સેન્ટ્રલ બેંક અને ક્રેડિટ રેગ્યુલેશન

• Central Bank and Credit Regulation

Syllabus

• Core Functions of Central Banks
• Quantitative and Qualitative Tools for Credit Regulation
• Instruments of Credit Regulation: Bank Rate Policy, Open Market Operations, Cash Reserve Ratio (CRR) Policy, Statutory Liquidity Ratio (SLR), Repo Rate, Reverse Repo Rate, Marginal Standing Facility Rate, Qualitative Instruments.

Introduction

• In modern economies, credit regulation is primarily managed by the central bank.
• Central banks perform functions such as issuing currency, acting as the government’s banker, serving as a banker to other banks, acting as a lender of last resort, regulating credit, managing foreign exchange reserves, and facilitating fund transfers.
• Credit regulation is very important in the modern framework

Credit Regulation by Central Banks

• Meaning of Credit Regulation: Regulating credit is a crucial function among the many roles of modern banks.
• Objectives of Credit Regulation.
• Instruments of Credit Regulation.
• Measures include quantitative (general) and qualitative (selective) methods.

Instruments of Credit Regulation

• Quantitative Credit Control: Aims to regulate the volume of credit in the economy.
• Qualitative Credit Control: Concerned with the purpose and direction of credit.

Conclusion

• Modern economics demands credit regulation and control

Quantitative Instruments

• Includes bank rate policy, open market operations, and variable reserve requirements.

Bank Rate Policy

• The bank rate is the rate at which the central bank rediscounts first-class bills of exchange or provides advances to commercial banks.
• Is sometimes called the discount rate.
• According to Prof. Spalding, it is the minimum rate at which the central bank is prepared to discount approved bills of exchange.

Influence on Credit Volume

• Most countries today use mainly credit money, making the central bank's control over currency incomplete.
• The authority to regulate credit money is crucial for the central bank to perform its functions effectively.
• Credit control aims to balance the volume of credit with the needs of trade and industry and involves regulating banks' lending policies.

Objectives of Credit Regulation:

• Exchange Rate Stabilization.
• Price Level Stabilization.
• Economic Stability by managing trade cycles.

Methods of Credit Regulation

• Qualitative Measures: Address the utilization of credit.
• Quantitative Measures: Affect the amount of credit.

Key Concepts

• Credit control involves adjusting the volume of credit to match business activity (Burgess).
• The bank rate is the minimum rate charged by the central bank for discounting approved bills of exchange.

Impact of Bank Rate Changes

• Changes in the bank rate affect market rates and lending rates.
• Three schools of thought exist on how bank rate changes influence the economy.

Views on Bank Rate Usage

• Some economists believe the bank rate directly affects the volume of bank money and the price level (Prof. Pigou).
• Others argue it protects gold reserves and manages foreign exchange transactions, preventing the export of gold by raising the bank rate.
• Knut Wicksell suggests it influences savings and investment, using rate cuts to boost investment and rate increases to curb speculative investments.

Effectiveness of Bank Rate

• Central banks use the bank rate as an important tool for credit management.
• Increasing the bank rate can curb excess money supply and inflation by making borrowing more expensive for commercial banks, which then raise their lending rates.
• This reduces demand for credit from producers and investors, curtailing unnecessary investments and prompting repayment of old loans.

The Opposite Effect

• Cutting the bank rate can stimulate economic activity by making funds cheaper for commercial banks, which lower their lending rates.
• This encourages producers and investors to borrow, boosting production.

Conflicting Views on the Impact

• Conflicting views exist regarding the effect of bank rate changes on prices and output.
• Views include that of R.G. Hawtrey (monetary) and John Maynard Keynes.

Hawtrey’s View

• Bank rate primarily affects short-term or working capital demand.
• Merchants tend to store goods with short-term loans.
• Changes in short-term interest rates alter storage habits.

Adjustments in Lending

• With increased interest rates, merchants store less stock and purchase less from producers, who may cut prices or reduce production.

Chain Reaction

• Reduced production leads to unemployed resources and lower incomes, decreasing retail sales and overall production and employment, trapping the economy in a recession cycle.

Opposite Scenario

• Lower interest rates decrease storage costs, leading merchants to order more goods, boosting production, employment, and incomes, and spurring economic activity.

Hawtrey’s Focus

• Hawtrey emphasizes storage costs (including interest rates).
• His theories rely on two factors.

Impact of Interest on Storage Costs

• When interest is a small part of total costs, changes in the bank rate have a limited impact.
• Higher interest rates significantly affect production and prices.

Demand Elasticity’s Role

• Elastic demand leads interest rate changes to affect storage habits.
• Inelastic demand provides less effect.

Keynes’s Perspective

• Keynes discusses long-term rates, which directly affect long-term or fixed capital demand.

