Give a brief account of the different methods of credit control by the Central Bank.
Controlling the supply of credit in the country’s economy is one of the main functions of the central bank. Every commercial bank deposits a portion of their total deposits with the central bank. In this situation, the central bank is able to control credit by controlling the deposit creation process by commercial banks.
The different methods of credit control by the central bank are –
1. Bank Rate:
Commercial banks discount various debt securities to the central bank and when taking loans, the discount rate imposed by the central bank is called bank rate. During inflation, the central bank raises the bank rate. This in turn increases the cost of debt collection of commercial banks. So, commercial banks also increase the interest rate on their loans. Hence, investment propensity decreases. Again, the central bank lowers the bank rate during deflation or economic recession.
2. Variable Reserve Ratio:
The Banking Act requires every commercial bank to deposit a fixed proportion of its total deposits with the central bank. The central bank increases this cash-reserve ratio to control inflation. This ratio is reduced during deflation. For this reason, this method is called variable reserve ratio.
3. Open Market Operations:
Through the sale of government bonds, the central bank can control the excess money supply in times of inflation. Central bank buys bonds during deflation or economic recession. This method is called open market operations.
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