By DSK

1. Credit Control Tools Used
by Central Bank in
Sri Lanka
Group - 23
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2. Meaning of credit control
• The central bank is having the authority to regulate
the amount of money supply in the economy as and
when required.
• Apart from the legal tender money, the credit money
is also playing almost equivalent role in the economic
system and almost affects in the same manner as the
legal money affects.
• Free and unlimited credit creation by the commercial
banks may create a serious threat in the economy, and
therefore, it becomes necessary to regulate the credit
money along with the legal money in the economy.
• Credit control means adjustment of volume credit to
suit the needs of the various sectors of the economy.
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3. Objectives of the credit control:
1. To maintain stability in the internal price level.
2. To maintain stability in the exchange rate.
3. To maintain stability in the money market of the
economy.
4. To eliminate or to reduce the vagaries of business
cycles by controlling and regulating the supply of
credit.
5. To maximize income, employment and output in the
economy.
6. To meet financial requirements of the economy not
only during normal times but also during the
emergency or war.
7. To promote economic growth.
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4. Methods of Credit Control
A. General Methods / Quantitative methods
of Credit Control
1. Bank rate policy
2. Open Market Operations
3. Variation in Reserve Ratio
B. Selective Methods / Qualitative methods
of Credit Control
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5. General or Quantitative methods
Bank Rate Policy
• The rate at which the central bank is willing to discount
the first class bills of exchange of the commercial banks
is known as the Bank Rate.
• In some countries it is also known as Discounting Rate.
• The rate at which general public is given loans and
advances and the bills of general public is discounted is
known as market rate or Interest rate.
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6. • When the commercial banks are continuously granting
loans and advances to the businessmen, then central
bank may not treat this as good for Economy.
• Now to control the lending activities of commercial
banks, their capacity of lending must be reduced.
• In the situation of Inflationary pressures, the CBSL
tends to increase the Bank rate.
• This will increase the cost of discounting the bills to
commercial banks.
• The lending activity will be reduced by the commercial
banks and therefore, the total supply of money in the
economy will also reduce.
• The reduction in the supply of money will also reduces
the inflationary pressures.
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7. • On the contrary, reduction in the bank rate will have
just the opposite effect.
• Lowering of the bank rate will imply that commercial
banks can borrow at a cheaper rate from the central
bank and therefore, they too will reduce their lending
rates.
• This will make bank credit cheaper and encourages
producers and traders to borrow and invest.
• The level of economic activity will increase resulting in
a general price level.
• This will offset the deflationary pressures.
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8. Conditions for the Success of the Bank
Rate Policy
• Close relationship between bank rate and interest
rate.
• Elastic economic structure; effects of changes on
the related factors.
• Well developed and well organized money market.
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9. Limitations of the Bank Rate Policy
• Commercial banks may not raise their lending rates
due to heavy surplus cash.
• In the optimistic atmosphere of inflation, the demand
for credit by businessmen will be interest inelastic.
• It makes credit costly for productive purposes and
speculative demand may increase.
• Non existence of well developed and well organized
money market in underdeveloped and developing
economies.
• Insensitivity towards the rate of interest, as it is a very
small part of the cost of production.
• Non banking financial intermediaries are not affected.
• Effects of other factors.
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10. General or Quantitative methods
Open Market Operations
• Open market operation simply imply the purchase or sale
by the central bank of any kind of eligible paper like
government securities or any other public securities or
trade bills, etc.
• When the central bank sells securities in the open
market, other thing being equal, the cash reserve of the
commercial banks decreases to the extent that they
purchase these securities.
• By this way the central bank can also reduce the amount
of consumers deposits with commercial banks to the
extent that these consumers acquire the securities sold
by the central bank.
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11. • The sell of securities by the central bank in the open
market ultimately contracts the credit in the economy.
• Conversely, when the central bank purchases the
securities from the commercial banks and general
public, the credit expands up to the extent that they
have sold their securities to the central bank.
• In this way the central bank can either expand or
contract the quantity of money in the economy and
can control the deflationary or Inflationary pressures in
the economy.
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12. Limitations of the Open Market
Operations
• Lack of well-developed securities market.
• Contradiction between bank rate and open market
operation.
• Restricted dealings. (central bank have to be ready to
incur loses, and that’s why this measure is generally
adopted for short run only to avoid the huge loses.)
• Difficulties in execution. (sale of securities is more
difficult as compared to purchase)
• Precaution for stabilizing the governments securities
market.
• Assumption of a constant velocity is not true.
