Q.8. Show how the Central Bank of a country
controls CREDIT?
The modern economy is a credit
economy. Credit is the life-blood of modern business. Accordingly control of
credit is essential for stability and orderly growth of an economy. There are
two types of controls used by the central banks in modern time for regulating
bank advances.
i. Quantitive or General Control
ii. Quantitive or Selective Credit
Controls
These are discussed below
1. Quantitive or General Control.
The aim of Quantitive Controls is to
regulate the amount of bank advances i.e. to make the banks lend more or lend
less. Some of the controls are
a.
Manipulation of Bank Rate
The bank rate is the rate at which
the central bank of a country is willing discount the first class bills. It is
thus the rate of discount of the central bank. If the central bank wants to
control credit, it will raise the bank rate. As a result the market rate will
go up. Borrowing will consequently be discouraged. Those who hold stocks of
commodities with borrowed money will unload their stocks, since as a result of
the rise in the interest. They will repay their loans thus the raising of bank
rate will lead to a contraction of credit.
b. Open
Market Operations
The term open market operations in
the wider sense means purchase or sale of any kind of papers in which it deals
like government securities or any other trade securities etc. In practice this
term is used to identify the purchase and sale of government securities by the
central bank. When the central bank sells securities in the open market it
receives payments in the form of a cheque on one of the commercial banks. If
the purchaser is a bank the cheque is drawn against the purchasing bank. In
both cases the result is the same. The cash balance of the bank in question
which it keeps with the central bank is to that extent reduced with the
reduction of its cash the commercial bank has to reduce its louding. Thus
credit contracts.
c. Varying
Reserve Ratio
The varying reserve ratio method is
comparative a new method of credit control used by central banks in recent
times. The minimum balance to be maintained by the member banks with the
central banks are fixed by law and the central bank is given statutory power to
change these minimum reserves. Variations of reserve requirements affect the
liquidity position of the banks and hence their ability to lend. It reduces the
excess reserves of member banks for potential credit expansions.
d. Credit
Rationing
Credit rationing means restrictions
placed by the central bank on demands for accommodation made upon it during
times of monetary stringency and declining gold reserves. The credit is
rationed by limiting the amount available to each applicant. Further the
central bank restrict its discount to bills maturing after short periods.
2. Quantitive or Selective Controls
In this regard the following methods
are used.
a. Varying
Margin Requirement
The central bank controls credit by
varying margin requirements. While lending money against securities the bank
keeps a certain margin. They do not advance money to the full value of the
security pledges for the loan. If it is desired to curtail bank advances the
central bank may issue directions that a higher margin be kept. The raising of
margin requirements is designed to check speculative in the stock market.
b. Regulation
of Consumer Credit
A part from credit for trade and
industry a great deal of credit in development countries at any time may be for
durable consumer goods like houses, motor cars, refrigerator etc on purchase or
installment credit system. Central seek to control such credit in several ways.
E.g.
by regulating the minimum down payments in specified goods.
by fixing the coverage of selective consumer goods
by regulating the maximum maturities on all installments credits.
by regulating the minimum down payments in specified goods.
by fixing the coverage of selective consumer goods
by regulating the maximum maturities on all installments credits.
c. Direct
Action
Direct action implies measures like
refusal on the part of the central bank to rediscount for the banks whose
credit policy is not in accordance with the wishes of the central bank or whose
borrowings are excessive in relation to their capital and reserves.
d. Moral
Sausion
The central bank may request and
persuade member banks to refrain from increasing their loans for speculative or
non-essential activities.
e. Publicity
The method of publicity is used by
issuing of weekly statistics, periodical review of the money market conditions,
public finances, trade & industry the issue of weekly statements of assets
& liabilities in the form of balance sheets.
BANKER’S BANK
Broadly speaking the central bank
acts as a bankers bank in three
capacities.
i. As the
Custodian of Cash Reserves
In every country its commercial bank
keep a certain percentage of their cash reserves with the central bank. Infact
the establishment of central bank makes it possible for the banking system to
secure the advantages of centralized cash reserves.
ii. As Lender
of the Last Resort
As a lender of the last resort in
times of emergencies the central bank gives financial accommodation to commercial
banks by rediscounting by bills. The monopoly of note issue and centralization
of cash reserves with the central bank increase its capacity of growing credit
and thus to rediscount the bills as the lender of last resort.
iii. As a
Bank of Central Clearance
The central bank act as a clearing
house for member banks. As the central becomes the custodian of cash reserves
of commerce was banks it is an easy and logical step for it to act as a
settlement bank or clearing house for other banks as the claims of banks
against one another are settle by simple transfers from and to other accounts.
CONTROL OF
CREDIT
By far the most important of all
central banks in modern times is that of controlling credit operations of
commercial banks i.e. regulating the volume and direction of bank loan. On the
level or volume of credit depends largely the level employment and the level of
prices in a country.
Maintenance
of Exchange Rates
Another important function of a
central bank is to keep stable the foreign value of the home currency. A stable
exchange rate is necessary to encourage foreign trade and inflow of foreign
investment which is so essential for accelerating the pace of economic growth
particularly underdeveloped countries.
Custodian of
Cash Reserves
It is the central bank which serves
as the custodian of a nation’s reserves of gold and foreign exchange. It is the
duty to take appropriate measures to safeguard these reserves.
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