Credit Control by RBI
The core business of a banking company is to lend money in the form of loans and advances. Lending may be for
short term or medium term or long term. Lending money can be on secured or unsecured basis to different kinds
of borrowers for various purposes.
RBI has to facilitate the flow of an adequate volume of bank credit to industry, agriculture and trade to meet their
genuine needs. At the same time, to keep inflationary pressures under check, it has to restrain undue credit
expansion and also ensure that credit is not diverted for undesirable purposes. As the central monetary authority,
the Reserve Bank’s chief function is to ensure the availability of credit to the extent that is appropriate to sustain
the tempo of development and promote the maintenance of internal price stability. The Reserve Bank is empowered
under the Banking Regulation Act to issue directions to control loans and advances by banking companies.
Reserve Bank at its discretion may issue directions to all banking companies or to any particular banking company,
The Reserve Bank may determine the policy in respect of banks’ loans and advances and issue directions from
time to time.
The instruments of credit control are of two types as under:
(a) General or Quantitative
(b) Selective or Qualitative
Quantitative/General Credit Control
Under the General Credit Control, the instruments often employed by RBI are discussed below:
1. Bank Rate Policy
The Bank rate has been defined in Section 49 of RBI Act as “ the standard rate at which it (RBI) is prepared to buy
or rediscount bills of exchange or other commercial paper eligible to purchase under this Act. By varying the rate,
the RBI can to a certain extent regulate the commercial bank credit and the general credit situation of the country.
The impact of this tool has not been very great because of the fact that RBI does not have a mechanism to control
the unorganized sector.
2. Reserve Requirements
The Reserve Bank of India is vested with the powers to vary the CRR and SLR as explained above. By varying
reserve requirements, the RBI restricts/frees the flow of funds by way of credit to different sectors of the economy.
When SLR or CRR is increased by RBI, It reduces commercial banks’ capacity to create credit and thus helps to
check inflationary pressures
3. Open Market Operations
Open market operations are a flexible instrument of credit control by means of which the Reserve Bank on its
own initiative alters the liquidity position of the bank by dealing directly in the market instead of using its influence
indirectly by varying the cost of credit. Open market operations can be carried out by purchases and sales, by
Central Bank, of a variety of assets such as government securities (G-sec), commercial bills of exchange, Foreign
exchange, gold and even company shares.
In practice, however, RBI confines to the purchase and sale purchase of government securities including treasury bills. When the RBI purchases government securities from the banks, the latest deposits with it tend to increase adding to the cash reserves of banks and hence their capacity to expand credit increase. Conversely, when the RBI sells securities to the banks, their deposits with RBI would get reduced, contracting the credit base. The net result would be a contraction of credit and a reduction in money supply.
Repo Rate and Reverse Repo Rate:
Repos: The RBI introduced repurchase auctions (Repos) since December,1992 with regards to dated Central
Government securities. When banking systems experiences liquidity shortages and the rate of interest is increasing,
the RBI will purchase Government securities from Banks, payment is made to banks and it improves liquidity and
Reverse Repos : Since November, 1996 RBI introduced Reverse Repos to sell Govt. securities through auction
at fixed cut-off rates of interest. It provides short term avenues to banks to park their surplus funds, where there
is considerable liquidity and call rate has a tendency to decline. These two rates are, now-a- days, commonly
applied for reducing money supply or increasing it.
4. Moral Suasion
Moral Suasion indicates the advice and exhortations given by the Reserve Bank to the banks and other players
in the financial system, with a view to regulate and control the flow of credit, generally, or to any one particular
segment of the economy. This may be attempted through periodical discussions/communications. With a substantial
share of banking business being in the public sector, this tool has proved effective.
5. Direct Action
This technique indicates the denial of the Reserve Bank to extend facilities to the banks which do not follow
sound banking principles or where the Reserve Bank feels the capital structure of the bank is very weak. This is
not attempted frequently but is used in rare cases involving continual and wilful violations of policies of the
Reserve Bank/Govt. of India.
Selective Credit Control
Under the Selective Credit Control, the authority of the Reserve Bank is exercised by virtue of the provisions of
Section 21 and 35 A of Banking Regulation Act. The Reserve Bank may give directions to banks generally or to
any bank or a group of banks in particular on different aspects of granting credit, namely, –
(a) the purposes for which advances may or may not be made
(b) the margins to be maintained in respect of secured advances
(c) the maximum amount of advances or other financial accommodation which may be made by a bank to or
the maximum amount of guarantees which may be given by a bank on behalf of any one company, firm, association of persons or individuals, having regard to the bank’s financial position such as paid-up capital, reserves nd deposits and other relevant considerations, and
(d) the rate of interest and other terms of conditions subject to which advances or other financial accommodation may be granted or guarantees may be given.
While the first two instruments control the quantum of credit, the third instrument works as a leverage on the cost
of credit. Selective Credit Control is imposed to manage the balance between the supply and demand of the
essential commodities. The main purpose of the Selective Credit Control is to restrict the speculative hoarding of
essential commodities using bank credit.
Some of the main restrictions on loans and advances are:
(i) As per the provisions of the Banking Regulation Act, no banking company in India can grant loans or
advances against the security of its own shares
(ii) No banking company can hold shares in a company (a) as pledge or mortgagee in excess of the limit of 30 per cent of the Paid up capital of that company or 30 percent of the Bank’s Paid-up capital and Reserves, whichever is less. No banking company can commit to grant or grant loans or advances to or on behalf of any of its directors
(iii) Further restrictions on the loans and advance to the director as a partner, guarantor of any loans and
(iv) No banking company can grant loans against (a) Fixed Deposits of other Banks (b) Certificate of Deposits
The restrictions on different types of loans and advance may be imposed from time to time by the Reserve Bank
of India according to the requirement of the situation as well.