Credit Control by Central Bank

Credit control policy or Monetary policy may be defined as “that branch of economic policy which is concerned with the regulation of the availability or supply, the costs and the directions of credit. ” OBJECTIVES or GOALS The objectives of credit control of monetary policy have been different at different times in different countries according to the economic situations and problems faced by them. In the modern times economic development with monetary stability is accepted as the most important goal of credit control.

The main objective of this credit-control function is to save economy from inflation and deflation and to stabilize the economy and prices. METHODS OF CREDIT CONTROL Credit control is one of the most important responsibility of a central bank. Central bank of a country can control credit by following two methods. (1) Qualitative controls (2) Quantitative controls QUANTITATIVE CONTROLS Quantitative controls are used to expand or contract the total quantity (overall size) of credit. These controls are of the following kinds: 1. Bank rate policy 2. Open market operations . 3.

Variable reserve ratios 4. Liquidity ratio 5. Credit rationing These are explained as under. i. Bank Rate (or Discount Rate) Policy Bank rate is the rate at which central bank rediscounts bill of exchange or provides credit to commercial banks. For controlling credit central bank may increase or decrease bank rate. When bank rate is raised, other bank’s interest rates on advances also move up. When bank rate is decreased, other banks’ interest rates on advances also go down. Borrowing from banks is discouraged or encouraged and, as a result, the rate of monetary expansion decreases or increases.

2. Open Market Operation Buying and selling of government securities by the central bank with a view to influencing money supply is called open market operations. When the central bank sells securities the buyers make payment for these to the central bank through commercial banks. A portion of commercial banks’ cash flows to the central bank. As a result, the lending and financing power of banks decreases which leads to reduction in the rate of credit expansion. The purchase of securities by the central bank has the reverse effects. 3. Variable Reserve Ratios.

The amount of money which the banks are legally required to keep with the central bank is termed legal cash reserve ratio or requirement. It is a certain percentage of deposits. If the cash reserve ratio is raised, say from 5% to 7% of total deposits, the lending and financing power of banks will contract accordingly. This will cause fall in the rate of money expansion. A decrease in ratio has an opposite effect. 4. Liquidity Ratio In Bangladesh, liquidity ratio refers to the amount of assets which banks are legally required to hold in the forms of (i) cash in hand, (ii) balances with SBB/NBB and (iii) approved securities.

At present it is 35% of total deposit liabilities. The effects of varying liquidity ratio are similar to those of varying cash reserve ratio. The increase in it causes a fall and decrease in it a rise in the rate of credit expansion. 5. Credit Rationing In order to keep the total credit expansion within desirable limits, the central bank may recommend ceilings (an upper limit) on the overall credit extended by each commercial bank. QUALITATIVE CONTROLS These include: (1) Moral suasion. (2) Method of Publicity. (3) Direct Action Selective controls are mainly, aimed at influencing the direction or distribution of credit. (1) Moral Suasion.

By virtue of its special position, the central bank can persuade commercial banks to follow a specific credit policy. In this connection the central bank can employ oral or written appeals or warnings. (2) Publicity The central bank through its different publications may give publicity to desirable credit policy in the form of a few broad principles. The banks may take guidance from this in respect of their lending and financing operations. (3) Direct Action if commercial banks do not follow the credit guidelines of central bank then central bank can impose a penalty or refuse to discount bill of exchanges of commercial banks.

LIMITATIONS OF CREDIT CONTROL POLICY or DIFFICULTIES IN CONTROLLING CREDIT Credit control or monetary policy has many limitations. In other words, there are several difficulties in the way of the central bank to control credit. 1. Absence of developed money markets. In underdeveloped countries, central bank control over bank credit is rendered very difficult by the absence of well-developed money markets. 2. Existence of non-monetized sector. In less developed countries there exists a large non-monetized and rural subsistence sector. Thus a big section of the community is quite unaffected by monetary policy. 3. Large-scale deficit financing.

A large-scale deficit financing by the government may make the central bank powerless in controlling the amount of credit and inflationary pressures. Thus, unless it is prevented, the credit control measures will have little value. 4. Cooperation of banks. It is very difficult for a central bank to control credit if commercial banks do not extend their full cooperation. 5. Conflicting objectives. The greatest difficulty in the way of the central bank in controlling credit is the simultaneous achievement of conflicting objectives. For example controlling inflation and increasing employment opportunities are conflicting objects.