Credit Control Techniques of the RBI – AHSEC Class 12 Finance Chapter 3

Here is a comprehensive study note for the AHSEC Class 12 Finance textbook, focusing on Chapter 3: Credit Control Techniques of the Reserve Bank of India.

Chapter 3:

Credit Control Techniques of the RBI

Summary Note

This chapter explains the various methods used by the Reserve Bank of India (RBI) to control the credit and money supply in the economy. This is a crucial function for achieving economic stability and growth.

• Meaning and Objectives of Credit Control:
  • Meaning: Credit control refers to the regulation of the lending activities of commercial banks by the central bank (RBI). It is a key component of the RBI’s monetary policy.
  • Objectives: The primary objectives of credit control are:
    1. Price Stability: To control inflation and deflation by regulating the money supply.
    2. Exchange Rate Stability: To maintain a stable exchange rate for the rupee, which is essential for foreign trade.
    3. Control of Business Cycles: To smoothen out economic fluctuations (boom and recession).
    4. Maximisation of Income and Employment: To promote economic growth by ensuring adequate credit for productive activities.
    5. Meeting Financial Requirements: To ensure that the credit needs of different sectors of the economy are met.
    6. Stability in the Money Market: To maintain stability and liquidity in the money market.
• Methods of Credit Control: The RBI uses two main types of credit control techniques: A. Quantitative (or General) Credit Control Techniques: These methods are designed to regulate the total volume or quantity of credit in the economy. They affect all sectors without discrimination.
  1. Bank Rate: This is the rate at which the RBI provides long-term finance to commercial banks. An increase in the bank rate makes borrowing from the RBI more expensive for commercial banks, which in turn increases their lending rates, leading to a contraction of credit. A decrease in the bank rate has the opposite effect, leading to credit expansion.
  2. Open Market Operations (OMO): This involves the buying and selling of government securities by the RBI in the open market. When the RBI sells securities, it absorbs liquidity from the market, reducing the lending capacity of banks (credit contraction). When it buys securities, it injects liquidity into the market, increasing the lending capacity of banks (credit expansion).
  3. Cash Reserve Ratio (CRR): This is the percentage of a bank’s Net Demand and Time Liabilities (NDTL) that it must keep as a cash balance with the RBI. An increase in CRR reduces the funds available with banks for lending (credit contraction). A decrease in CRR increases the funds available for lending (credit expansion).
  4. Statutory Liquidity Ratio (SLR): This is the percentage of NDTL that a bank must maintain in the form of liquid assets like cash, gold, and approved government securities. An increase in SLR restricts a bank’s lending capacity (credit contraction), while a decrease expands it.
  B. Qualitative (or Selective) Credit Control Techniques: These methods are used to regulate the flow of credit to specific sectors or for particular purposes. They aim to control the use of credit rather than its total volume.
  1. Issue of Directives: The RBI issues oral or written directives to commercial banks regarding their lending policies, cautioning them against lending to certain sectors or encouraging them to lend to priority sectors.
  2. Regulation of Consumer Credit: This involves restricting bank loans for the purchase of non-essential consumer durables (like cars, electronics) to curb consumer spending during inflation.
  3. Credit Rationing: The RBI fixes credit quotas for commercial banks for specific categories of loans and advances, thereby restricting the flow of credit to undesirable sectors.
  4. Margin Requirements: This refers to the difference between the market value of a security and the loan amount granted against it. By increasing the margin, the RBI can discourage borrowing for speculative purposes.
  5. Moral Suasion: This involves the RBI making requests, giving suggestions, and persuading commercial banks to follow its monetary policy directives without any compulsion.
  6. Direct Action: As a last resort, if a commercial bank does not adhere to the RBI’s directives, the RBI can take direct action against it. This may include imposing penalties, refusing rediscounting facilities, or even recommending the cancellation of its license.

Complete Textual Question Answers

Here are the answers to all the questions given at the end of Chapter 3.

A. Very Short Question Answer (1 Mark each)

1. What is the meaning of credit control?
   Ans: Credit control means the regulation of the credit or lending activities of commercial banks by the Reserve Bank of India.
2. What is the meaning of credit control techniques?
   Ans: Credit control techniques are the instruments or methods adopted by the Reserve Bank of India to control the lending activities of commercial banks to achieve its monetary policy objectives.

