Monetary policy is a regulatory policy by which the central bank
or monetary authority of a country controls the supply of money, availability
of bank credit and cost of money, that is, the rate of Interest.
Monetary policy / monetary management is regarded as an
important tool of economic management in India. RBI controls the supply of
money and bank credit. The Central bank has the duty to see that legitimate
credit requirements are met and at the same credit is not used for unproductive
and speculative purposes. RBI rightly calls its credit policy as one of
controlled expansion.
The Monetary Policy of RBI is not merely one of credit
restriction, but it has also the duty to see that legitimate credit
requirements are met and at the same time credit is not used for unproductive
and speculative purposes RBI has various weapons of monetary control and by
using them, it hopes to achieve its monetary policy.
I) General / Quantitative Credit Control Methods:-
Quantitative credit
controls are used to maintain proper quantity of credit o money supply in
market. Some of the important general credit control methods are:-
1. Bank Rate Policy:-
Bank rate is the rate at which the Central bank lends money to the
commercial banks for their liquidity requirements. Bank rate is also called
discount rate. In other words bank rate is the rate at which the central bank re discounts eligible papers (like approved securities, bills of exchange, commercial papers etc) held by commercial banks.
Bank rate is important because it is the pace setter to other
market rates of Interest. Bank rates have been changed several times by RBI to
control inflation and recession.
2. Open market operations:-
It refers to buying and selling of government securities in
open market in order to expand or contract the amount of money in the banking
system. This technique is superior to bank rate policy. Purchases inject money
into the banking system while sale of securities do the opposite. During last
two decades the RBI has been undertaking switch operations. These involve the
purchase of one loan against the sale of another or, vice-versa. This policy
aims at preventing unrestricted increase in liquidity.
3. Cash Reserve Ratio (CRR)
The Gash Reserve Ratio (CRR) is an effective instrument of credit
control. Under the RBl Act of, l934 every commercial bank has to keep certain
minimum cash reserves with RBI. The RBI is empowered to vary the CRR between 3%
and 15%. A high CRR reduces the cash for lending and a low CRR increases the
cash for lending.
4. Statutory Liquidity Ratio (SLR)
Under SLR, the government has imposed an obligation on the banks to;
maintain a certain ratio to its total deposits with RBI in the form of liquid
assets like cash, gold and other securities. The RBI has power
to fix SLR in the range of 25% and 40% between 1990 and 1992 SLR was
as high as 38.5%. Narasimham Committee did not favour maintenance of high SLR.
The SLR was lowered down to 25% from 10thOctober 1997.It was further
reduced to 24% on November 2008.
5. Repo and Reverse Repo Rates
In determining interest rate trends, the repo and reverse repo
rates are becoming important. Repo means Sale and Repurchase Agreement.
Repo is a swap deal involving the immediate Sale of Securities and simultaneous
purchase of those securities at a future date, at a predetermined price. Repo
rate helps commercial banks to acquire funds from RBI by selling securities and
also agreeing to repurchase at a later date.
Reverse
repo rate is the rate that banks get from RBI for parking their short term
excess funds with RBI. Repo and reverse repo operations are used by
RBI in its Liquidity Adjustment Facility. RBI contracts credit by increasing
the repo and reverse repo rates and by decreasing them it expands credit.
II) SELECTIVE / QUALITATIVE CREDIT CONTROL METHODS:-
Under Selective Credit Control, credit is provided to
selected borrowers for selected purpose, depending upon the use to which
the control tries to regulate the quality of credit - the direction
towards the credit flows. The Selective Controls are:-
1. Ceiling on Credit
The Ceiling on level of credit restricts the
lending capacity of a bank to grant advances against certain controlled
securities.
2. Margin Requirements
A loan is sanctioned
against Collateral Security. Margin means that proportion of the value of
security against which loan is not given. Margin against a particular security
is reduced or increased in order to encourage or to discourage the flow of
credit to a particular sector. It varies from 20% to 80%. For agricultural
commodities it is as high as 75%. Higher the margin lesser will be the loan
sanctioned.
3. Discriminatory
Interest Rate (DIR)
Through DIR, RBI makes
credit flow to certain priority or weaker sectors by charging concessional
rates of interest. RBI issues supplementary instructions regarding granting of
additional credit against sensitive commodities, issue of guarantees, making
advances etc. .
4. Direct Action
It is too severe and is
therefore rarely followed. It may involve refusal by RBI to rediscount bills or
cancellation of license, if the bank has failed to comply with the directives
of RBI.
5
.
Moral Suasion
Under Moral Suasion, RBI issues periodical
letters to bank to exercise control over credit in general or advances against
particular commodities. Periodic discussions are held with authorities of
commercial banks in this respect.
