Question

Discuss two qualitative methods of controlling credit by a central bank in an economy.

Answer 1

Selective or Qualitative Methods of Credit Control are designed to regulate the distribution and usage of credit among different sectors or types of borrowers, instead of affecting the total supply of credit in the economy. Below are two key instruments used under these methods:

1. Consumer Credit Regulation: A major tool of selective credit control is the control of consumer credit, especially when it involves hire purchase financing. This system allows consumers to buy costly durable goods like motor cars, computers, etc., with the help of bank loans. Consumers typically make a down payment covering part of the cost, while the remaining balance is financed by the bank. The borrowed amount is then repaid in instalments over a fixed period.

2. Margin Requirement Regulation: Another crucial selective credit control tool is the regulation of margin requirements. Commercial banks usually offer secured loans where the borrower provides securities as collateral. However, the loan amount sanctioned is less than the full value of the security. The difference between the market value of the security and the loan provided is called the margin requirement. This margin serves to protect the bank against any possible decline in the security’s value. The central bank regulates the supply of credit by adjusting these margin requirements.