Role of RBI in Control of Credit: Quantitative and Qualitative Instruments Explained

RBI, the central bank of India, is the apex monetary institution that supervises, regulates, controls, and develops the monetary and financial system of India. The Reserve Bank was established in April 1935, under the Reserve Bank of India Act, 1934. RBI serves as a banker to the government, i.e., for both the Central and State governments. Apart from the bankers, there are various functions of the Reserve Bank of India which played an important role in various areas, like representing India in the IMF meetings, handling borrowing programmes for the government (Central and State), issuing currency in the country, and being the bankers of banks and custodians of foreign exchange reserves.

RBI is also the controller of credit created by commercial banks; it controls the credit.

So in this article, despite having various functions of the RBI, we will explore its core functions as the role of the RBI in the control of credit.

What is RBI’s Credit Control Policy?

It refers to the policy of the central bank of a country to regulate and control the credit policy.

RBI adopts various measures to control the credit supply by commercial banks. That’s why the monetary policy of the RBI is often known as credit control policy, and these measures are called instruments of monetary policy, where the RBI controls the credit policy based on two methods, which are:

1. Quantitative Instrument

2. Qualitative Instrument

Quantitative instruments

In quantitative instruments, there are five major policy rates on which the RBI uses its credit control policy, which are:

1. Bank Rate:

It is the rate of interest at which the RBI provides re-discounting facilities to the commercial banks in India. RBI increases the bank rate in times of inflation and decreases the bank rate in times of slowdown or recession.

In simple terms, the bank rate is the rate at which the RBI provides loans to commercial banks in India for a long period.

Note:

Re-finance: When one piece of paper is being used more than once to finance the requirement, i.e., when the same instrument is being used more than once to fulfil the finance requirements, it is “Re-finance”.

At the time when we cancel the security of the finance paper, that event, i.e., money is paid with interest and the instrument gets canceled, that event is termed as “Discounting of Bonds”

So, Re-Discounting means when one security is discounted more than once.

2. Cash Reserve Ratio (CRR):

It is the ratio of the average daily balance of (Net Demand & Time Liabilities, that is, NDTL ) banks, i.e., the total deposits of banks, which a bank has to necessarily keep with the RBI in cash, and this money is only returned to the bank when the bank is at high financial risk.

When the RBI increases the CRR, it is known as Tight Monetary Policy, and when the RBI decreases the CRR, it is known as Liberal Monetary Policy.

3. Statutory Liquid Ratio (SLR):

SLR is the ratio of the NDTL, i.e., Total Deposits of the banks in India, which a bank has to maintain 18% savings of itself at any given point in time in the form of liquid assets, such as cash, gold, or government security. The main reasons to keep this amount of savings in banks themselves are to maintain a sufficient banking system for any future problems, such as bankruptcy, and at the time when governments ask for a loan amount, banks easily provide loans to the central and state governments.

4. Repo and Reverse Repo Rate:

A repo is essentially a short-term auction exercise conducted by the RBI in India since 1992 to manage the short-term fluctuations in the money supply.

Thus, the RBI frequently adopts repo, which means “Re-Purchase”. 

So, the repo rate means the injection of liquidity, that is, money by the RBI to buy government securities or bonds from banks with an agreement to sell them on a fixed date. In simple terms, when any commercial bank wants a loan from the RBI, the interest at which the bank will return the loan amount to the RBI will be the repo rate.

While the reverse repo rate means absorption of liquidity by the RBI through borrowing funds from banks in the short term. In simple terms, when the RBI itself is asking for money from banks and, in return, the money with the interest at which the RBI is returning it to banks, that returned amount of interest will be your reverse repo rate.

This Repo and Reverse repo rate can be applied from both sides, i.e., from the bank's side also and from the RBI also. But if the reverse repo rate is applied from the RBI, then it is known as the Open Market Operation (The bank can control the flow of credit by buying and selling government securities in the open market. Selling securities allows the RBI to absorb cash from the economy, while buying them releases liquidity back into the market.)

5. Marginal Standing Facility (MSF):

MSF is the facility under which scheduled banks can borrow additional amounts of money overnight from the RBI by dipping into their SLR portfolio up to a limit of 2% of NDTL at a panel rate of interest (Repo Rate + 0.25%).

This provides a safety wall against unanticipated liquidity shocks to the banking system.

Qualitative Instruments

These instruments are employed to regulate the availability of credit within specific sectors of economic activity, either by expanding or contracting the flow of funds. Broadly, they can be categorised into three types:

1. Margin Requirement:

Margin requirement refers to the difference between the market value of the security pledged as collateral and the amount of the loan sanctioned against it. For instance, if an individual pledges a property valued at ₹1 crore to secure a loan of ₹80 lakh, the margin requirement would amount to ₹20 lakh. Central banks adjust the margin requirement to influence credit supply: a reduction encourages greater borrowing, while an increase serves to restrict it.

2. Credit Rationing:

Credit rationing involves the establishment of maximum lending limits for various sectors or activities. Commercial banks are mandated to operate within these prescribed limits and are prohibited from exceeding the quotas when extending credit.

3. Moral Suasion:

Moral suasion is a strategy wherein the Reserve Bank of India (RBI) persuades or exerts informal pressure on commercial banks to comply with its monetary policies. Banks may be urged to adopt a restrictive lending approach during periods of inflation and to adopt a more accommodative stance during times of deflation.

Conclusion

The Reserve Bank of India (RBI) plays a crucial role in ensuring the stability and growth of the Indian economy through its effective credit control measures. By implementing a blend of quantitative tools like CRR, SLR, Repo Rate, and MSF, along with qualitative methods such as margin requirements, credit rationing, and moral suasion, the RBI carefully manages the flow of credit in the economy. This dual approach not only curbs inflation and stimulates growth but also ensures a balanced and resilient financial system essential for India’s long-term economic progress.