B. Short Answer Questions (2 Marks each)

1. Write two objectives of credit control.
   Ans: Two objectives of credit control are: (i) To maintain stability in the price level, and (ii) To attain stability in the exchange rate.
2. What are the two types of credit control techniques?
   Ans: The two types of credit control techniques are: (i) Quantitative or General credit control techniques, and (ii) Qualitative or Selective credit control techniques.
3. What is Bank Rate?
   Ans: Bank rate is the standard rate at which the RBI is prepared to buy or rediscount eligible bills of exchange or other commercial papers. It is the rate at which the RBI provides long-term finance to commercial banks.
4. What is Open Market Operation?
   Ans: Open Market Operation refers to the purchase or sale of Government securities by the Reserve Bank of India in the open market to regulate the money supply.
5. What is Cash Reserve Ratio?
   Ans: Cash Reserve Ratio (CRR) refers to the percentage of a scheduled bank’s net demand and time liabilities (NDTL) that it is required to maintain as a cash balance with the RBI.
6. What is Statutory Liquidity Ratio?
   Ans: Statutory Liquidity Ratio (SLR) refers to the requirement for banks to maintain a certain percentage of their net demand and time liabilities in the form of liquid assets like cash, gold, and unencumbered approved securities.
7. What is Issue of Directives?
   Ans: Issue of Directives is a qualitative credit control method where the RBI issues oral or written communications, warnings, or appeals to commercial banks regarding their lending policies.
8. What is Regulation of consumer credit?
   Ans: Regulation of consumer credit is a selective credit control method designed to curb consumer expenditure on non-essential consumer durables by restricting bank loans for such purchases.
9. What is credit Rationing?
   Ans: Credit rationing means the fixing of credit quotas by the RBI for commercial banks for special categories of loans and advances to restrict the flow of credit to undesirable sectors.
10. What is Margin requirements?
    Ans: Margin requirement is the difference between the loan amount and the market value of the asset deposited as security against the loan. The RBI can change this margin to control credit.
11. What is moral suasion?
    Ans: Moral suasion implies the ‘request’ or persuasion made by the RBI to commercial banks to comply with the general monetary policy, without using any legal compulsion.

C. Long Answer Questions (Type-I) (5 Marks each)

1. State the various objectives of credit control.
   Ans: The various objectives of credit control by the RBI are:
   • Stability in price level: To control inflation and deflation.
   • Exchange rate stability: To maintain the value of the rupee against foreign currencies.
   • Control of cyclical fluctuations: To moderate the effects of business cycles (boom and recession).
   • Maximisation of income, employment, etc.: To promote economic growth.
   • Meets financial requirements: To ensure adequate credit is available for the country’s needs.
   • Stability in the Money market: To ensure the smooth functioning of the money market.
2. Briefly state the qualitative credit control techniques applied by the RBI.
   Ans: The qualitative or selective credit control techniques applied by the RBI are:
   • Issue of Directives: The RBI issues directives to banks regarding their lending policies.
   • Regulation of Consumer Credit: It restricts loans for purchasing non-essential consumer goods.
   • Credit Rationing: It fixes credit quotas for banks for specific types of loans.
   • Margin Requirements: It changes the margin required for loans against securities to control speculative credit.
   • Moral Suasion: It uses persuasion and requests to make banks follow its policies.
   • Direct Action: It takes punitive action against banks that do not comply with its directives.

D. Long Answer Questions (Type-2) (8 Marks each)

1. Discuss the quantitative credit control techniques applied by the RBI.
   Ans: The quantitative credit control techniques are designed to regulate the total volume of credit in the economy. The main techniques applied by the RBI are:
   • Bank Rate: The RBI changes the bank rate to influence the cost of credit. A higher bank rate makes loans expensive and contracts credit, while a lower rate makes loans cheaper and expands credit.
   • Open Market Operations (OMO): The RBI buys or sells government securities. Selling securities soaks up liquidity from the banking system, reducing their capacity to lend. Buying securities injects liquidity, increasing their lending capacity.
   • Cash Reserve Ratio (CRR): The RBI mandates banks to keep a certain percentage of their deposits as cash with it. By increasing the CRR, the RBI reduces the loanable funds available with banks, thus contracting credit. Decreasing the CRR has the opposite effect.
   • Statutory Liquidity Ratio (SLR): The RBI requires banks to maintain a certain percentage of their deposits in liquid assets. An increase in SLR locks up more funds, reducing the banks’ ability to grant loans and contracting credit. A decrease in SLR frees up funds for lending.
2. Discuss the credit control techniques applied by the RBI.
   Ans: (This is a comprehensive question. For the answer, you should discuss both Quantitative and Qualitative techniques in detail. First, explain the meaning of Quantitative techniques and discuss Bank Rate, OMO, CRR, and SLR. Then, explain the meaning of Qualitative techniques and discuss Issue of Directives, Regulation of Consumer Credit, Credit Rationing, Margin Requirements, Moral Suasion, and Direct Action.)

