Credit Control Instruments used by RBI

1. The Bank Rate Policy:

From the very inception of the Reserve Bank of India (1935) until November 1951, the bank rate was kept unchanged at 3 p.c.

However, since then, it has been raised from time to time. Bank rate remained virtually inoperative between 1981 and 1991 as the RBI pegged it at 10 p.c. for the period 1981-91.

It was raised to 11 p.c. on 3 July, 1991 and to 12 p.c. on October 1991 for curbing money supply and reducing liquid­ity, credit and hence aggregate demand.

Reliance on bank rate on the part of the RBI has been greatly reduced. In the early months of 1997, we found stringent monetary growth as well as some sort of ‘recession’ in industries. Seeing this, the RBI in June 1997 lowered down the bank rate from 12 p.c. to 10 p.c. in two stages. Again, in April 1998, bank rate was slashed to 9 p.c., 8 p.c. in March 1999 and 7 p.c. in April 2000. It was raised to 7.50 p.c. in February 2001.

As some sort of price stability was achieved, the RBI kept on reduc­ing the bank rate from time to since 2001. Bank rate was lowered down to 6 p.c. in April 2003. However, from 2003 to the present time (i.e., January 2009), bank rate has been kept un­changed at 6 p.c.

In fact, the RBI has been emphasising less on the bank rate and putting greater reliance on repo rate and reverse repo rate. Repo rate is the rate at which commercial banks take loans from the RBI by depositing securities while reverse repo rate is the rate at which the RBI sells securities to the commercial banks. Increase in repo rate means control over the money supply.

In November 2006, repo rate was raised to 7.25 p.c. and to 7.75 p.c. in Octo­ber 2007 which the aim of reducing liquidity of cash so that current inflationary tendencies can be curbed. In April 2008, both repo rate and reverse repo rate have been kept un­changed at 7.75 p.c. and 6 p.c., respectively.

The second quarter of the current fiscal year 2008-2009 saw an ugly head of high dose of inflation with the record rise in prices of crude oil ($ 147 per barrel), global rise in the prices of foodgrains. Indian economy wit­nessed an inflation rate of nearly 13 p.c. in September 2008. The RBI had to intervene in the money market to curb excess liquidity. It then raised repo rate to 8.5 p.c. in June 2008 and to 9 p.c. in September 2008. Reverse repo rate had, however, been kept at 6 p.c.

Against the backdrop of recessionary ten­dencies developed in the banking industry, share market, etc. in mid-October 2008, the RBI cut the repo rate to 8 p.c. on 20 October 2008. As these measures were considered to be inadequate against the growing economic meltdown in India, the RBI kept on lowering repo rate to 6.5 p.c. in December 2008 and again slashed to 5.5 p.c. on 2 January 2009. Likewise, reverse repo rate was reduced from 6 p.c. in October 2008 to 5 p.c. in December 2008 and again to 4 p.c. in 17 January 2009.

2. Open Market Operations (OMOs):

The RBI Act has empowered the Bank to buy and sell government securities, treasury bills, other approved securities and short-term commer­cial bills. But this provision has served very little purpose, largely due to the absence of a organised bill market in the country. Moreo­ver, the bulk of government securities in In­dia are held by institutional investors, nota­bly commercial banks and insurance compa­nies.

Consequently, dealings of the RBI in re­gard to open market operations are largely confined to them. However, the RBI has not been using it as an anti-inflationary weapon. After economic reforms the RBI has been widely undertaking switch operations pur­chase of one loan against sale of another.

This means this instrument has been reacti­vated by the RBI. Active use of OMO was made in 1993-95 to curb inflationary tenden­cies. The RBI has had to divest government securities from its portfolio through the OMO.

3. Cash Reserve Ratio (CRR):

This is a very important and effective instrument of credit control. The RBI used this instrument for the first time in 1960 when there was a sharp increase in commodity prices.

This technique of credit control has been used very frequently in recent years with a view to stabilising prices. It was raised to 5 p.c. in June 1970. Since this measure had failed to yield necessary results, the cash reserve ra­tio was raised again to 7 p.c. in September 1973.

Due to huge growth of liquidity in the economy over time, this ratio was raised from time to time. Following the recommendations of the Narasimham Committee, the Govern­ment has decided to reduce CRR to a level below 10 p.c. over a four-year period. By Janu­ary 1997, CRR had been lowered down to 10 p.c. as suggested by the Narasimham Com­mittee. The CRR was reduced further from 10 p.c. to 9.5 p.c. in November 1997, and again raised to 11 p.c. in August 1998 to reduce li­quidity.

