Question

Explain in brief four methods usually adopted by the central bank to control credit in the country.

What are the methods adopted by the central bank to control credit?

Answer 1

1. Cash Reserve Ratio (CRR): Commercial banks are required to keep a specified percentage of their cash reserves with the central bank. An increase in the cash reserve ratio reduces the capacity of commercial banks to grant credit. On the other hand, a decrease in the cash reserve ratio expands the credit-granting capacity of commercial banks.
2. Credit Rationing: Sometimes, the central bank fixes a limit on the credit facilities available to commercial banks. The available credit is rationed among them according to the purpose of the credit. This method is used in an exceptional situation of monetary stringency. Moreover, this method cannot be used for the expansion of credit.
3. Moral Suasion: Under this method, the central bank requests and persuades the commercial banks not to grant credit for speculative and non-essential activities. It is an informal and non-statutory method. But commercial banks honour the authority of the central bank. The central bank may also issue directives to commercial banks to refrain from certain types of lending.
4. Publicity: The central bank issues reports and reviews statements of assets and liabilities. These publications keep commercial banks aware of conditions in the money market, public finance, trade, and industry in the country. They adjust their credit activities accordingly.