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October 13, 2016

Banking Awareness 2017 in Simple Language - Lesson 4

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Banking Awareness 2017 Lesson 4

Dear Gr8 Ambitionists, here is the 4th lesson of our Banking Awareness 2017 series. This is the 3rd lesson about the Reserve Bank of India (RBI). In previous lessons, we have learnt about the Introduction, Structure, Organizations, Functions of RBI. In today's Banking Awareness lesson, we shall learn about the Methods of Credit Control by RBI. 

​What is Credit Control ?
In simple words, we can say that Credit Control is a set of actions used by a government to reduce the amount of money available for borrowing or spending. Using this, the RBI will control the demand and supply of money (liquidity) in the economy.

​Methods of Credit Control by RBI

Mainly, we can divide these methods into two categories. They are, 
  • Quantitative Methods
  • Qualitative Methods

​Banking Awareness - Methods of Credit Control by RBI

​There are several sub categories in these two methods. They are,

​Quantitative Methods
  • ​Bank Rate
  • ​Net Liquidity Ratio
  • ​Open Market Operation
  • ​Cash Reserve Ratio
  • Statutory Liquidity Ratio (SLR)
​Qualitative Methods
  • ​Direct Action
  • ​Credit Authorization Scheme
  • ​Moral Suasion 
  • ​Publicity
  • ​Margin Requirement
  • ​Rationing of Credit
Now let's have a detailed look at them.

Quantitative Methods :

  • Bank Rate : It is also known as discount rate. The bank rate is the rate at which the Reserve Bank advances to the member banks against approved securities or re-discounts the eligible bills of exchange and other papers. 
    • Note : It is a Long Term lending. 
  • Net Liquidity Ratio : It was introduced in the year 1964 by the Reserve Bank of India (RBI) to control excessive borrowings by commercial banks from RBI. Thus a commercial bank can borrow from the Reserve Bank at the Bank Rate only if it maintains minimum Net Liquidity Ratio to its total demand & time liabilities. 
  • Open Market Operation (OMO) : With OMO tool RBI buys and sells government securities from / to public and banks on its own account in order to control liquidity in market. 
  • Cash Reserve Ratio (CRR) : It started in June 1973. Commercial Banks are required to maintain certain percentage of NDTL (Net Demand & Time Liabilities) as cash on fortnightly average basis. 
    • Important Points to Note
      • If CRR increases then excess reserve of bank decreases. If CRR decreases the exess reser of bank increases. 
      • RBI will not pay any interest on CRR with effect from 31st March 2007.
  • Statutory Liquidity Ratio (SLR) : Every commercial bank is required to maintain liquid assets in form of cash, gold and other approved securities with RBI in order to control bank credit. There is no minimum limit but maximum limit is 40% of NDTL (Net Demand & Time Liability). 
    • Formula : Liquid assets (Demand + time liabilities) x 100

Qualitative Methods :

It aims at diverting the bank advances into certain productive functions from unproductive functions.
  • Direct Action : RBI can issue directives to the banking companies regarding their advances. These directions may relate to :
    • The purpose for which advances may or may not be made. 
    • The margins to be maintained in respect of secured advances. 
    • The maximum amount of advance to any borrower. 
    • The rate of interest and other terms and conditions for granting advances. 
  • Credit Authorization Scheme : Under this scheme the commercial banks has to obtain RBI's authorization before granting any fresh credit of Rs. 1 crore or more to any single party. 
  • Moral Suasion : In simple words, we can say that Suasion is nothing but Influence. The influence used to make banks and other financial institutions to keep to rules and act in the best interests of the economy. RBI periodically sends letter to the commercial banks to use restraint over their credit policies in general and in respect to certain commodities & unsecured loan in particular. 
  • Publicity : RBI uses media for the publicity of its views on the current market condition and its directions that will be required to be implemented by the commercial banks to control the unrest. 
  • Margin Requirement : The margin requirement of loan refers to the difference between the current value of the security offered for loans and the value of loans granted. 
    • Example : 
      • Value of Security = 100 Rs.
      • Loan granted = 80 Rs. 
      • Margin of loan = 20%
  • Rationing of Credit : It refers to fixation of credit quotas for different business activities. 

Other Methods :

  • Liquidity Adjustment Facility (LAF) : LAF was introduced by RBI during June 2000. It is a monetary policy tool which allows banks to borrow money through repurchase agreements. LAF consists of Repo & Reverse Repo operations. It helps to control inflation.
  • REPO Rate : Its abbreviation is Repurchase Rate. It was started in December 1992. It is  a short term borrowing. It is the rate at which the RBI lends money to commercial banks. Reduction in repo rate helps banks get money at a cheaper rate or vice-versa.
  • Reverse Repo Rate : It is the rate at which the RBI borrows money from commercial banks. 
  • Marginal Standing Facility (MSF) : It is effective from 9th May 2011. MSF is the rate at which scheduled banks could borrow funds overnight from the RBi against approved government securities maximum upto 2% of their NDTL. 
    • Important Note : MSF is pegged 100 bps or 1% above the repo rate.
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