Credit Creation and Credit Control, Study notes of Economic Theory

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Fri, 08 Sep, 2023 22:

Credit creation and Credit control

Credit Creation: Definition: Banks create new money when they make loans. How it works: When a bank lends money, it increases the amount of money in the economy. Multiplier effect: This process can lead to even more money creation as borrowers deposit theirloans in banks, which can then lend out a portion of those deposits. Credit Control: Definition: Measures to manage and regulate the amount of money in the economy. Tools: Interest rates: Central banks can change interest rates to influence borrowing and spending. Reserve requirements: Rules that dictate how much money banks must keep in reserve. Open market operations: Central banks buying or selling government securities to affect moneysupply. Direct lending: Central banks may lend money to banks during crises. Objectives: Used to achieve goals like controlling inflation, promoting growth, and ensuringfinancial stability. Following are the two major methods through which credit creation can be stopped or controlled. A. Qualitative MethodsB. Quantitative Methods A. Qualitative methods These are discriminatory type of methods. It includes both the essential and non essential use ofloans or credit. Qualitative methods are direct and personal.They effect both borrower and lender. e.g. margin requirements, rationing of credit, publicity, direct action etc. 1.Margin requirements This refers to difference between the securities offered and amount borrowed by the banks. It refers to the difference between the value of Collateral loan and the value of granted loan.

2. Rationing of credit:

The bank rate is the Official interest rate at which RBI rediscounts the approved bills held bycommercial banks. For controlling the credit, inflation and money supply, RBI will increase the Bank Rate. 2.Open Market Operations Open Market Operations refer to direct sales and purchase of securities and bills in the openmarket by Reserve bank of India. The aim is to control volume of credit.

3.Cash Reserve Ratio Cash reserve ratio refers to that portion of total deposits in commercial Bank which it has to keepwith RBI as cash reserves.

4.Statutory Liquidity Ratio SLR refers to that portion of deposits with the banks which it has to keep with itself as liquidassets(Gold, approved govt. securities etc.) If RBI wishes to control credit and discourage credit it would increase CRR & SLR.