RAJIV GANDHI NATIONAL UNIVERSITY OF LAW,

PATIALA, PUNJAB

TOPIC: -

Submitted by: Submitted to:

Name = Shubham Pandey Mrs. Jasmine Kaur

Roll No. = 19003

Subject = Economics Minor

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 CERTIFICATE

Date: 24th October,2020

This is to certify that the dissertation titled- _____________________submitted to Rajiv

Gandhi National University of Law, Punjab, in partial fulfilment of the requirement of the
B.A.LL.B.(Hons.) course is an original and bonafide research work carried out by Shubham
Pandey under my supervision and guidance. No part of this project has been submitted to
any university for the award of any degree or diploma, whatsoever.

Mrs. Jasmine Kaur

Assistant Professor of Economics

Rajiv Gandhi National University of Law, Punjab

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 ACKNOWLEDGEMENT
It is a great pleasure that I find myself penning down these lines to express my sincere thanks
to various people who helped me a long way in completing this project.

It is my privilege to acknowledge my heartfelt gratitude and indebtedness towards my

teachers for their valuable suggestions and constructive criticism

I would like to thank to my teacher Mrs. Jasmine Kaur who helped me in all ways possible to
complete this project, and completion of this project would not have been possible without her
guidance.

I would also like to extend my gratitude towards my immediate seniors who helped me in
coming out of the fear that had mounted me due to the technicalities related to this project.
They gave me their guidance up to their best capacity and helped me immensely by giving
wise advice

It was a privilege to have been guided by Mrs. Jasmine Kaur

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 TABLE OF CONTENTS
1. INTRODUCTION................................................................................................................5
2. CREDIT CONTROL: MEANING.....................................................................................5
3.OBJECTIVES OF CREDIT CONTROL...........................................................................6
4. METHODS OF CREDIT CONTROL IN INDIA.............................................................8
4.1 Quantitative Methods.................................................................................................................. 8
4.2 Qualitative or Selected Credit Control....................................................................................... 12
5. MONETARY POLICY IN INDIA...................................................................................14
5.1 Features of current Monetary Policy.......................................................................................... 14
5.2 Features of New Monetary Policy of the RBI............................................................................15
6. CHALLENGES FACED BY RBI.....................................................................................16
7. SOLUTION.........................................................................................................................18
7. CONCLUSION...................................................................................................................19

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 1. INTRODUCTION
The pattern of Central Banking in India was based on the Bank of England. England had a
highly developed banking system in which the functioning of the Central Bank as a banker's
bank and their regulation of money supply set the pattern. The Central Bank's function as ‘a
lender of last resort’ was on the condition that the banks maintain stable cash reserve ratios as
prescribed from time to time. The effective functioning of the British model depends on an
active securities market where open market operations can be conducted at the discount rate.
The effectiveness of open market operations, however, depends on the member bank’s
dependence on the Central Bank and the influence it wields on interest rates.

2. CREDIT CONTROL: MEANING

Credit Control means the regulation of the creation and contraction of credit in the economy.
It is an important function of central bank of any country. The importance of credit control
has increased because of the growth of bank credit and other forms of credit. Commercial
banks increase the total amount of money in circulation in the country through the
mechanism of credit creation. In addition businessmen buy and sell goods and services on
credit basis. Because of these developments, most countries of the world are based on credit
economy rather than money economy. Fluctuations in the volume of credit cause fluctuations
in the purchasing power of money. This fact has far reaching economic and social
consequences. That is why, credit control has become an important function of any central
bank.

In India, the Reserve Bank of India Act, 1934 says that Bank is “generally to operate the
currency and credit system of its country to its advantages.” The RBI, like all other central
banks, is conferred by its Act wide powers for this purpose

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 3.OBJECTIVES OF CREDIT CONTROL

The central bank is usually given many weapons to control the volume of credit in the
country. The use of these weapons are guided by the following objectives.

