An Idea on Limitations of Credit Control by RBI

Credit Control is a role of the Reserve Bank of India’s central bank, which regulates credit, or the supply and demand of money or liquidity in the economy. The central bank regulates the credit extended by commercial banks to their customers through this function. Its goal is to achieve stable economic growth while also managing inflation and deflationary pressures.

It entails controlling the amount of credit created by commercial banks, regulating the amount of credit created, diverting credit to productive uses, and putting in place measures to strengthen bank structures.

Objectives of Credit Control

The main objectives are as followed-

• To maintain the pricing stability within the company
• To achieve foreign exchange rate stability, this maintains the currency’s external worth
• Liquidity control strategies are used to keep the money market stable
• Maximize income, employment, and output to support overall economic growth and development
• To advance the national interest

Limitations of Credit Control 

The central bank is a government-controlled bank that regulates a country’s financial affairs by setting key interest rates, issuing currency, overseeing commercial banks, and controlling the foreign exchange rate. Credit control, on the other hand, is a method used by manufacturers and merchants to encourage excellent credit among creditworthy borrowers while denying credit to delinquent borrowers.

The central bank may occasionally fail to maintain optimal credit flow regulation. The following are the reasons for the same-

• To be successful in a credit control programme, you must have complete control over the money market, however, this is not always achievable
• Credit control methods can only affect a short-term loan due to the various terms of the loan period
• The credit control strategy is not appropriate for use in an uncontrolled money market
• Commercial banks and the central bank do not work together very well
• Credit restriction is not appropriate in an uncertain economy
• If credit control measures are not done at the primary level, they will not be effective afterwards
• Credit control will not operate as well if a lengthy plan is implemented

Methods of Credit Control

• Quantitative Methods of Credit Control

These instruments regulate the price and quantity of the credit.

1. Bank rate Policy- The bank rate is the interest rate at which the central bank loans money to commercial banks in order to meet their liquidity needs. The bank rate is also known as the discount rate. In other words, the bank rate is the rate at which the central bank rediscounts eligible papers held by commercial banks (such as approved securities, bills of exchange, and commercial papers). The bank rate is significant because it sets the tone for other interest rates on the market. The RBI has altered bank rates multiple times in order to curb inflation and recession.
2. Open market operation- It refers to the open market purchase and sale of government securities in order to increase or decrease the amount of money in the banking system. This method outperforms bank rate policy. Purchases provide money to the financial system, but securities sales have the opposite effect. The RBI has been conducting switch operations over the past two decades. These transactions entail the purchase of one loan in exchange for the selling of another, or vice versa. This policy seeks to prevent unrestricted liquidity growth.
3. Repurchase option- The central bank conducts repo transactions, also known as repurchase transactions, to manage the money market situation. The Central Bank grants commercial banks loans against government-approved securities for a set length of time at a fixed rate, known as the Repo Rate, on the premise that the borrowing bank will repurchase the securities at the established rate once the period is up. The central bank conducts these transactions in order to absorb or drain money from the system.
4. Variations in the Reserve ratio- Commercial banks are required to keep Cash Reserves with the RBI equal to a certain proportion of their net demand and time obligations. Banks must also keep a specified amount of their net demand and time obligations in the form of liquid assets. The Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) are the two reserve ratios.

• Qualitative Methods of Credit Control

1. Credit Rationing- it is the practise of limiting the amount of credit available to specific industrial sectors in order to ensure that other sectors receive adequate credit. The RBI uses this strategy to set a ceiling (maximum limit) on loans and advances for specified categories, which commercial banks are not allowed to exceed.
2. Moral Suasion – This is the mechanism through which the RBI persuades and convinces commercial banks to perform particular activities that are in the country’s economic interests. The RBI uses this strategy to ask and persuade commercial banks to cooperate with the central bank in the implementation of its credit and monetary policies.
3. Changing of Margin Requirements – The Reserve Bank of India (RBI) uses this technique to set margin requirements for commercial banks on securities used to offer loans to clients. Various types of securities have different margin requirements mandated by the RBI. The flow or direction of credit is influenced by changes in margin requirements. An rise in margin requirements reduces credit flow, whereas a decrease in margin requirements increases credit flow.
4. Consumer Credit Regulation – Consumer credit refers to loans taken out by individuals to acquire goods and services. To influence the flow of credit in a particular direction, the RBI regulates the total volume of credit that commercial banks may provide to consumers and sets minimum payback duration or increases the down payment required for specified categories.
5. Direct Action – If all of the preceding techniques fail to regulate credit, the RBI takes direct action by establishing specific rules and regulations under which commercial banks must operate. Banks that refuse to implement the RBI’s instructions face severe consequences.

Conclusion

Credit control supports in attaining the primary goal of price and financial stability, which is to reduce inflation. Furthermore, it contributes to the expansion of the economy by facilitating an adequate flow and volume of bank credit to various sectors, as well as encouraging the growth of key industries by giving adequate credit to these sectors.