Short-term vs. Long-term Rates

• Changes in short-term rates affect long-term rates.
• Increasing short-term rates while long-term rates remain steady increases the attractiveness of short-term securities.

Investments

• People and entities sell long-term securities to buy short-term ones, reducing long-term security prices and increasing long-term interest rates, negatively affecting capital investment.

Economic Effects of Lower Rates

• Lower long-term rates have the opposite effects, and Keynes says that long-term interest rate changes through the bank rate lead to fluctuations in production and prices.

Combined Views

• Pro. Hawtrey and Keynes differ in views, but complement each other.
• Hawtrey focuses on short-term rates, while Keynes focuses on long-term rates.
• Both influence the demand for money.

Radcliffe Committee (1959)

• Britain's Radcliffe Committee explains that capital demands are interest inelastic.
• They found that interest rates do not significantly affect investment plans.
• Future prices and profits, not interest rates, drive new capital.

Housing Industry

• House building and public utilities are “interest-elastic", however, these areas are public.
• They conclude that private capital demand is not significantly affected by interest rate changes.

Newer Methods

• Recent years have seen central banks use tools like India's Repo Rate and Reverse Repo Rate.

Limitations of Bank Rate Policy

• Effectiveness Uncertain: Changes in the bank rate do not always lead to corresponding changes in commercial banks' interest rates.

High Liquidity Impedes

• When commercial banks have substantial excess reserves, exceeding the minimum requirements, they may not need to raise their interest rates in response to an increase in the bank rate.

Lack of Developed Instruments

• In less developed countries, the absence of first-class bills of exchange and an unintegrated money market further diminish the bank rate’s effectiveness.

Opposite Effect

• Even for commercial banks that raise their interest rates, it may not effectively curb inflation.

Negative Impact

• The belief is that speculators stop investing and that lending money results in national production, employment, and income.
• A negative impact occurs in this situation.

Ineffective in Depression

• During economic depressions, the bank rate’s ineffectiveness becomes evident.
• Lowering the bank rate fails to spur investment if an atmosphere of pessimism and low expected returns persists.

Structural Rigidities

• Bank rates are contingent on whether the product needs to be produced.

Economic Structure

• The bank rate is contingent on a dynamic, elastic product, but contemporary products are hard to sell.

Inherent Limitation

• Commercial banks must sustain administrative costs, preventing them from lowering rates beyond a certain point.

Reduced Potency

• The bank rate’s role has waned post-World War I.

Economic Shifts

• Post-war, the structure is now one sided to one aspect only.

Alternative Instruments

• Other instruments, like open market operations and variations in cash reserves, have become more directly effective.

Money Market Changes

• Money Market changes have also lowered effectiveness.

Limited Effectiveness

• In conclusion, the bank rate’s effectiveness is limited by economic shifts and the use of alternative credit control instruments. However, it retains psychological importance and can be beneficial when coordinated with other measures (M.H. De Kock).

Radcliffe Committee Conclusion

• The bank rate’s inclusion is vital due to its symbolic importance (Radcliffe Committee Report).

Open Market Operations

• Central banks buy or sell government securities in the open market to regulate money supply and credit conditions.
• Selling securities contracts credit, while buying expands it.

Contraction

• The central bank sells securities in the open market.
• This reduces the cash reserves of commercial banks.
• Affects their ability to create credit.

Expansion

• A central bank buys government securities, so commercial banks are in line with money production.
• Banks use money for loans and interest.

Importance of open market operations

• Open market operations have become increasingly popular as they are directly effective. So they will affect money production.

Direct Influence

• Reduces the cash reserves, so their is liquidity for more loans.

Advantages

• Ability to conduct operations gradually.
• Operations do not have a defined time limit, so you can continually do it.
• Flexibility; operations can be started, stopped, or reversed as needed (H.G. Halm).

Cautions

• In some cases, open market operations are carried out for some issues.

Limitations of Open Market Operations

• When the central bank buys securities, it decreases the volume of business.

The Economy

• Business can be hard in some economics because the central bank cannot expand business.

Bank Liquidity

• Liquidity tends to decrease with the selling of government securities.

Interconnectedness with Instruments

• Instruments help support the economy, with the aid of government assistance.

Variable Reserve Requirements

• Third quantitative credit control instrument is a policy.
• Most countries require commercial banks to hold a percentage of deposits.
• Most of this percentage is regulated by law.
• Central banks have the authority for control (The Rules of Authority).

The Influence of Changes

• The changes affect commercial banks.
• Central banks can control the situation.

Historical Context

• First used in the U.S. in 1933 (improved in 1935), this control helps with situations.

Expansion of Method

• 1936: The method was formally instated.
• 1056: Use in New Zealand

Other Countries

• Maxico, Sweden, Australia, Canada, all have a form of use.

Problems the Method Solves

• Helps curb nonessential spending.

Power

• Gives extensive power to banks.