Control on credit creation
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The document outlines the credit creation process and its significance in modern economies, emphasizing the need for control to prevent inflation and deflation. It details the Reserve Bank of India's (RBI) role in implementing monetary policy through various quantitative and qualitative tools to manage money supply. Specific tools like bank rate, cash reserve ratio, and open market operations are explained in terms of their effects on credit availability and economic conditions during inflation and recession.
Control on credit creation
- 1. Control on Credit Creation PREPARED BY HEMANT KUMAR JAIN PGT ECONOMICS KV AMBIKAPUR
- 2. Introduction • Credit creation process is the backbone of the modern economies. Development and growth of all the countries is based on credit creation capacity. • But it has its own limits also. If credit creation process becomes uncontrolled then it can harm the economy’s growth process. • If commercial banks distribute loans in excess then it may be a cause of increase in money supply in economy. Then it would create ‘inflationary conditions’ in economy. • If commercial banks distribute loans in short then it may be a cause of decrease in money supply in economy. Then it would create ‘deflationary conditions’ in economy. • So it is essential to control both situations. This will be done through ‘control on credit creation process’ by Central Bank or RBI. for this Monetary Policy is used.
- 3. Monetary Policy • The Reserve Bank of India (RBI) has the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934. • Monetary Policy refers to “The policy of change in money supply and various interest rates through which RBI wants to achieve the various goals like economic stability, growth of economy etc.” • Central Bank or RBI uses various tools for attaining its goals.
- 4. Tools / Instruments of Monetary Policy Quantitative Tools Bank Rate CRR SLR Open Market Operations RePO Rate Reverse RePO Rate Qualitative Tools Margin Requirement Rationing of Credit Moral Suasion Direct Action
- 5. Quantitative Tools • Quantitative tools refer to the tools which will affect the total volume of money supply in economy. • Policies are made to reduce money supply During the inflation and during recession policies are made to increase money supply by RBI.
- 6. Bank Rate:-The interest rate at which RBI lends money to commercial banks for long run is known as Bank Rate. Bank Rate ↓ • Cost of credit for Banks↓ • Interest rate for Public ↓ • Demand for loan ↑ • Supply of money↑ • Recession controlled Bank Rate↑ • Cost of credit for Banks↑ • Interest rate for Public ↑ • Demand for loan ↓ • Supply of money↓ • Inflation controlled
- 7. Cash Reserve Ratio:-it refers to the minimum percentage of bank’s total deposit that a commercial bank has to keep with RBI in the form of cash. Statutory Liquidity Ratio:-It refers to the percentage of banks total deposits that a commercial bank has to Keep with itself in the form of cash or any other liquid assets.
- 8. CRR / SLR↓ • Reserves to be kept with RBI↓ • Availability of funds with banks ↑ • Capacity of Loans providing by banks ↑ • Supply of money ↑ • Recession controlled CRR/ SLR↑ • Reserves to be kept with RBI↑ • Availability of funds with banks ↓ • Capacity of Loans providing by banks↓ • Supply of money↓ • Inflation controlled
- 9. Open Market Operation: - open market operation refers to sale and purchase of govt. securities by RBI in the open market on behalf of govt. Purchase of securities by RBI • Cash reserves of banks↑ • Credit creation capacity of banks↑ • Supply of money↑ • Recession controlled Sale of securities by RBI • Cash reserves of banks ↓ • Credit creation capacity of banks↓ • Supply of money↓ • Inflation controlled
- 10. RePO Rate:- The interest rate at which RBI lends money to commercial banks for short run is called RePO rate. RePO Rate↓ • Cost of credit for Banks↓ • Interest rate for Public ↓ • Demand for loan ↑ • Supply of money↑ • Recession controlled RePO Rate↑ • Cost of credit for Banks↑ • Interest rate for Public ↑ • Demand for loan ↓ • Supply of money↓ • Inflation controlled
- 11. Reverse RePO Rate:- it is the rate at which commercial banks can deposit their excess funds with RBI or central bank. Reverse RePO Rate↓ • Interest rate for Banks↓ • Funds deposited with RBI by banks ↓ • Funds available for loans with banks↑ • Supply of money↑ • Recession controlled Reverse RePO Rate↑ • Interest rate for Banks↑ • Funds deposited with RBI by banks ↑ • Funds available for loans with banks↓ • Supply of money↓ • Inflation controlled
- 12. Qualitative Tools • Qualitative Tools refer to the tools which do not affect the volume of money supply in economy but they can affect the direction of money supply. • Through these tools RBI can change the flow of money supply from high availability to low availability sectors/ goods.
- 13. Margin Requirement:-It refers to the difference between the value of asset which is mortgage and amount of loan. It is useful in case about the goods which are sensitive to inflation. Margin requirement ↓ • Loans provided by banks↑ • Demand for loan ↑ • Supply of money↑ • Recession controlled Margin requirement↑ • Loans provided by banks ↓ • Demand for loan ↓ • Supply of money↓ • Inflation controlled
- 14. Schedule for overview of concept Monetary Policy Tool Use of tool during Inflation Use of tool during Recession Bank Rate ↑ ↓ CRR ↑ ↓ SLR ↑ ↓ Open Market Operation Sale of securities Purchase of securities RePO Rate ↑ ↓ Reverse RePO Rate ↑ ↓ Margin Requirement ↑ ↓