Credit control by Reserve Bank of India

RBI has to facilitate the flow of an adequate volume of bank credit to industry, agriculture and
trade to meet their genuine needs. At the same time, to keep inflationary pressures under check,
it has to restrain undue credit expansion and also ensure that credit is not diverted for undesirable
purposes. As the central monetary authority ,the Reserve Bank’s chief function is to ensure the
availability of credit to the extent that is appropriate to sustain the tempo of development and
promote the maintenance of internal price stability. The Reserve Bank is empowered
under the Banking Regulation Act to issue directions to control loans and advances by banking
companies. Reserve Bank at its discretion may issue directions to all banking companies or to
any particular banking company ,The Reserve Bank may determine the policy in respect of
banks’ loans and advances and issue directions from time to time .

The instruments of credit control are of two types as under:

(a) General or Quantitative
(b) Selective or Qualitative

Quantitative/General Credit Control

Under the General Credit Control, the instruments often employed by RBI are discussed below:

1. Bank Rate Policy

The Bank rate has been defined in Section 49 of RBI Act as “ the standard rate at which it (RBI)
is prepared to buy or rediscount bills of exchange or other commercial paper eligible to purchase
under this Act. By varying the rate ,the RBI can to a certain extent regulate the commercial bank
credit and the general credit situation of the country.
The impact of this tool has not been very great because of the fact that RBI does not have a
mechanism to control the unorganized sector.

2. Reserve Requirements
The Reserve Bank of India is vested with the powers to vary the CRR and SLR as explained
above. By varyingreserve requirements, the RBI restricts/frees the flow of funds by way of credit
to different sectors of the economy.When SLR or CRR is increased by RBI, It reduces
commercial banks’ capacity to create credit and thus helps tocheck inflationary pressures.

3. Open Market Operations

Open market operations are a flexible instrument of credit control by means of which the
Reserve Bank on its own initiative alters the liquidity position of the bank by dealing directly in
the market instead of using its influence indirectly by varying the cost of credit. Open market
operations can be carried out by purchases and sales, by Central Bank, of a variety of assets such
as government securities (G-sec), commercial bills of exchange, Foreign exchange, gold and
even company shares. In practice, however, RBI confines to the purchase and sale purchase
of government securities including treasury bills. When the RBI purchases government securities
from the banks, the latest deposits with it tend to increase adding to the cash reserves of banks
and hence their capacity to expand credit increase. Conversely, when the RBI sells securities to
the banks, their deposits with RBI would get reduced, contracting the credit base. The net result
would be a contraction of credit and a reduction in money supply.

4. Moral Suasion
Moral Suasion indicates the advice and exhortations given by the Reserve Bank to the banks and
other player sin the financial system, with a view to regulate and control the flow of credit,
generally, or to any one particular segment of the economy. This may be attempted through
periodical discussions/communications. With a substantial share of banking business being in the
public sector, this tool has proved effective.

5. Direct Action
This technique indicates the denial of the Reserve Bank to extend facilities to the banks which do
not follow sound banking principles or where the Reserve Bank feels the capital structure of the
bank is very weak. This is not attempted frequently but is used in rare cases involving continual
and wilful violations of policies of the Reserve Bank/Govt. of India.

Selective Credit Control

Under the Selective Credit Control, the authority of the Reserve Bank is exercised by virtue of
the provisions of Section 21 and 35 A of Banking Regulation Act. The Reserve Bank may give
directions to banks generally or to any bank or a group of banks in particular on different aspects
of granting credit , namely, –

