Instruments of monetary policy of the central bank are broadly classified as :
(A) Quantitative methods : Under this method, the central bank tries to control credit by influencing the total quantity of credit in the country. Following are the measures of quantitative methods :
(i) Bank rate policy : Bank rate is the rate charged by the Central bank on its loans that it advances to a commercial bank against the securities. When Central bank needs to expand the credit then Bank rate is decreased and when it is needed to contract the credit, bank rate is increased. It directly affects the loan giving ability of the central bank. It is the easiest way of credit control.
(ii) Open market operations : Open market operations refer to the buying and selling of government securities by the central bank from the public or banks. When government wants to contract credit, the central banks start selling securities to the commercial banks, and when they want to expand credit, the central bank starts buying the securities. Buying the securities results in more money with the banks and they have more capability to advance loans. Similarly, selling the securities to the bank leaves them with less cash reserves, by which they become less capable for advancing loans.
(iii) Change in (CRR) Cash Reserve Ratio : Under CRR, the banks are required to deposit with the central bank a percentage of their net demand and time liablities in the form of liquidity or cash. Banks reduce the percentage of deposits if they want to expand the credit, and they raise the percentage if they want to contract the credit.
(iv) Change in (SLR) Statutory Liquidity Ratio : The SLR requires the banks to maintain a specified percentage of their net total demand and time liablities in the form of designated liquid assets with itself.
(B) Qualitative methods : Under this method, selective methods of credit control are meant to regulate and control supply of credit among its possible users and uses. Following are the qualitative methods adopted by the central bank for credit control :
(i) Selective credit control: Central banks adopts the selective credit control measures for specific sectors and specific requirements.
(ii) Credit rationing: Rationing of credit refers to the fixation of credit quotos for different business activities. Under this method, commercial banks cannot advance loans more than such limits.
Credit Rationing can be done in the following ways:
(i) The comfort of discounting the bill by any bank would be demolished.
(ii) Stating a limit on re-discounting of bills of the bank.
(iii) Applying a quota or stating a limit on the loans provided to the various businesses and industries.
(iii) Moral suasion: It means advising, requesting and persuading the commercial banks to co-operate with the central bank in implementing its general monetary policy. The central bank may request the commercial banks not to grant the loans for their speculative purposes.
(iv) Publicity: Central banks in modem time control the credit by publishing magazines, journals, bulletins, etc. In these publications, the central bank puts forward the type of policies to be adopted.
(v) Direct action: If commercial banks do not follow the methods and policies suggested by central bank issued from time to time, then Central Bank has legal power to take direct action.
Direct Action – Under this, Central bank puts a stop on the loan advancing policy of such banks, and do not re-discount their business bills. Also, it charges a high rate of interest. By applying such measures, commercial banks are forced to follow the rules applied by the central banks.