(i) Stability of Internal Price-Level

The commercial bank can create credit because their main task is borrowing and
lending. They creates credit without any increase in cash with them. This leads to
increase in the purchasing power of many people which may lead to an increase in the
prices. The central bank applies its credit control to bring about a proper adjustment
between the supply of credit and measures required to that effect in the country
concerned. This helps in keeping the prices stable under control.

(ii) Checking Booms and Depressions

The operation of trade cycles causes instability in the country, so the objective of the
credit control should be to reduce the uncertainties caused by these cycles. The central
bank adjusts the operation of the trade cycles by increasing and decreasing the volume
of credit.

(iii) Promotion of Economic Growth:

The objective of credit Control policy in backward and underdeveloped countries

should be to promote economic growth within the shortest possible time. Generally
speaking, the economic development in these countries is retarded on account of lack
of financial resources. Hence, the Central Banks in these countries often try to solve
the problems of financial stringency through planned expansion of bank credit.

(iv) To Regulate and Expand Banking

RBI regulates the banking system of the economy. RBI has expanded banking to all
parts of country. Through monetary policy, RBI issues directives to different banks
for setting up rural branches for promoting agricultural credit. Besides it, government

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has also set up cooperative banks and regional rural banks. All this has expanded
banking in all parts of country.

(v) Stabilisation of the Money Market

According to some economists the credit control policy of the Central Bank should
aim at the stabilisation of the money market in the country. To achieve this objective,
the Central Bank should neutralize seasonal variations in the demand for funds. It
should for example, provide extra credit in times of emergencies. In fact, the control
on credit should be exercised by the Central Bank in such a manner as to bring about
an equilibrium in the demand and supply of money at all times.

(vi) Stability in Exchange Rates

This is also an important objective of credit control. Credit control measures certainly
influence the price level in the country. The internal price level affects the volume of
exports and imports of the county which may bring fluctuations in the foreign
exchange rates. While using any measure of credit control, it should be ensured that
there will be no violent fluctuation in the exchange rates.

(vii) Preparation for war and other Emergencies

Sometimes the objective of the Central bank is to prepare the country for war through
expansion of credit to enable the Government to meet its financial requirement.
Modem v/ars are so expensive that it is not possible to meet their costs without
adequate expansion of bank credit. During the second world war almost every country
resorted to expansion of credit on a large scale to meet the rising war expenditure.

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 4. METHODS OF CREDIT CONTROL IN INDIA

Credit control is one of the most important functions of the Reserve Bank of India. The
Reserve Bank controls the credit in the country with the twin objectives of checking inflation
and facilitating economic development. Credit control weapons used by the Reserve Bank
may be either quantitative or qualitative.
The Reserve Bank has been employing both types of weapons to control the credit by virtue
of powers given to it by the Reserve Bank of India Act, 1934 and the Banking Regulation
Act, 1949. The Reserve Bank of India Act confers on the Reserve Bank powers to control
credit quantitatively. These include bank rates or discount rates, open market operations and
variable reserve requirements. The Banking Regulation Act confers on the Reserve Bank vast
powers to control and regulate the entire banking system of the country. The Reserve Bank
controls credit qualitatively by virtue of these powers. The Reserve Bank has the power to
issue directions regarding the rate of interest that they should pay on fixed and savings
deposits, the rate of interest they may charge on types of advances, the types of securities
they can accept as collaterals, the branch expansion programme of the banks and many other
matters.

Now we shall discuss in detail the various methods of credit control used by the Reserve
Bank.

4.1 Quantitative Methods

Quantitative methods aim at controlling the total volume of credit in the country. They relate
to the volume and cost of bank credit in general, without regard to the particular field of
enterprise or economic activity in which the credit is used or utilised.The important
quantitative or the general methods of credit control are as follows:

(A) Bank Rate or Discount Rate Policy

(i) Meaning

The bank rate is the ‘minimum rate of interest’ at which the central bank is ready to grant
loans to commercial banks or to rediscount the bills of exchange. Hence the ‘bank rate’ is
also called as the ‘discount rate’ Section 49 of the Reserve Bank of India Act has defined the
bank rate as the standard rate at which the Reserve Bank is prepared to buy or rediscount bills

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of exchange or other commercial papers eligible for purchase under the Act.Thus bank rate is
the rate at which the Reserve Bank purchases or rediscounts the specified bills and
commercial papers. But it is significant to note that for a long time there was no bill market in
India. So the rate of interest charged by the Reserve Bank on the advances made by it to the
commercial banks was treated as the bank rate.

