Saturday, August 22, 2009

Quantitative Credit Control

The important quantitative or the general methods of credit control are as follows.
(i) Bank Rate or Discount Rate Policy
(ii) Open Market Operations
(iii) Variable Cash Reserve Ratios
These methods are discussed in brief as under.
(i) Bank Rate or Discount Rate Policy: The bank rate policy is one of the principal methods of general credit control. It is the earliest method of credit control which was used by the Bank of England till the out break of the First World War. But later on with the change in economic conditions in Great Britain, the bank rate policy became rather ineffective and the Bank of England was compelled to advise other methods of credit control which were more effective than bank rate policy. The Central Bank, thus tries to control credit (through Bank Rate Policy) by influencing both the cost as well as the availability of credit. The cost of credit is influenced by changing the bank rate. By raising the bank rate or the discount rate, the Central Bank raises the cost of credit and by lowering the bank rate or the discount rate, it lowers down the cost of credit. The bank rate policy also affects the availability of credit by changing the conditions under which the Central Bank grants loans to the commercial banks. Thus the bank rate policy influences both cost as well as the availability of credit.
(ii) Open Market Operations: Open market operations as a method of credit control developed only after the First World War. The term ‘Open Market Operations’ is used in two senses. In the narrow sense open market operations imply the purchase and sale by the Central Bank of government, securities in the money market. Bank in the broad sense this term implies the purchase and sale by the Central bank not only of government securities but also of other eligible papers like bills and securities of private concerns.
(iii) Variable Cash Reserve Ratio: This method of credit control requires variations in the cash reserve ratio of commercial banks. It was first suggested by Lord Keynes who did much to popularize it as a method of credit control by the Central Bank. The theory underlying the method of Variable Cash Reserve Ratio is that by changing the cash reserve ratio, the cash reserves of the commercial banks can be directly changed, affecting thereby their ability to create credit in the economy. This can be illustrated by an example. Let us suppose that the commercial banks have excessive cash reserves on the basis of which they are creating too much credit. The Central Bank considers this over expansion of credit as harmful for the larger interests of the economy. So it will raise the cash reserve ratio which the commercial banks are required to maintain with the Central Bank. This will automatically sterilize a part of the cash reserves of the commercial banks and force them to curtail the creation of credit in the economy. In this way by raising the cash reserve ratio of the Commercial Banks, the Central Bank will be able to put an effective break on the inflationary expansion of credit in the economy.

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