Since then the RBI has been reducing it regularly as soon as stability in price level was reached. It was lowered down to 4.50 p.c. in 2002-03 and again raised to 5.50 p.c. in Janu­ary 2007 with the increase in oil price and low rainfall.

Since then, we have been seeing a rise in the CRR almost regularly witnessing a high price rise. CRR had been raised to 8 p.c. in May 2008 and again to 8.25 p.c. in May 2008, with no sign of drop in inflationary situation. In order to control excess liquidity, the RBI raised CRR to 8.75 p.c. in July 2008 and to 9 p.c. in September 2008 so as to check a high inflation rate of almost 13 p.c.

Meanwhile, in September-end 2008, the US economy plunged into deep recession, al­though its signs were visible at least since March-April 2008. Its impacts were felt by the major economies of the world in late Septem­ber and early October. Several drastic meas­ures had been taken by the US Government and many other Governments of Europe, China, Japan, etc. for concerted action. Indian share market witnessed also such cataclysm. Share prices plummeted down to an abnor­mally low level, thereby threatening the mo­rale of investors.

It had been estimated by the RBI that the banking industry was starving of liquidity to the tune of at least Rs. 90,000 crore. To prevent further erosion of confidence amongst investors and the banking industry, the RBI decided immediately and that too without hesitation to take immediate meas­ures to come out of the crisis. It employed the most “directest” method of credit instrument to inject more liquidity in the banking indus­try and mutual funds.

First, it lowered down CRR from 9 p.c. to 8.50 p.c. on October 6 and to 7.50 p.c. on Octo­ber 10 so as to infuse liquidity of Rs. 60,000 crore in banks. However, as the downhill in share market could not be prevented on desired direction, further cut in CRR to 7 p.c. was made on October 14 to provide additional money of Rs. 40,000 crore in the banking industry.

The RBI had injected Rs. 1,25,000 crore in the economy but it had failed to check the exit of foreign institutional investors from the stock market resulting in a drop in Sensex below 10,000 mark on 17 October 2008. Mean­while, recessionaries tendencies deepened fur­ther.

To inject more liquidity, the RBI cut the CRR to 5.5 p.c. in November 2008 and to 5 p.c. in January 2009. We will have to wait to a fu­ture date to get the desired results. However, only one good thing that is visible is that the inflation rate has been showing some sort of decelerating trend. It came to down to less than 6 p.c. on end January 2009.

4. Statutory Liquidity Ratio (SLR):

Apart from cash reserve requirements (CRR) that all commercial banks have to meet with the RBI, the Banking Regulation Act of 1949 says that the banks are under obligation to invest a cer­tain amount of gold and unencumbered gov­ernment and other approved securities as sec­ondary reserve. This is called the SLR.

How­ever, since 1970, the RBI has been raising it gradually and banks are complying with it. It was raised to 38.5 p.c. in April 1990. The mo­tive behind raising SLR over the past several years was the desire to mobilise even larger resources through the so-called market bor­rowings in support of Central and State budg­ets.

Following the recommendations of the Narasimham Committee, SLR had been low­ered down to the floor of 25 p.c. (October 1997). Consequent upon the amendment of the Banking Regulation Act in 2007, the statutory floor of 25 p.c. has been removed and the RBI has been provided the discretion to prescribe the SLR at a lower level. Accordingly, since 1 November 2008, the SLR stands reduced to 24 p.c.

5. Selective Credit Control (SCC):

The RBI has used this method for regulating the flow of credit of specific branches of economic activity and thus check the misuse of borrowing facilities.

Commercial banks have been prohibited from extending credit for speculative hoarding of such commodities by traders. This is the main thrust of selective controls.

SCC was first introduced in early 1956 as part of the RBI’s policy of ‘controlled expan­sion’. Usually, the following commodities are covered by the SCC: foodgrains, major oil seeds and vegetable oils, cotton and kapas, sugar, gur and khandsari, cotton textiles, in­cluding cotton yarn, manmade fibres and yarn, and fabrics made out of manmade fibres (including stock-in-process)’.

There has been no change in the selective credit controls imposed by the RBI against price-sensitive essential commodities in 1994- 95. During April 1996, there was an across- the-board liberalisation of selective credit con­trols on bank advances against some price- sensitive essential goods.

One form of selec­tive credit control introduced in 1965 was the Credit Authorisation Scheme. With the aim of liberating and deregulating the financial sys­tem, the RBI abolished this scheme in 1998. The RBI no longer relies on this technique of credit control.