Control of credit is one of the principal functions of the Reserve Bank of India. Control of credit means increase or decrease of the flow of credit in the system in accordance with its need. Reserve Bank of India adopts all those measures for the control of credit which Central Banks in other countries do. These measures may be classified as:
1. Quantitative Credit Control
2. Qualitative or Selective Credit Control
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1. Quantitative Credit Control:
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To control the flow of quantum of credit, Reserve Bank adopts all those measures as are generally adopted by the Central Banks in different countries. These measures are as under:
(i) Bank Rate:
Bank Rate is the rate of interest charged by the Reserve Bank for loans to its member banks. On November 15,1935 the bank rate was fixed at 3%. This rate continued till November 15,1951 when it was raised to 3.5%. This was with a view to check the rise in prices as also to check unfavourable trend in the balance of payments. In February 1957, bank rate was further raised to 4%. Three main reasons for this were:
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(a) To check inflation,
(b) To bring parity between the Bank Rate and the Rate of Hundies,
(c) To bring parity between bank rate and interest rate on Treasury Bills. On January 2,1963 bank rate was raised to 4.5%. It was fixed at 5% in 1964 and 6% in 1965. In 1968 it was lowered by 1% in view of the symptoms of industrial recession and therefore to give financial assistance to the industries. On May, 1973 it was again raised to 7%. On July 23,1977 it stood at 9% and July 11,1982 at 10%.
In Seventh Plan, it was raised to 12% but in the third year of the ninth plan (April, 2000) it has been reduced to 7%. In fact, RBI followed cheap money policy till 1964, thereafter it changed over to dear money policy. Policy of bank rate has not been used as a wagon to check rise in prices. According to Sir Rama Rao, the objective of rise in bank rate in India has been to serve as a warning signal. In the context of Indian conditions, it is doubtful if a small increase in bank rate will have any significant effect on inflationary situation.
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(ii) Multiple Rates of Interest:
In October, 1960 the Reserve Bank started ‘Multiple Rates of Interest’ programme. According to this programme if any bank borrows from the Reserve Bank beyond the quota fixed for it, it has to pay higher interest rate than the prevailing Bank Rate. On December 28, 1974, a new scheme was introduced.
According to this scheme a member bank would be given loan at the prevailing bank rate only if its Net Liquidity Ratio is 39%. In case Net Liquidity Ratio is less than it, the Bank Rate could be raised to any limit upto 18%. Reserve Bank also decides the rate of interest to be paid by the banks on different types of deposits and what rate of interest will be payable by them on loans secured from it. This policy aims at discouraging the commercial banks from borrowing from R.B.I.
(iii) Open Market Operations:
Open Market Operations is yet another technique adopted by the Reserve Bank for Quantitative Credit control. This means that the bank controls the flow of credit through the sale and purchase of securities in the open market.
This technique was rarely used before Second World War. But after the war it has become fairly popular. Since 1962, the objective of open market operations has been to contain inflation. In 1998-99, RBI sold securities worth Rs. 8,330 cr. and purchased securities worth Rs. 1,194 cr., respectively.
(iv) Variable Cash Reserve Ratio:
Reserve Bank also controls the Cash Reserve Ratio of the commercial banks. Initially, all Scheduled Banks had to keep 5% of their Demand Deposits and 2% of their Time Deposits as cash deposits with Reserve Bank. In 1956, Reserve Bank of India was granted the right to raise the percentage of Demand Deposits upto 20% and that of Time Deposits upto 8%.
In 1962, cash receive ratio was fixed at 3% of total deposits of the banks and Reserve Bank was granted the right to raise this percentage upto 15%. In 1993 CRR was fixed at 14% but on April 2000, it was reduced to 8%.
(v) Statutory Liquidity Ratio:
According to the Indian Banking Act 1949, a bank is legally bound to keep 20% of its deposits in the form of Liquid Assets. This is kept by the bank itself. Amendment of 1962 to the Indian Banking Act raised this liquidity ratio to 25%. It was further raised to 33% in 1974, to 34% in 1978, to 37.5% on April 25,1987. It has been reduced to 25 percent in 1997.
