Credit Control in Banking

The lending method used by the financial institutions and the banks to lend the money to the customers is known as credit control. The strategy focuses on providing credit to consumers with a solid credit score or the credit history. Customers with a strong credit score have a good track record of paying their bills on time. When granting a new credit line to customers, this enables the lenders to reduce the risk of default. Credit control enables banks and financial organizations to identify delinquent users with a poor credit history and ensure that they are granted credit. This can eventually assist lenders in reducing the likelihood of clients defaulting on their debts and increasing the successful lending.

Methods of Credit Control

There are basically two methods of controlling the credit. They are Qualitative and the Quantitative or the General Methods.

Qualitative Method

Marginal Requirement Fixation- The central bank establishes the margin that financial institutions and commercial banks must keep for amounts provided in the form of loans against commodities, stocks, and shares using this method. To prevent speculative trading on stock exchanges, the central bank sets margin restrictions for the underlying securities.

Credit Rationing- The central bank uses this strategy to try to limit the maximum amount of loans and advances to a specific sector. Furthermore, the central bank may set a ceiling for different types of loans and advances in specific instances. This restriction is also expected to be adhered to by commercial banks. This makes it easier to reduce bank lending exposure to undesirable industries.

Regulation of the consumer credit– The apex bank establishes the down payments and the length of time over which installments are to be spread in order to regulate consumer credit. Higher limitations are imposed during inflation to control prices by reducing demand, whereas relaxations are offered during depression to promote demand for commodities.

Control through the directives- The central bank uses this strategy to issue regular directives to the commercial banks. Commercial banks are guided by these directives in developing their lending policies. The central bank can use a directive to alter credit structures and limit credit supply for a specified purpose. The Reserve Bank of India (RBI) issues guidelines to commercial banks prohibiting them from lending money to the speculative sector, such as securities, in excess of a specified amount.

Publicity- Another way of selective credits control.. The Reserve Bank of India (RBI) uses it to issue various reports on what is excellent and poor in the system. The publicly available information can assist commercial banks in targeting credit supply to specific industries. 

The Moral Suasion- It refers to the Reserve Bank of India (RBI) exerting pressure on the banking system of India without taking any serious action to ensure compliance with the laws. It’s a recommendation to the banks and aids in the restraint of lending during periods of high inflation. Monetary policy keeps commercial banks informed about the central bank’s expectations. Central banks may offer directions, recommendations, and suggestions to commercial banks to reduce loan supply for the speculative motive under moral suasion.

Direct Actions-The RBI has the power to take actions against a banks using this way. Second, the RBI has the authority to refuse credit to bank whose borrowings exceed their capital. By adjusting some rates, the central banks can penalize a bank. Finally, it has the authority to impose a prohibition on specific banks if they fail to obey its instructions and works against the monetary policy’s goals.

Quantitative Methods

Bank Rate Policy- The bank rate is the lowest rate at which a country’s central bank will lend money to its commercial bank and RBI utilizes it to regulate the credit in the economy. Because the central bank provides funding to the commercial banks by rediscounting bills, it is also known as the discount rate. 

Open Market operations- The RBI’s purchase and the sale of securities are referred to as OMO. In an inflationary scenario, for example, the RBI will begin selling government securities, which will reduce money supply in the system (because the buyer of the securities will pay in Rupee, thus currency from the system will go out). The decline in money supply will lead to a reduction in funds with commercial banks, which will further minimize their lending capability. As a result of the decrease in lending, credit in the economy is reduced. However, it is limited by a number of factors, including an underdeveloped securities market, surplus reserves held by commercial banks, commercial bank debts, and so on.

Variation in the Reserve Ratio– The commercial banks are required by the RBI to keep a certain percentage of their net demand and time obligations in Cash Reserves. 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. The reserve position of commercial banks, which regulates the availability of money in the economy, can be affected by even little changes in these ratios.

Repurchase Option- The central bank conducts repo transactions, also known as repurchase transactions, to manage the cash 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 drain or drain money from the system.

Conclusion

When it comes to keeping lending organizations cash flows under check, credit control is crucial. Subsequently, only prospective consumers with a solid credit history of repaying their debts are chosen, according to credit control. This will ensure that the business has sufficient cash flow and liquidity to continue operating.