(ii) Conducive Conditions for the Bank Rate Policy

(a) Close Relationship between Bank Rate and other Interest Rates

It is necessary that the relationship between bank rate and the other interest in the
economy should be as far as possible close and direct. Changes in the rate should
bring about similar and appropriate changes in the other interest rates in the economy.
Otherwise the efficacy of bank rate will be limited.

(b) Existence of an Elastic Economic System

The success of bank rate requires the existence of an elastic economic structure. That
is, the entire economic system should be perfectly flexible to accommodate itself to
changes in the bank rate. Changes in the bank rate should bring about similar and
desirable changes in prices, costs, wages, output, profits, etc.

(c) Existence of Short Term Funds Market

Another condition required for the success of bank rate policy is the existence of
market for ‘short- term finds’ in the country. Short-term funds helps to handle foreign
as well as domestic funds which come up on-account-of changes in the interest rates,
consequent to changes in the bank rate. Before the first World War, bank rate policy
was very effective as an instrument of quantitative credit control because, the
conditions necessary for the success of bank rate were conducive then.

(B) Refinance Policy

Reserve Bank of India has restricted the availability of its refinance to banks through the
various methods followed by it from time-to-time since 1960.

(i) Food Credit Refinance

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 Reserve Bank provided refinance to the banks against food credit provided by them.
But such refinance was restricted to an amount equal to the excess of total food credit
by all the banks, over a minimum level of such credit. Such minimum level of credit
was called the ‘threshold level' which was fixed by the Reserve Bank from time to
time. Banks used to get 100% refinance in respect of their food credit in excess of the
threshold level

(ii) Export Credit Refinance

Export refinance is also provided by Reserve Bank, but its quantum is determined on
the basis of the increase in export credit of a bank over the level of such credit
reached in the base year. In the past, such base year has been brought forward from
time to time, for calculating the export refinance limits of banks

(iii) 182 Days Treasury Bills Refinance Facility

Reserve Bank of India introduced this facility in April, 1987. Under this facility
refinance is provided to the extent of 50% of the holding of the bank's 182 Days
Treasury Bills.

(C) Open Market Operations

Open market operations of a central bank consist of purchase and sale of government and
other securities in the open market with a view to regulate the supply of money. But in India,
open market operations are used by the Reserve Bank more to give support to the government
securities than to regulate the volume of money. It was in Germany perhaps for the first-time
‘Open Market Operations’ were conceived as an instrument of quantitative credit control and
later adopted in other countries. The Reserve Bank of India can influence the reserves of
commercial banks i.e. the cash basis of commercial banks buying or selling Govt, securities
in Open market.

The main objectives of “open market operations” are:

(a) To eliminate the effects of exports and imports to gold under tile gold standard.

(b) To impose a check on the export of capital.

(c) To remove the shortage of money in the money market.

(d) To make bank rate more effective.

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 (e) To prevent a 'run on the bank'.

(D) Variable Cash Reserve Ratio

Variable Reserve Ratio refers to the percentage of the deposits of the commercial banks to be
maintained with the central bank, being subject to variations by the central bank. In other
words, altering the reserve requirements of the commercial banks is called variable reserve
ratio. It is a well known fact that all the commercial banks are required to keep a certain
percentage of their deposits as cash reserves with the Reserve Bank of India. The Reserve
Bank of India is legally authorized to raise or lower the minimum reserve that the bank must
maintain against the total deposits. This reserve requirement is subject to changes by the
central bank depending upon the monetary needs and conditions of the economy.