(vi) Direct Action:
According to the 1949 Act, Reserve Bank can stop any commercial bank from any type of transaction. In case of defiance of the orders of Reserve Bank, it can resort to direct action against the member bank. It can stop giving loans and even recommend the closure of the member bank under pressing circumstances.
(vii) Credit Authorisation Scheme:
In 1965, Credit Authorisation Scheme was adopted. It aims at regularising of the credit given by the banks. Before sanctioning a credit limit of Rs 2 crore or more to any one debtor, every bank will have to get authorisation from the Reserve Bank. Even, after the autharisation the creditor bank can inspect the account books of the debtor to ascertain the use of the credit.
(viii) Moral Persuasion:
Reserve Bank can also exercise moral influence upon the member banks with a view to pursue its monetary policies. From time to time Reserve Bank holds meetings with the member banks seeking their co-operation in effectively controlling the monetary system of the country. It advises than against the expansion of credit, except to priority sector i.e., agriculture, small industries etc. Reserve Bank has also counseled the banks to invest more and more in Government securities and increase their liquidity. R.B.I, can initiate direct action against such banks as disregard its advice. Role of moral persuasion has increased considerably ever since the nationalization of the banks.
2. Selective Credit Control:
This refers to the control of specific credit meant for certain specific objectives. For example, if the Government wants to check the rising prices of wheat in India, the Reserve Bank may instruct the member banks not to give loans against the security of wheat. Traders will not get credit for the purchase of wheat and, therefore, they will not be able to buy large quantities of wheat. This would bring down wheat prices as the credit squeeze is directed towards wheat alone. It is thus called ‘Selective Control’.
Banking Companies Act, 1949 has conferred upon the Reserve Bank many rights of selective credit control. These rights are being frequently exercised by the Reserve Bank particularly since 1956 onwards. Following techniques of selective control are generally adopted.
(i) Change in Margin Requirements on Loans:
Reserve Bank directs the member banks to change their margin requirement from time to time. First such direction was given by the Reserve Bank in May and September 1956 regarding rice-trade. In 1957, margin requirement for wheat was fixed at 40%. In 1958, it was raised to 80 percent. In 1970, it was again brought down to 40 percent. In 1997, it was raised to 45 percent. Likewise, margin requirement has been varied regarding various commodities from time to time.
(ii) Rationing of Credit:
Rationing of credit is yet another technique of selective credit control. Under this programme, the Reserve Bank fixed credit quota for member banks as well as their limits for the payment of Bills. Quota system was introduced in 1960. If the member banks seek more loans than their fixed quota, they will have to pay higher interest charges to the Reserve Bank than the prevailing Bank Rate.
(iii) Credit Authorisation Scheme (CAS):
This scheme was introduced by RBI in November 1965. Under this scheme, the banks were to attain the authorisaion of the Reserve Bank before sanctioning any fresh limit of Rs. 1 crore or more to any single party. The amount of the limit has been changed from time to time.
It was raised in 1986, to Rs. 6 crore. Since 1987, Credit Authorisation Scheme has been liberalised to allow large amount of loans to meet genuine demands of production sector without the prior sanction of the Reserve Bank. However in such cases a system of post sanction scrutiny called Credit Monetary Arrangements (CMA) has been introduced by the Reserve Bank.
(iv) Loan System for Delivery of Bank Credit:
The ‘Loan System’ for delivery of bank credit has been introduced with effect from April 21, 1995. The objective of the loan system is to bring about discipline in the utilisation of bank credit by large borrowers and gain better control over credit fund.
As per the loan system, it is mandatory for banks to restrict the cash credit component to 75 per cent of the maximum permissible bank finance (MPBF) for borrowers with assessed MPBF of Rs. 20 crore and above. The balance of 25 percent of MPBF mostly sanctioned by way of short term loans for working capital purposes. It is to be sanctioned as a demand loan for a minimum period of one year.
(v) Ceiling on Term Loans:
In October 1994, the ceiling for term loans for any project of Rs. 50 crore for each bank was abolished and the limit of Rs. 200 crore for the banking system as a whole was raised to Rs. 500 crores for any project.