Under the Selective Credit Control, the authority of the Reserve Bank is exercised by virtue of
the provisions of
Section 21 and 35 A of Banking Regulation Act. The Reserve Bank may give directions to
banks generally or to any bank or a group of banks in particular on different aspects of granting
credit, namely, –
(a) the purposes for which advances may or may not be made
(b) the margins to be maintained in respect of secured advances
(c) the maximum amount of advances or other financial accommodation which may be made by
a bank to or the maximum amount of guarantees which may be given by a bank on behalf of any
one company, firm,
association of persons or individuals, having regard to the bank’s financial position such as paid
up capital, reserves nd deposits and other relevant considerations, and
(d) the rate of interest and other terms of conditions subject to which advances or other financial
Accommodation may be granted or guarantees may be given.
While the first two instruments control the quantum of credit, the third instrument works as a
leverage on the cost of credit. Selective Credit Control is imposed to manage the balance
between the supply and demand of the essential commodities. The main purpose of the Selective
Credit Control is to restrict the speculative hoarding of essential commodities using bank credit.
Some of the main restrictions on loans and advances are:
(i) As per the provisions of the Banking Regulation Act, no banking company in India can grant
loans or advances against the security of its own shares

(ii) No banking company can hold shares in a company (a) as pledge or mortgagee in excess of
the limit of 30 percent of the Paid up capital of that company or 30 percent of the Bank’s Paid-up
capital and Reserves, whichever is less. No banking company can commit to grant or grant loans
or advances to or on behalf of any of its directors

(iii) Further restrictions on the loans and advance to the director as a partner, guarantor of any
loans and advances

(iv) No banking company can grant loans against (a) Fixed Deposits of other Banks (b)
Certificate of Deposits The restrictions on different types of loans and advance may be imposed
from time to time by the Reserve Bank of India according to the requirement of the situation as
well.

RBI AS A CONTROLLER OF THE FOREIGN EXCHANGE

RBI has got the powers under Foreign Exchange Management Act, 1999 (FEMA) to prohibit,
restrict and regulate the following:
(a) transfer or issue of any foreign security by a resident of India and by a person residing
outside India

(b) transfer or issue of any security or foreign security by any branch, office or agency in India
owned by a person outside India

(c) any borrowing or lending in foreign exchange

(d) any borrowing or lending in rupees between a resident in India and a person outside India
(e) deposits between residents in India and residents outside India

(f) export, import or holding of currency or currency notes

(g) transfer of immovable property outside India other than a lease not exceeding five years by a
person resident in India
(h) acquisition or transfer of immovable property in India other than a lease by a person resident
outside India
(i) giving guarantee or surety in respect of any debt obligation or other viability incurred by
person resident in India to a person outside India and vice-versa.
The Reserve Bank does not deal in foreign exchange directly with the public. It gives license to
certain Scheduled Commercial Banks and other entities to deal in foreign exchange and those are
known as authorized dealers (ADs) in foreign exchange.
RBI AS BANKER TO GOVERNMENT
In terms of Section 20 and 21, the RBI has the obligation to transact the banking business of the
Central Government. Accordingly, it is required to accept money for account of the Government,
to make payments on its behalf up to the amount outstanding in the credit of the Government,
and also to carry out the Government’s exchange, remittance and other banking operations
including the management of the public debt. It acts as an advisor to the Government. RBI
performs similar functions on behalf of State Governments by virtue of agreements
entered into with them under Section 21A. RBI has entrusted the work of payment and receipts
on behalf of Government to its agents like State Bank of India and its Associate Banks. Some
other commercial banks are also doing some Government transactions as an agents of RBI.

Effectiveness of Credit Control Measures:

The effectiveness of credit control measures in an economy depends upon a number of factors.
First, there should exist a well-organised money market. Second, a large proportion of money in
circulation should form part of the organised money market. Finally, the money and capital
markets should be extensive in coverage and elastic in nature.

Extensiveness enlarges the scope of credit control measures and elasticity lends it adjustability to
the changed conditions. In most of the developed economies a favourable environment in terms
of the factors discussed before exists, in the developing economies, on the contrary, economic
conditions are such as to limit the effectiveness of the credit control measures.

RBI AS A CONTROLLER OF FOREIGN EXCHANGERBI AS A CONTROLLER OF

FOREIGN EXCHANGERBI AS A CONTROLLER OF FOREIGN EXCHANGE
REFERENCES

1. Banking law and practice in india - M L TANNAN

2. Banking law and practice by ICSI.
3. Reserve bank of india Act , 1934
4. Banking regulation Act , 1949