Selective Credit Controls and Controlling Inflation | Banking

Selective credit control refers to qualitative method of credit control by the central bank. The method aims, unlike general or quantitative methods, at the regulation of credit taken for specific purposes or branches of economic activity. It aims at encouraging good credit, i.e., development credit while at the same time discouraging bad credit, i.e., speculative credit.

The techniques of selective credit control generally are of two varieties:

(a) minimum margins, higher or lower, for lending against specific securities, ceilings on the amount of credit for certain purposes, and differ­ential rates of interest for certain types of advances, and

(b) regulation of consumer credit for durable goods.

While the general instruments of credit control seek to control the volume and the cost of credit, selective credit controls aim at altering its distribution, i.e., purpose or use of credit. This is why such controls are treated as qualitative instruments of credit control.

Selective credit controls relate to tools available with the monetary authority for regulating the distribution or direction of bank resources to particular sectors of the economy in accordance with broad national priorities considered necessary for achieving the set developmental goals.

Selective controls have special relevance in the developing countries where, on the one hand, the scarce supply of credit has to be channelized into productive areas and, on the other, credit flows to less essential activities have to be curbed so that the physical shortages of essential goods are not exploited for speculative profits with the aid of bank finance.

Operationally, therefore, such controls seek to influence the demand for bank credit by making the borrowing, for certain purposes, which are regarded as relatively inessential or less desir­able, costly or by imposing stringent conditions for lending for these pur­pose or to certain sectors, or conversely, by giving concessions to certain desired types of activity.

Broadly stated, the objective of selective credit control in developing countries like India is one of preventing speculative hoarding, with the help of bank credit, of certain commodities like food grains and basic raw materials and thereby checking an undue rise in their prices.

Selective credit control is considered as a useful supplement to general credit regulation and its effectiveness may be greatly enhanced when used together with general credit controls. Thus, selective control measures are formulated by the central bank in harmony with the general credit and monetary policies and are operated in consonance with the policies, priorities and controls of the government. It should, however, be noted that selective control is not basically intended to correct general inflationary trends in the economy.

Prices are primarily determined by the interaction of supply and demand and when supply is substantially short, selective control can at best be expected to moderate the price rise rather than arrest the basic trend.

Also, there are certain other limitations to the effectiveness of this technique. An atmosphere of general expansion of money supply and the availability of alternative sources of funds in lieu of bank credit may reduce the efficacy of such qualitative control.

Besides, where the branches of commercial banks are functioning in the far-flung areas (as in the case of India), it takes some time for the central bank’s directives to percolate and for the bank branches to give effect to them. Meanwhile, it is likely that the original situation which prompted the initiation of the specific measures might have undergone a change.

Many central banks have, in addition to selective credit controls, acquired powers of direct regulation of the aggregate quantum as also the distribu­tion of advances and investments of individual banks as well as of the banking system as a whole.

Modus Operandi:

Selective credit control operates from the positive as well as negative side. From the positive side selective credit control is used to ensure greater channeling of credit into specific (the so-called top priority) sectors of the economy such as agriculture and small-scale and cottage industries.

From the negative side selective credit control operates to restrict the flow of credit to certain sectors or activities (which may create destabilising forces in the economy). In most cases, the term ‘selective credit control’ is used in this latter sense.

The objectives or purposes of the selective credit control differ in two groups of countries.

In industrially advanced countries like the USA, Japan, Canada, etc., selective credit controls are used for two main purposes:

(i) regulating stock market credit or

(ii) controlling the volume of credit used to purchase consumer durables.

In developing countries like India such controls have largely been used for preventing speculative hoarding of certain essential commodities such as food grains and agricultural raw materials with a view to checking an undue rise in their prices.

The basic logic behind such controls is that by restricting the availability of bank credit for purchasing and hoarding of some sensitive commodities (i.e., commodi­ties subject to speculative pressures), it will be possible to restrict the capacity of traders to hold the stock of such goods rather automatically. Consequently, the market supply of such goods will be easier than other­wise. Therefore, at the end, the prices of such goods will not rise as much as they would have otherwise.

