Saturday, August 22, 2009

Selective Credit Control

Qualitative or Selective credit control is a recent development in monetary management by the Central Bank. The objective of qualitative control is to divert the flow of credit into particular uses or channels in the economy. Infact the objective of selective credit control is to encourage the flow of credit into those uses or channels which help the growth of economy.
The following are the main types of selective credit controls exercised by the Central Bank.
1. Fixation of Margin Requirements on secured loans.
2. Regulation of Consumer Credit.
3. Control through Directives by Central Bank.
4. Rationing of Credit.
5. Moral Suasion.
6. Publicity.
7. Direct Action.
All the above mentioned types of selective credit control are discussed as under.
1. Fixation of Margin Requirements: The margin is the difference between the ‘loan value’ and the ‘market value’ of securities offered by borrowers against secured loans. By prescribing the margin requirements on secured loans, the Central Bank does not permit the commercial banks to lend their customers the full value of the securities offered by them, but only a part of their market value. To start with, this method was applied to stocks and shares only. But now its scope has been extended to cover goods stored in authorized godowns. At present, this method is being extensively used by developing as well as developed countries to check the flow of credit into undesirable speculative activities.
2. Regulation of Consumer Credit: As we are aware that, durable consumer goods such as T.Vs, refrigerators, washing machines, motor vehicles etc are purchased in Western countries by the consumer on instalment credit. According to this system, a certain percentage of the price is paid by the consumers in downright cash. The remaining part of the price is financed by bank credit which is repayable by the consumer in instalments spread over a specified period of time. The objective of this method is to curb the consumption of durable consumer goods which happen to be in short supply in the economy.
This method controls excessive consumer demand for durable goods. This method was first introduced by the Federal Reserve System in the U.S.A. in August 1941 to regulate the terms and conditions under which credit repayable in instalments could be extended to the consumers for purchasing durable goods. Later on the method of consumer credit regulation was adopted by Central Banks in other countries, such as those of Britain, Canada, Australia and New Zealand.
3. Control through Directions: Sometimes, selective credit controls may be enforced on the commercial banks through directives issued by the Central Bank from time to time. These directives may be in the form of written orders, appeals or warnings by the Central bank addressed to the commercial banks. These directives are issued to the commercial banks in order to realize the following objectives.
i) To divert credit less urgent uses to more urgent uses.
Or from less productive uses to more productive use.
ii) To prohibit lending for certain purposes altogether.
iii) To fix maximum limits of credit for certain purposes.
The commercial banks generally decide by the directives issued to them by the Central Bank from time to time. These directives generally supplement the traditional weapons of control, such as, the bank rate and open market policy.
4. Rationing of Credit: This is another weapon in the armoury of the Central Bank. Rationing of credit as an instrument of credit control was first used by the Bank of England in the closing years of the eighteenth century. The term ‘rationing of credit’ implies two things, first it means that the Central Bank fixes a limit upon its rediscounting facilities for any particular banks. Second it means that the Central Bank fixes the quota of every affiliated bank for financial accommodation from Central Bank. This method of rationing of credit has a historical background. Due to the operation of the usuary law, the Bank of England could not raise its rate of discount beyond maximum limit of 5 percent. It was not possible for the bank to discourage excessive borrowing from it by the banks during periods of monetary stringency. The Bank of England was thus compelled to ration credit among the member banks. But after the repeal of usuary law, the method of rationing of credit lost its importance in Britain. Central Banks in other countries such as Germany, France, and Mexico also make use of this method to check excessive borrowing by the commercial banks from Central Bank. The rationing of credit as a method of credit control occupied a prominent place in Soviet Economic planning.
5. Moral Suasion: The moral suasion method is frequently employed by the Central Bank to exercise control on the commercial banks. This method involves advice, request and persuasion with commercial banks to cooperate with the Central Bank in implementing its credit policies. If the commercial banks do not abide by the advice or request of the Central Bank, no punitive action is taken against them. The Central Bank merely uses its moral influence with the commercial banks to prevail upon them to accept its policies. For example, the Central Bank may request the commercial banks not to extend credit for speculative purposes or it may request the member banks not to press with the demand for additional financial accommodation from it. The Central Bank under this method can only appeal to the patriotic and nationalistic sentiments of the commercial banks. The Central Bank may even hold occasional conferences with the commercial banks to make its policies known to them. Anyway, the method of moral suasion is a purely informal method with no legal sanction.
The method of moral suasion has also its limitations. The main drawback of this method is that it lacks legal sanction. As such, it fails to be effective at a line when the forces of credit expansion in the economy happen to be very strong and powerful. Nevertheless, this method has its uses and can serve as useful supplement to other methods of credit control.
6. Publicity: Central Banks have adopted publicity as an instrument of credit control. They use this instrument not only for influencing the credit policies of commercial banks but also to educate and influence public opinion in the country. Infact publicity is an essential instrument to ensure the effectiveness of the monetary policy of The Central Bank. Under this method the Central Bank gives wide publicity to what is good and what is bad in credit system of the country. The Central Bank gives wide publicity to its thinking in the field of bank credit. The commercial banks, in their turn are guided by the ideas of the Central Bank in matters relating credit creation.
Publicity as a method of credit control has been very extensively used in the U.S.A. when the Federal Reserve System regularly publishes reports regarding the credit creating activities of the member banks. The method is also widely used by the Central Bank in Germany and Sweden. The State Bank of Pakistan also periodically published returns and statements about the affairs of commercial banks. There is some controversy going on amongst the economists with regard to effectiveness of publicity as a method of credit control. While some economists feel that publicity is useful instrument of credit control, there are others who are of the opinion that it is at best only a minor instrument of credit policy.
7. Direct Action: The method of direct action is most extensively used by the Central Bank to implement their credit policies. This methods can be used to enforce both quantitative as well as qualitative credit controls by the Central Banks. This method is not used in isolation, it is used as a supplement to other methods of credit control.
This method of direct action implies the use of coercive measures against those commercial banks whose credit policies do not confirm to the declared objectives of the Central Bank. This method also involves the issuing of general instructions by the Central Bank to all the commercial banks. It may also take the form of special instructions by the Central Bank issued to erring banks. It should however by remembered that the method of direct action is sued only as last resort when other methods fail to yield the desired result.
The method of direct action can prove effective only when the Central Bank is armed with sufficient Legal powers to enforce its directives on the commercial banks. Hence the Central Banks in several countries have been given statutory powers to take drastic action against the defaulting banks. According to recent Central Banking legislation, the Central Banks in different countries have been given extensive powers under the law to formulate the general credit policy to be followed by the commercial banks. They have also been authorized to prescribe rates of interest to be charged on different types of loans and advances.

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