Control Of Credit By The Reserve Bank Of India
In India, the legal framework of the RBI’s control over the credit structure has been provided under the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949. The various techniques of credit regulation in India are :
The Bank Rate Policy
The RBI, like all other central banks, is empowered to use bank rates as an instrument of credit control. Proper organisation of the various components of the money market is a prerequisite for the success of the RBI’s bank rate policy. From its very inception until September 1964, the RBI maintained its bank rate below 5 per cent As a part of the financial sector reforms the RBI has taken steps to strengthen the bank rate as a policy instrument for transmitting signals of monetary and credit policy. With this new role assigned to the bank rate it has been brought down to 6.0 per cent per annum in phases As a policy rate, it is now defunct as the RBI has decided to shift to a single policy rate regime is repo-rate.
Open Market Operations
The technique of open market’ operations as an instrument of credit control was developed later. In fact, the need for open market operations was felt only when the bank rate policy turned out to be a rather weak instrument of monetary control. At present, the RBI Act authorises the RBI to conduct purchase and sale operations in the government securities, treasury bills and other approved securities. The RBI is also empowered to buy and sell short term commercial bills. In India, since government securities are predominantly held by institutional investors, notably banks and insurance companies, dealings of the RBI in regard to open market operations are mostly confined to them. Now the RBI normally does not purchase any securities against payments in cash. The current policy of making purchases only in switch transactions aims at preventing an unrestricted increase in liquidity.
The Cash Reserve Ratio
The Cash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBI (Amendment) Act 1962, the RBI is empowered to determine CRR for the commercial banks in the range of 3 per cent to 15 per cent for the aggregate demand and time liabilities. This technique of credit control was used quite often. The Narasimham Committee in 1991 did not favour the use of CRR to combat inflationary pressures. Now it is used selectively.
The Statutory Liquidity Ratio
The Banking Regulation ( Amendment) Act 1962 provides for maintaining a minimum statutory liquidity ratio (SLR) of 25 per cent by the bank against their net demand and time liabilities. The Amendment Act also empowers the RBI to raise to SLR upto 40 per cent if it is considered necessary to control liquidity. Thus the RBI is tested with the power to determine SLR for commercial banks. The RBI used this power to raise SLR quite often during the 1970s and 1980s. Effective from September 22, 1990, SLR was made as high as 38.5 per cent of the commercial banks’ net demand and time liabilities. The SLR remained at this level upto March 31, 1992. There were two reasons why the RBI had raised the SLR for banks. First, it reduced commercial banks’ ability to crate credit and thus eased inflationary pressures. Secondly, it made larger resources available to the State.
The Narasimham Committee did not favour maintenance of a high SLR. In its opinion, the SLR had become an instrument in the hands of the government to mobilise resources in support of the Central and State budgets. Keeping in view the recommendations of the Narasimham Committee the government decided to reduce SLR in stages over a three year period from 38.5 per cent to 25 per cent. The SLR was lowered down to 25 per cent effective from October 10, 1997. Thereafter it was reduced in stages.