Previous Year AHSEC Question Answers (2015-2025)

Short Questions (1-2 Marks)

• What is Bank Rate? (AHSEC 2015, 2019)
  Ans: Bank rate is the standard rate at which the RBI is prepared to buy or rediscount eligible bills of exchange or other commercial papers. It is the rate at which it provides long-term finance to commercial banks.
• What do you mean by Open Market Operations? (AHSEC 2016, 2020)
  Ans: Open Market Operations refer to the buying and selling of government securities by the RBI in the open market to regulate the money supply and credit in the economy.
• What is CRR? (AHSEC 2017)
  Ans: Cash Reserve Ratio (CRR) is the percentage of a bank’s Net Demand and Time Liabilities (NDTL) that it must maintain as a cash balance with the RBI.
• Mention two qualitative methods of credit control. (AHSEC 2018)
  Ans: Two qualitative methods of credit control are (i) Moral Suasion and (ii) Regulation of Consumer Credit.

Long Questions (5-8 Marks)

• Explain the quantitative methods of credit control of RBI. (AHSEC 2017, 2022)
  Ans: (This answer is the same as the textual Long Answer Question D.1. Please refer to that answer above).
• Discuss the objectives of credit control. (AHSEC 2019)
  Ans: (This answer is the same as the textual Long Answer Question C.1. Please refer to that answer above).

10 Most Important Questions in English

1. What is the primary difference between quantitative and qualitative credit control?
   Ans: Quantitative controls regulate the total volume of credit in the economy, while qualitative controls regulate the flow or direction of credit for specific purposes or sectors.
2. How does Open Market Operations (OMO) work to control inflation?
   Ans: To control inflation, the RBI sells government securities in the open market. This absorbs excess money from the banking system, reducing the banks’ lending capacity, which in turn reduces the money supply and helps control inflation.
3. Define Statutory Liquidity Ratio (SLR).
   Ans: SLR is the percentage of a bank’s Net Demand and Time Liabilities that it must maintain in the form of liquid assets like cash, gold, and unencumbered approved government securities.
4. What is ‘Direct Action’ in the context of credit control?
   Ans: Direct Action is a punitive measure taken by the RBI against a commercial bank that fails to comply with its directives. It can include imposing penalties or refusing to provide financial assistance.
5. Why is ‘Bank Rate’ considered an important tool of credit control?
   Ans: Bank Rate is important because it directly influences the cost of borrowing for commercial banks from the central bank, which in turn affects the interest rates they charge to the public, thereby influencing the overall demand for credit.
6. Explain ‘Moral Suasion’ with an example.
   Ans: Moral Suasion is the use of persuasion by the RBI to influence banks. For example, during an inflationary period, the RBI Governor might hold a meeting with the heads of major banks and ‘request’ them to be more cautious in their lending to curb speculative activities.
7. What is the main objective of regulating consumer credit?
   Ans: The main objective is to control spending on non-essential consumer goods during periods of inflation, thereby reducing aggregate demand in the economy.
8. How does changing the ‘Margin Requirement’ control credit?
   Ans: By increasing the margin requirement for a loan against a security, the RBI reduces the amount of loan a person can get for that security. This discourages borrowing, especially for speculative purposes, and thus controls credit.
9. Which is considered a more direct method of credit control: Bank Rate or CRR? Why?
   Ans: CRR is considered a more direct method because it directly affects the volume of loanable funds available with commercial banks, whereas the Bank Rate works indirectly by influencing the cost of credit.
10. What is the main purpose of ‘Credit Rationing’?
    Ans: The main purpose of Credit Rationing is to channel credit away from non-essential or undesirable sectors and direct it towards priority sectors of the economy by fixing credit quotas.