E) Statutory Liquidity Requirement (SLR)

Section 24 of the Banking Regulation Act, 1949 contains a statutory requirement regarding
he maintenance of liquid assets by banks in India. This Section was amended by the Banking
Laws (Amendment) Act, 1983. Before such amendment every banking company was
required to maintain in India in cash, gold or unencumbered approved securities an amount
which shall not at the close of business on any day be less than 25 per cent of the total of its
demand and time liabilities in India. After the amendment, the Reserve Bank has been
empowered to step up this ratio to 40% of the net demand and time liabilities, so as to compel
the banks to keep a large proportion of their deposit liabilities in liquid assets.

(i) Basis for Maintenance of S.L.R.

S.L.R. is to be maintained as at the close of business every day. It means that S.L.R. is
to maintained on a daily basis. Section 24 (2A) which was inserted by the Banking
Companies (Amendment) Act, 1962 provides that a. scheduled bank in addition to the
average daily balance which it is, or may be, required to maintain under Section 42 of
the Reserve Bank of India Act, 1934 and every other bank in company in addition to
the cash reserve which it is required to maintain under Section 18 shall maintain in
India. (a) in cash, or (b) in gold valued at a price not exceeding the current market
price or in unencumbered approved securities valued at a price determined in

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 accordance with such one or more of, combination of, or the following methods of
valuation, namely valuation with reference to cost price, market price, book value or
face value, as may be specified by the Reserve Bank from time to time.

i. the deposit required under Section 11(2) to be made with the Reserve
Bank by a banking company incorporated outside India;
ii. any cash or balances maintained in India by a banking Company other
than a scheduled bank with itself or with the Reserve Bank or by way of
net balance in current account in excess of the aggregate of the cash or
balance or net balance required to be maintained under Section 18;
iii. any balances maintained by a scheduled bank with the Reserve Bank in
excess of the balance required to be maintained by it under Section 42 of
the Reserve Bank of India Act, 1934;
iv. the net balance in current accounts maintained in India by a scheduled
bank.

4.2 Qualitative or Selected Credit Control

The selective credit control is used to prevent speculative hoarding of commodities like Food
grains so as to prevent or control inflationary pressures in these areas. Sections 21, 35 and 36
of particular the Banking Regulation Act, 1949 empower the Reserve Bank to determine the
policy in relation to advances to be followed by banking companies generally or by any
banking company in particular, if it is satisfied that it is necessary or expedient in the public
interest or in the interest of depositors.

Objectives

The following are the broad objectives of selective instruments of credit:

(a) To divert the flow of credit from undesirable and speculative uses to more
desirable and economically more productive and urgent uses.

(b) To regulate a particular sector of the economy without affecting the economy as a
whole.

(c) To regulate the supply of consumer credit.

(d) To stabilise the prices of those goods very much sensitive to inflation.

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 (e) To stabilise the value of securities.

Tools of Selective Credit Control

The main instruments of selective credit control in India are:

(a) Fixation of Party-Wise Ceiling on Credit

The ceilings are fixed keeping in view the crop prospects, supply position and price
trends. After the fixation of ceiling of credit on a party-wise basis since November,
1972, banks are required to seek prior permission of the Reserve Bank for (i) granting
loans to new borrowers, and (ii) or increasing the credit limits in case of existing
borrowers.

(b) Regulation of Minimum Margin

In case of advances against commodities subject to selective control, higher margins

are prescribed in order to restrict the borrowing capacity of the borrowers.

(c) Fixation of Minimum Lending Rate

Though the Reserve Bank had prescribed the interest rates on various categories of
commercial bank advances (which include the maximum rates of interest to be
charged in certain cases), the minimum lending rate was prescribed for advances for
commodities subject to selective controls

Limitations of Selective Credit Controls

(i) The selective controls embrace the commercial banks only and hence the nonbanking
financial institutions are not covered by these controls.

(ii) It is very difficult to control the ultimate use of credit by the borrowers.

(iii) It is rather difficult to draw a line of distinction between the productive and unproductive
uses of credit.

(iv) It is quite possible that the banks themselves through manipulation advance loans, for
unproductive purposes.

(v) Selective controls do not have much scope under a system of unit banking.