SCC in India:

In India, selective credit control is exercised by the RBI which has been vested with wide powers to control advances by banks and to determine government policy relating to bank loan, when it considers necessary to do so in the public interest or in the interests of the depositors in particular.

Additionally, the RBI may give directions to banks generally or to any bank or a group of banks in particular on different aspects of granting accommodation:

(a) The purposes for which advances may or may not be made,

(b) The margins to be maintained in respect of secured advances,

(c) The maximum amount of advances or other financial accommodation which may be made by a bank or the maximum amount of guarantees which may be given by a bank on behalf of any one company, firm, association of persons or individual, having regard to that bank’s financial position such as paid-up capital, reserves and deposits and other relevant considerations, and

(d) The rate of interest and other terms and conditions subject to which advances or other financial accommodation may be granted or guarantees may be given.

The main instruments of selective credit control in India are:

(i) Minimum margins for lending against selected commodities,

(ii) Ceilings on the levels of credit, and

(iii) Charging of minimum rate of interest on advances against specified commodities. While the first two instruments control the quantum of credit, the third instrument controls the cost of credit.

While margin against a particular commodity is increased or decreased depending upon the state of the economy which dictates whether flow of bank credit to that sector should be curtailed or encouraged, fixation of ceiling restricts the capacity of the lending bank to grant advances against controlled commodities.

Banks have been advised not to allow to customers dealing in commodi­ties, covered by selective credit control, any credit facilities which would directly or indirectly defeat the purpose of the directions.

Conditions of the Success of Selective Credit Control:

According to Prof. Suraj B., the degree of success of selective credit controls depends on the following three factors:

1. The Extent of Effective Credit Restrictions:

Firstly, selective credit controls are generally security-oriented and not purpose-oriented at least in industrially advanced countries. In such countries large and influential borrowers can avoid the restrictive effects of these measures by borrowing against the security of other collaterals and utilising the funds so borrowed for speculative purposes, i.e., for speculative holding of stocks. Therefore, for making selective credit controls effective they are to be used in conjunc­tion with other (general) credit control measures.

2. The Availability of Non-Bank Finance:

The selective credit controls also lose effectiveness in those situations where there occurs a parallel expansion of money supply through non-banking financial intermediaries. This is usually observed in less developed countries like India whether traders do not have much reliance on bank finance for accumulating inventories (i.e., stocks of finished goods).

They largely depend on private sources of finance (their own as also of the unregulated credit markets). So it is quite possible for the traders to overcome the constraints imposed by selective credit controls. In a parallel economy like our own, the availability of non-bank finance becomes more and more important over time.

This means that even if the quantum of bank credit is effectively restricted in certain directions, speculative hoarding are not curtailed drastically. Of course, the effective­ness of the measure depends largely, if not entirely, on the cost and avail­ability of non-bank finance to the traders and other borrowers.

3. The Excess Demand Pressure in the Economy:

The effectiveness of selective credit controls as an anti-inflationary measure largely depends on the degree of shortage of essential commodities or the shortfall in supply in relation to normal demand. The larger this shortfall, the stronger will be the speculative pressure. It has been suggested that in case of acute shortages, credit controls should be imposed much in advance of the actual rise in prices of sensitive commodities.

Conclusion:

From the above discussion one may predict that selective credit controls can, at best, serve as useful supplements to general credit controls and will prove to be really effective if it is given proper support by general credit control measures.

In other words, selective credit controls are to be used in addition to, and not in lieu of, the traditional instruments of credit control. Even then, selective credit controls are to be viewed as short-term and not a long-term stabilisation measure.

In the long run demand-management policies (i.e., policies directed towards reducing the demand for essential commodities by curtailing the volume of bank credit) are to be supported by supply-management policies (i.e., policies aimed at raising production of essential commodities) so that a better balance be­tween aggregate demand and aggregate supply is achieved in the long run. Moreover, the RBI itself has admitted that the selective credit controls can at best moderate the trend of rising prices, they cannot eliminate price inflation altogether.