Methods of Credit Control

Methods of Credit Control –

The central bank of a country is the apex body of the monetary system which has the responsibility of controlling the volume and direction of credit in the economy. The volume and direction of bank credit has a direct effect on the economic activities. Excessive credit will create the inflation in the economy while deficiency of adequate credit can create disinflation in the economy. Lack of the adequate credit also slow the economic growth. In order to maintain economic stability and to promote economic growth, central bank seeks to control credit according to the needs of the situation.

There are two types of methods to control credit –

1. Quantitative Methods or General Methods –

These methods seek to change the total quantity of the credit in the economy.

These are –  

a. Changing the Bank Rate

b. Open Market Operations

c. Changing the Cash Reserve Ratio

2. Qualitative Methods or Selective Methods –

These methods aim at changing the volume of a specific type of credit. or

These methods affects the use of credit for particular or specific purposes.

1. Quantitative Methods –

Bank Rate Policy –

Bank rate is the minimum rate at which the central bank of a country gives the loans to the commercial banks of the country. It is also called Discount rate.

By changing the bank rate, central bank can control the credit created by the commercial banks. Credit is an important part of the money supply. So, change in supply of creates change in the money supply. Change in money supply affects aggregate demand which in turn changes the output and prices in the economy.

For instance, when central bank raises the bank rate, the cost of borrowing by the commercial banks from the central bank also raises. This will discouraged the commercial banks to borrow from central bank. When the bank rate is raised, commercial banks will also raise their lending rates. This will discourage the borrowing by the businessmen and other borrowers and reduce the money supply in the economy. Reduction in the money supply will reduce the aggregate demand. This reduction in demand would reduce the the prices and inflation in the economy.

In times of recession or depression this process would be reversed.

Change in the bank rate affects the credit creation by the commercial banks by changing the cost of credit. Change in the cost of credit affects the borrowing by the commercial banks, which in turn affects the demand for credit by the businessmen and other borrowers.

Limitations of the Bank Rate Policy –

Bank rate policy doesn’t have always the desired effects on the investment, output and prices. There are some certain conditions which must be met for successful working of the bank rate policy.

1. All other rates such as lending rate of commercial banks should follow the bank rate in its movement so that bank credit should expand or contract as desired.

This can only happen in a well organised money market which is very difficult.

If the commercial banks have a considerable reserve of their own, then their dependency on the borrowed funds may be vary less. So that, the change in the bank rate won’t have desired effect on the supply of credit.