What do you mean by Credit Control?
The Central Bank of a country undertakes a policy to control and regulate the availability and the flow of credit with the public, known as the monetary policy of the central bank. Since the banknotes or the fiat currency and bank credit are a crucial part of the money supply in an economy, control over money is only possible through control over bank credit supplied to the public.
For the reason mentioned above, the monetary policy is also termed the credit policy. In simpler words, the central bank of a country pursues the monetary policy to control and regulate not only the supply of money but also the cost and availability of credit in a country. The methods adopted by the Central Bank to control credit are also called instruments or weapons of credit control.
Importance of Credit Control
This is done to stabilize prices, ensure full employment, maintain equilibrium, and give a push to the economic growth of a nation. Credit control plays a crucial role in eliminating the business cycle and the period of excessive inflation or deflation and helps to meet the financial requirements of a country in times of emergencies or war.
Methods of Credit Control by Central Bank
There are two such methods – qualitative credit control methods and quantitative methods of credit control. Now let’s take a look at these methods and how they are carried out.
1. Quantitative Methods of Credit Control
These methods are used to control the overall quantity of credit and its cost in general, affecting all sectors of the economy uniformly. They are the traditional or general methods of controlling credit.
The important quantitative instruments are as follows:
Bank Rate
When the Central bank of a country advances loans to a commercial bank for a long-term period, they do so at a certain rate. This rate is known as the bank rate and is slightly higher than the market rate. During inflation, this rate is increased and is decreased during the time of deflation.
If the bank rate changes, the rate at which the commercial banks charge interest from their customers also changes. The current bank rate in the United Kingdom as of February 2022 is 0.50%.
Open Market Operation
This process is carried out by the sale or purchase of government and other approved securities by the central bank in and from the capital as well as the money market. It influences the cash reserve ratio. This is carried out in two circumstances – during deflation and inflation.
During the boom period, the economy is in inflation, and thus the amount of credit is to be decreased. The central bank commands the commercial banks to sell off the government and other approved securities in the market.
Similarly, the expansion of credit is done during the recession period when the economy faces deflation. The central bank commands the commercial banks to purchase these securities to increase their credit creation power.
Cash Reserve Ratios
The commercial banks have to make a deposit in cash reserves with the country’s central bank. So the minimum percentage of the total deposits made by the commercial banks is known as the cash reserve ratio. It is variable in nature and is controlled by the central banks.
The cash reserve ratio is decreased by the central bank during deflation to increase the credit creation capacity of the commercial banks, whereas the central bank increases this ratio during the time of inflation to curtail the credit creation capacity of the commercial banks.
2. Qualitative Methods of Credit Control
These methods can also be called Selective Methods of Creating Credit in the economy. Unlike Quantitative methods, they do not affect the general availability of credit in the economy instead, they are used to regulate and control the credit allocation among various users or customers.
Some of the prominent selective methods are as follows:
Consumer Credit Regulation
When the customers buy higher purchase goods like cars, bikes, computers, or other expensive assets, a certain percentage of their price is paid by the customer as the down payment, and the remaining is financed by the commercial bank.
This process is used to regulate the customer instalment on these hire purchase finances. If the central bank requires more credit to be given, it may deduce the amount of down payment along with increasing the repayment period, and if it wants less credit to be available, it may increase the amount of down payment by the customer and would reduce the time period.
Regulation of Margin Requirements
Regulation of margin requirements is done on credit union loans provided by commercial banks to their customers and are known as secured loans. The total amount of the security mortgaged when taking loans is not provided as a whole, the difference between the value of the security and the amount of loan provided is called margin requirements.
This is done to protect the bank during the recovery if the value of the security decreases in the future. The rate of margin requirements is increased to curb the bank credit, and it is reduced to expand the same.
Rationing of Credit
To limit the maximum or the ceiling amount of the loans provided by commercial banks, they tend to restrict that ceiling amount in a few cases for specific purposes. These credit limits can be increased or decreased in two ways to regulate the credit creating power of commercial banks.
The two methods are:
- The central bank limits the maximum amount of loans and advances provided by commercial banks.
- The central bank fixed the maximum ratio of loans and advances provided by the commercial banks in accordance with its total deposits.
Direct Action
When the policies implemented by the central bank are not taken into consideration by the commercial banks, then the central bank itself has to take charge. This process is called direct action.
It is not mandatory to enforce all banks but is restricted to the erring banks. This involves the refusal of rediscounting facilities or refusal of loans by the commercial bank, and it might be liable for a penalty if the direct action is issued.
Moral Suasion
Suasion is the act of influencing or persuading someone, so moral suasion refers to the requests, advice, or informal suggestions provided by the central bank to commercial banks. A meeting of the heads of all the commercial banks is convened by the central bank in order to explain a policy followed by an appeal to implement that policy in the daily working of the banks.
Publicity
Nowadays, in order to implement a credit policy, the central bank may take the help of publicity and ask for public opinion on a certain policy and may put forward its own views by the medium of publicity.
Conclusion
This article aims to educate people about the meaning and importance of credit control along with the necessary methods followed by the central bank for the same. The central bank is the apex banking body in a country and thus has all the powers to influence the credit supply in the country.