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 5. MONETARY POLICY IN INDIA

5.1 Features of current Monetary Policy

Following are the main features of the monetary policy of the Reserve Bank of India:

(i) Active Policy

Before the advent of planning in India in 1951, monetary policy of RBI was a passive
policy. RBI did not use the measures of monetary policy to regulate the availability of
credit. RBI has been following an active monetary policy- It has been using all the
measures of credit control.

(ii) Controlled Money Supply

Monetary supply of RBI has been achieving contradictory objectives of economic

growth and controlling inflation. For promoting economic growth, more money
supply is needed, while to control inflation money supply has to be curbed.

(iii) Seasonal Variations

The monetary policy is characterised by the changing behaviour of busy and slack
seasons. These seasons are tied to the agricultural seasons. In the busy season, there is
an expansion of funds on account of the seasonal needs of financing production, and
inventory building of agricultural commodities.

(iv) Flexible

Monetary policy has been changed according to change in market conditions and
requirements. If, there is more requirement of funds in the market, then RBI follows
liberal monetary policy by lowering bank rate, CRR, repo rates, interest rates, etc. For
example, at present, economy needs more funds for economic growth, so RBI has
given liberal monetary policy.

(v) Investment and Saving Oriented

To encourage investment, rate of interest on loan should be low, while to encourage

saving rate of interest on deposits should be high. The monetary policy adopted by
Reserve Bank is both investment and saying oriented. To encourage investment,

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 adequate funds and loans are made available for productive purposes at reasonably
low rates of interest.

5.2 Features of New Monetary Policy of the RBI

The new monetary policy has been announced to meet the growing demands of credit with
the

increase in growth rate of economy:

(i) Reduction in Cash Reserve Ratio (CRR)

RBI has reduced cash reserve ratio to increase liquidity in the market. CRR has been
reduced to maintain growth rate in the economy.

(ii) Bank Rate

It is considered desirable to leave the bank rate unchanged at 6 per cent. The matter,
however, will be kept under constant review.

(iii) Repo Rate and Reverse-Repo Rates

Repo and Reverse-Repo rates are constantly reviewed by RBI

(iv) Interest Rate Flexibility

(a) Up to some extent banks should have freedom to fix interest rates.

(b) Introduction of flexible interest rate system for all new deposits which will be
reviewed at six-monthly intervals. It means interest rates can be revised after six
months.

(v) Transparency in the Interest Rate

Banks should provide information about deposit rates for various deposits and
effective annualised return to the depositors. Banks should provide information to
RBI about maximum and minimum interest rates charged by them from their
borrowers.

(vi) Kisan Credit Cards (KCCs)

KCC is a credit card which is issued by banks to farmers for availing credit facility as
per their requirements. The Reserve Bank has advised all banks to issue Kisan Credit
Cards to the farmers.

(vii) Automated Teller Machines (ATMs)

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 The coverage of the Automated Teller Machines (ATM) network and the facilities
provided by the banks through ATMs are increasing.

6. CHALLENGES FACED BY RBI

In the wake of global anthropological shock Covid-19, a sharp slowdown in economic growth
and employment prospects is evident in the Indian economy. In this context, Reserve Bank of
India’s role in ensuring economic stability, growth and development through effective
monetary policy assumes more importance than ever.

RBI’s job involves balancing short-term as well as long-term growth, ensuring economic
growth while meeting the inflation targets. However, issues pertaining to the incomplete
transmission of monetary policy and inherent weakness of inflation targeting approach, are
some of the challenges faced by RBI.

(i) Incomplete Transmission of Monetary Policy

Incomplete Transmission of Monetary Policy means that the cumulative easing in

policy rates by RBI has not yet been reflected in the lowering of their lending rates by
banks. This can be attributed to the following reasons:

(ii) Inflexible Cost of Funds

In India, customer deposit constitutes the majority of funds to be lent by the banks,
whereas the market borrowings through the issuance of debentures/commercial papers
is negligible. The cost of funds typically remains inflexible as most of these deposits
are contracted at fixed rates .Further, Interest rates on small savings remained at
elevated levels compared to that of banks. This has led to a decline in deposits with the
banks.

