Credit control refers to the various measures taken by a central bank or monetary authority to regulate and manage the availability, cost, and use of credit in an economy. Effective credit control is crucial for achieving monetary policy objectives such as price stability, economic growth, and financial stability. Here are some common methods of credit control:
1. Credit Rationing
Central banks can directly influence the allocation of credit by rationing the amount of credit that banks can extend. This can be done by setting limits on the overall credit growth or on specific types of loans.
2. Open Market operations
Through open market operations, central banks buy or sell government securities. Purchasing securities injects money into the banking system, making it easier for banks to lend, while selling securities has the opposite effect. This influences the overall money supply and credit availability.
3. Margin Requirements
To control the flow of credit via the commercial banks, the central bank increases the amount of margin requirement needed to acquire loan. Margin is the difference between the loan amount and the value of the asset kept as mortgage against the loan. The greater this amount is, the less attractive loan taking becomes.
4. Repo Rates
Reporates, that is Repurchase agreement. Repo rate is the rate at which the central bank issues loan to the commercial banks in the hour of need. It is also used as one of the methods to control credit. For example, in the situation of inflation, this rate is increased so as to make lending from the central bank unattractive. This would incapacitate the commercial banks to issue credit due to dearth of funds.
5. Reverse Repo Rates
On the other hand, reverse repo rate is the rate at which the central bank borrows funds from the commercial banks. The central bank can also increase or decrease this rate so as to control the amount of cash available with the commercial banks to issue in the form of credit.
6. Cash reserve ratio (CRR)
Cash Reserve Ratio (CRR) is the amount of cash that the commercial banks are obligated to maintain as a reserve with the central bank at all times. This ratio is not constant and it responds to the changes in the markets. When the central bank needs to control credit, it may change the CRR. In the event of inflation, when the flow of credit needs to be reduced, the central bank increases the CRR, which mandates the commercial banks to keep relatively higher cash amounts as reserves with the central bank, hence incapacitating them to issue it as credit. Whereas, in the event of deflation, the opposite action is seen.
7. Statutory Liquidity Ratio (SLR)
Statutory Liquidity Ratio is the value of liquid assets that the commercial banks are to maintain at all times, as recommended by the central bank. SLR is used by the central bank as a measure to control the flow of credit in the instance of economic imbalance. When the economy faces inflation, the central bank may increase the SLR, so that higher amounts of liquid assets have to be kept by the commercial banks, so as to limit them from issuing these funds as credit. In the event of deflation, an exact inverse is witnessed.
8. Bank rate
Bank rate is the rate at which the central bank issues loans to the commercial banks. The difference between bank rate and Repo rate is that in the case of bank rate, the central bank does not mandate the deposit of any security. To control flow of credit, the central bank may decide to change the bank rate so as to incapacitate the commercial banks to further issue credit.
9. Moral suasion
Another measure that the central bank implements to control the credit is to persuade the commercial banks to follow the stricter rules of issuing credit. The central bank’s approach is to first request the commercial banks, and then to ultimately persuade them to adopt tight rules if they disagree in the first attempt.