Model Answer
0 min readIntroduction
Credit control refers to the measures undertaken by a central bank to regulate the volume and cost of credit in an economy. These measures are crucial for maintaining price stability, controlling inflation, and promoting economic growth. The Reserve Bank of India (RBI), as the central bank, employs both direct and indirect methods of credit control. Quantitative methods, also known as indirect methods, operate by influencing the overall level of credit available in the economy, rather than targeting specific sectors. These methods are widely used due to their broad impact and relative ease of implementation.
Quantitative Methods of Credit Control
The quantitative methods employed by the RBI to control credit include:
1. Statutory Liquidity Ratio (SLR)
SLR is the minimum percentage of a bank’s net demand and time liabilities (NDTL) that it is required to maintain in the form of liquid assets like cash, gold, and approved government securities. Increasing the SLR reduces the amount of funds available for banks to lend, thereby contracting credit. Conversely, decreasing SLR expands credit availability. As of December 2023, the SLR is maintained at 18%.
2. Cash Reserve Ratio (CRR)
CRR is the percentage of a bank’s NDTL that it is required to keep with the RBI. A higher CRR reduces the amount of money banks have available for lending, thus curbing credit growth. Lowering the CRR increases the funds available for lending. Currently, the CRR stands at 4.5% (as of December 2023).
3. Repo Rate
The repo rate is the rate at which the RBI lends money to commercial banks against the security of government securities. An increase in the repo rate makes borrowing more expensive for banks, leading to a decrease in credit demand. A decrease in the repo rate encourages borrowing and expands credit. The current repo rate is 6.5% (as of December 2023).
4. Reverse Repo Rate
The reverse repo rate is the rate at which the RBI borrows money from commercial banks. An increase in the reverse repo rate incentivizes banks to deposit more funds with the RBI, reducing the amount of credit available in the market. A decrease in the reverse repo rate encourages banks to lend more. The current reverse repo rate is 6% (as of December 2023).
5. Open Market Operations (OMO)
OMO involves the buying and selling of government securities by the RBI in the open market. When the RBI sells securities, it absorbs liquidity from the market, reducing credit availability. Conversely, when the RBI buys securities, it injects liquidity into the market, expanding credit. OMO are a flexible and frequently used tool for managing liquidity.
6. Liquidity Adjustment Facility (LAF)
LAF is a corridor consisting of the repo and reverse repo rates. It allows banks to borrow short-term funds from the RBI to meet their liquidity requirements. The LAF provides a mechanism for the RBI to maintain stability in the money market and control short-term interest rates. The Marginal Standing Facility (MSF) rate, which is above the repo rate, acts as a safety valve for banks needing emergency funds.
| Instrument | Impact on Credit | Current Rate (Dec 2023) |
|---|---|---|
| SLR | Increase = Contraction, Decrease = Expansion | 18% |
| CRR | Increase = Contraction, Decrease = Expansion | 4.5% |
| Repo Rate | Increase = Contraction, Decrease = Expansion | 6.5% |
| Reverse Repo Rate | Increase = Contraction, Decrease = Expansion | 6% |
| OMO | Selling Securities = Contraction, Buying = Expansion | N/A |
Conclusion
In conclusion, the quantitative methods of credit control employed by the RBI – SLR, CRR, Repo Rate, Reverse Repo Rate, OMO, and LAF – are powerful tools for managing liquidity and influencing credit conditions in the economy. The RBI strategically adjusts these instruments to achieve its macroeconomic objectives of price stability and sustainable growth. The effectiveness of these tools depends on various factors, including the responsiveness of banks and borrowers to interest rate changes and the overall economic environment.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.