m&b presentation .pptx
- 1. Instruments for credit control • Group members • Maham jabeen • Reeba akram • Rida abbas • Ramza Shafique
- 2. Credit Control Credit control is defined as the lending strategy that banks and financial institutions employ to lend money to customers. The strategy emphasizes on lending money to customers who have a good credit score or credit record. Quantitative or General Methods: The methods used by the central bank to influence the total volume of credit in the banking system, without any regard for the use to which it is put, are called quantitative or general methods of credit control.
- 3. Instruments of credit control The important quantitative methods of credit control are- (a) bank rate, (b) open market operations, (c) cash-reserve ratio. These methods regulate the lending ability of the financial sector of the whole economy and do not discriminate among the various sectors of the economy.
- 4. Manipulation of bank rate Bank Rate policy The bank rate policy is the traditional method of credit control used by a central bank. The bank rate or the discount rate is the rate at which a central bank is prepared to discount the first-class bills of exchange. In its capacity as ‘lender of last resort’, the central bank helps the commercial banks by rediscounting the first-class bills (i.e., by advancing loans against approved securities). The rate of interest which the central bank charges from the commercial banks for rediscounting the bills is called bank rate. The bank rate is distinct from the market interest rate. The bank rate is the rate of discount of the central bank, while the market interest rate is the lending rate charged in the money market by the ordinary financial institutions. There is a direct relationship between the bank rate and the market interest rates. A change in the bank rate leads to change in other interest rates prevailing in the market. In this sense, bank rate is the effective rate for lending or borrowing which prevails in the market.
- 5. Effects of Bank Rate Policy: Various effects of bank rate policy are discussed below: • Effect on Cost and Availability of Credit: Bank rate policy influences both the cost and the availability of credit lo the commercial banks. By changing the bank rate, the central bank affects the cost of credit; by raising the bank rate, it raises the cost of credit and by lowering the bank rate, it lowers the cost of credit • Determination of Interest Rates and Money Supply: The central bank, through its bank rate policy, is able to influence the interest rates and the money supply in the economy. Changes in the bank rate influence the interest rates in the money market. Changes in the amount that the central bank is willing to lend influence the money supply. But, the central bank cannot simultaneously set both interest rates as well as the money supply.
- 6. • Effect on the Level of Economic Activity: • The bank rate policy affects the level and structure of interest rates and thereby the level of economic activity in an economy. A change in the bank rate leads to a corresponding change in the other interest rates of the market. This makes credit either dearer or cheaper. The changes in the market interest rates affect the willingness of the businessmen to borrow and invest. This will, in turn, affect the level of economic activity and the price level. • Bank Rate Policy during Inflation and Depression: Bank rate policy is used to control the inflationary as well as deflationary situations in the economy. During inflation, the central bank increases the bank rate. As a result, other interest rates in the money market will rise, thereby rising the cost of bank credit. This will discourage the businessmen from borrowing from banks. The Volume of credit will decrease, the level of economic activity will decline and the price level will fall. During depression, the bank rate is reduced. It will reduce the market rates of interest, make the bank credit cheaper, encourage the businessmen to borrow, and invest, push up the level of economic activity and the price level.
- 7. Limitations of Bank Rate Policy: Ineffective in Controlling Deflation: Bank rate policy is more ineffective in off-setting depression than in controlling inflation. When bank rate is lowered during a period of deflation, the resulting lower rates of interest may not be able to induce the entrepreneurs to borrow and invest more because of falling prices and falling profits. Indiscriminatory: The bank rate policy is indiscriminatory in nature. In other words, it makes no distinction between the productive and unproductive activities in the country. For example, if the bank rate is raised to control speculative activities, it will also adversely affect the genuine productive activities.
- 8. Varying reserve Requirements Variations of reserve requirements affect the liquidity position of the banks and hence their ability to lend. The raising of reserve requirements is an anti- inflationary measure inasmuch as it reduces the excess reserves of member-banks for potential credit expansion. Reserve requirements are the amount of funds that a bank holds in reserve to ensure that it can meet liabilities in case of sudden withdrawals. Reserve requirements are a tool used by the central bank to increase or decrease the money supply in the economy and influence interest rates. Reserve requirements are currently set at zero as a response to the COVID-19 pandemic
- 9. The method of variable cash reserve ratio or changing minimum cash reserves to be kept with the central bank by the commercial banks is comparatively new method of credit control used by the central banks. the method of cash reserve ratio is a more direct and more effective method in dealing with the abnormal situations when, for example, there are excessive reserves with the commercial banks based on which they are creating too much credit, leading to inflationary situation. Thus, a change in reserve requirements affect the money supply in two ways- (a) it changes the level of excess reserves; (b) it changes the credit multiplier.
- 10. Excess reserves are capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities. These required reserve ratios set the minimum liquid deposits (such as cash) that must be in reserve at a bank; more is considered excess. Credit Multiplier Economists and bankers often look at a multiplier effect from the perspective of banking and money supply. This multiplier is called the money supply multiplier or just the money multiplier. The money multiplier involves the reserve requirement set by the Board of Governors of the Federal Reserve System and it varies based on the total amount of liabilities held by a particular depository institution. The most recent Federal Reserve reserve requirements prior to the Covid-19 pandemic mandated that institutions with more than $127.5 million have reserves of 10%. This changed as the Fed responded to the Covid-19 pandemic by eliminating these requirements to free up liquidity.
- 11. Limitations of Variable Cash Reserve Ratio: This method is not effective when the commercial banks keep very large excessive cash reserves. In such a case ever if cash reserve ratio is raised, ample reserves remain after satisfying the minimum requirements. This method is not effective when the commercial banks happen to possess large foreign funds. Thus, even if the central bank reduces the reserves by raising the cash reserve ratio, these banks will continue to create credit based on the foreign funds. Despite the limitations, the variable cash reserve ratio is a useful method of credit control. It assumes special significance in the underdeveloped countries
- 12. Differences: • Bank Rate Policy: It is an indirect method of influencing the volume of credit in the economy. It first influences the cost and availability of credit to the commercial banks and thereby, influences the willingness of the businessmen to borrow and invest. • Varying Reserve Requirement It is the most direct method because it controls the volume of credit by directly influencing the cash reserves of the commercial banks. (ii) It produces immediate effect on the cash reserves of the commercial banks. It is suitable when large changes in the cash reserves of the commercial banks are required.
- 13. Conclusion: • The comparative study of the two methods of credit control shows that each method has its own merits and demerits. No method, taken alone, can produce effective results. The correct approach is that, instead of selecting this method or that method, all the three methods should be judiciously combined in right proportions to achieve the objectives of credit control effectively.
- 14. Thank you