

LIQUIDATE

THEIR

STOCKS

TO

PAY

OFF

THEIR

LOANS

BANK

RATE

GOING

DOWN

• LENDING RATES

GO

DOWN

• PEOPLE

ARE

ENCOURAGED

TO

TAKE

LOANS

• MERCHANTS

HOLD

THE

STOCKS

• STOCK’S WILL BE

HELD

ON

TO

BY

THE

BROKERS

• MORE

PURCHASE OF

STOCKS

WILL

ALSO

TAKE

PLACE


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• Open Market Operations

– Deliberate and direct buying and selling of securities andbills in the money market by the Central Bank on its owninitiative


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• Reserve Ratio Requirements

• The requirement of a commercial bank to maintain

a minimum percentage of their time and demandliabilities with the Central Bank also know as ‘CashReserve Ratio’

• The objective

– To ensure liquidity & solvency among the banks

– To provide Central Bank with supply of deposits for its localoperations

–

To influence ultimately restrict commercial banks’ extensionof credit


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Selective credit control methods

• Unlike the quantitative controls – they are notindiscriminately impact across all sectors

•

Historically – these were designed and appliedduring the World War II period

• Advantages

– They distinguish between essential and non essential usesof the Bank credit

– Only non essential uses are brought under the scope ofCentral Bank controls; and

– They affect not only lenders but borrowers as well


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Selective credit control methods

• Margin requirements

– The stock-market crash of 1929 in USA

–

There was extensive speculation in stock markets in US – The Federal Reserve Bank of America ordered commercial

banks to restrict their loans and advances to stock brokersby raising the margin requirements


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Regulation of customer credit

• The restraint under these regulations were two fold

– They limited the amount of credit for the purchase of anyarticle listed in the regulation; and

– They limit the time for repaying the debt


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Moral persuasion

• Implies persuasion and request made by theCentral Bank to the commercial banks to follow the

general monetary policy of the former


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Rationing of credit

• Method of controlling and regulating the purposefor which credit is granted by the commercial banks


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Direct action

• in 1959 – RBI directed the entire banking system torefrain from excessive lending

Credit Control by RBI in India

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