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13. Usefulness of the Open Market
Operation Policy
• It enhances the efficiency of the bank rate policy as it is
complementary to it.
• It helps in maintaining the stability in the prices of
government securities by sell and purchase of it at a
suitable time.
• It also helps in contracting extreme trend in the
business.
• It helps in increasing the level of exports and indirectly
helps in improving the balance of payment situation.
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14. General or Quantitative methods
Variations in cash reserve ratio
• The countries where the money market is disorganized or less
developed, they can adopt this method of quantitative credit
control.
• The central bank is having the power to acquire a part of
reserves of commercial banks as being a bank of the bankers.
• The central bank is also having a power to alter the quantum of
this reserve according to the needs of the economy.
• The increase in the customary reserve ration contracts the
liquidity with commercial banks and lending power of the same.
• On the other hand, decrease in the reserve ration increases the
lending power of the commercial banks by increasing their
liquidity.
• The central bank changes the reserve amount according to the
inflationary or deflationary situations of the economy.
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15. Limitations of the Variations in the cash
Reserve ratio
• Large excess reserves are available with the
commercial banks.
• Determination of bank credit policy: other things are
considered at the time of deciding credit policies by
the commercial banks.
• Demand for bank credit: if demand does not changes,
there may not be a desired effect on the bank credits.
• Distortions caused by frequent use: can only be used
when the large changes are to be made in the credit
capacity.
• Discriminatory effect: non banking financial
institutions remains outside its purview.
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16. Selective or Qualitative methods
Objectives of the Selective Methods
• To diversify the credits towards the more productive uses.
• To tackle only the sensitive spot of the economy.
• To discourage excessive consumer demand for certain goods,
induced by hire-purchase and installment schemes.
• Discrimination can be made in favor of exporting industries,
and to influence the balance of payment situation.
• To eliminate the limitations of the quantitative methods and
to control all types of credits.
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17. Measures of selective credit control:
Fixation of Margin Requirements
• Fixation of margin requirements was introduced for the first
time in India in 1956. The term margin denotes that part of
the loan amount, which cannot be borrowed from bank.
Hence this portion of finance is to be compulsorily brought
by the borrower from own source.
• The Central bank has power to vary the margin requirements
depending upon the business conditions prevailing in the
country.
• By using this method, during the period of inflation with a
view to control credit, the Central bank raises the margin and
during deflation it lowers the margin to expand the credit.
This method also enables the commercial banks to direct
their funds to essential activities rather than speculative
activities.
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18. Measures of selective credit control:
Consumer Credit Regulation
Under this method consumers are given credit in a little
quantity and this period is fixed for 18 months;
consequently credit creation expanded within the limit.
This method was originally adopted by the U.S.A. as a
protective and defensive measure, there after it has
been used and adopted by various other countries.
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19. Measures of selective credit control:
Moral Suasion and Publicity
• Moral suasion aims at strengthening natural confidence and
understanding between the monetary authority and the
banks as well as financial institutions. It is not a statutory
obligation. It is only a persuasion of commercial banks not to
apply for further accommodation from Central Bank.
• Central bank has been sending letters periodically to the
commercial banks requesting them to cooperate with it for
controlling credit.
• The Central bank held regular meetings and discussions with
commercial banks to highlight the need for mutual
cooperation to implement the monetary policy effectively.
Here there is no element of compulsion. So the effectiveness
of this method depends on the willing cooperation extended
by the commercial banks.
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20. Measures of Selective Credit Control:
Direct Action
Under this method if the Commercial Banks do not follow
the policy of the Central Bank, then the Central Bank has the
only recourse to direct action. This method can be used to
enforce both quantitatively and qualitatively 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.
Even then the Commercial Banks do not fall in line, the
Central Bank has the constitutional power to order for their
closure. This method can be successful only when the Central
Bank is powerful enough and has cordial relations with the
Commercial Banks. Mostly such circumstances are rare when
the Central Bank is forced to resist to such measures.
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21. Limitations of the Selective methods
• The selective methods too excludes the non
financial institutions which indirectly making the
credits .
• The qualitative credit control can not be
materialized in the real sense as the commercial
banks can not watch over the utilization of the
loans it has granted.
• The velocity of bank money makes the measure
ineffective.
• Commercial banks are having the profit motives at
the centre, and that is why they may mischief by
manipulating the accounts and sanctioning loans
for forbidden uses.
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22. THANK YOU
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EU/IS/2014/MS/57
EU/IS/2014/MS/58
EU/IS/2014/COM/67
EU/IS/2014/COM/ 69