(iii) Policy Rates not linked to Market

Repo rate, being the policy rate, is administered by the Monetary Policy Committee and
therefore cannot be treated as a market-determined rate. Banks are asked to link their
lending rate to repo rate, without any reference to the cost of lending funds.

(iv) High Non-Performing Assets (NPAs’

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The accumulation of large NPAs has reduced the profitability of banks. Due to this,
banks keep the weighted average lending rate much higher than the marginal lending
rate.

(v) Four Balance Sheet Problem

According to Former chief economic advisor, Arvind Subramanian, the economic

slowdown in India is facing a ‘Four balance sheet challenge’. This has marred the credit
growth in India and thus created hindrance in the greater transmission of monetary
policy.

(vi) Monetary Policy Vs Fiscal Policy

High fiscal deficit leads to more market borrowing by the governments. This results in
crowding out of the private investment. Also, government-determined purchase prices
of agri-commodities (through minimum support prices), government subsidy levels on
fuels and imperfections in agricultural markets, hinders the functioning of monetary
policy. This creates a problem of non-coherence between the two policies. New
challenges also emanate from the evolution of cryptocurrency.

(vii) Issues Pertaining to Inflation Targeting

Monetary policies can stabilize inflation only caused due to demand shocks and are
ineffective against supply shocks. Inflation in emerging markets such as India is very
sensitive to exogenous shocks like global oil prices, a weaker rupee and a poor
monsoon. Food inflation, which impacts the common people the most, is prone to
supply-side bottlenecks, which are out of the scope of any remedy under the aegis of
monetary policy of RBI. In order to contain inflation, RBI often undertakes liquidity
management through Open Market Operations.

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 7. SOLUTION

Adoption to Multi-Indicator Approach

Being the Central bank of the country, RBI has expected to take care of other
parameters like economic growth, stable exchange rate and financial stability, and
cannot restrict itself to the single objective of inflation.

In this context, the Government should consider, Multiple Indicator Approach of RBI,
where price stability, financial stability and economic growth are considered for
decision-making. A greater weightage to inflation can be considered in the Multiple
Indicator Approach, as it is done by many emerging economies.

Linking Cost of Funds with Market

In order to make the cost of funds flexible, both deposit and lending rates are linked to
external benchmarks like the Mumbai Inter-Bank Offer Rate (MIBOR). Linking small
savings scheme interest rates to the market would be beneficial. An innovative way to
make both asset and liability sides of a bank balance sheet flexible is to link both
deposit and lending rates to the average inflation rate.

Coordination Between Fiscal Policy and Monetary Policy

Any of these alone cannot deliver on inflation and growth. If the government truly
wants to reduce lending rates in India in a meaningful and sustained manner, it would
be far better served to focus on bringing down its own fiscal deficit. Separating debt
management from monetary management in order to make the central bank more
independent would be a good move.

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Covid-19 has to lead to economic disruption in the Indian economy. However, it also
provides an opportunity to carry out much need economic reforms. Establishing synergy
between Fiscal and monetary policy can be a right step in pursuit of bringing holistic reforms.

7. CONCLUSION

The main function of the Reserve Bank, as of all the other central banks, is to formulate and
administer monetary policy. Monetary policy refers to the use of instruments within the
control of the Central Bank to influence the level of aggregate demand for goods and services
by regulation of the total money supply and credit. The total expansion of money supply
depends on the creation of high powered money (reserve base) and the multiplier acting upon
it. Through the various instruments available, the Reserve Bank seeks to control both
dimensions of money supply change.

The authority of the Reserve Bank of India for the control of the credit system is embodied in
the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949. The former Act
confers on the Reserve Bank the traditional powers of general credit control while the latter
Act provides special powers of direct regulation of the operations of commercial banks and
cooperative banks. One of the main functions of the Reserve Bank of India, as the central
bank of the country, is to control credit granted by commercial banks. The Reserve Bank of
India, like all other central banks, is conferred with wide powers for this purpose.

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