Question

How does the central bank use the credit rationing to exercise credit control in a country?

Answer 1

Credit rationing is a qualitative (selective) method of credit control. This method involves the central bank setting a limit on the loan facilities available to commercial banks. The available credit is divided among them based on the purpose of the credit; priority sectors and important industries receive more, while non-essential and speculative purposes receive less.

1. It ensures that available credit flows to the most productive and necessary applications (e.g., agriculture, small businesses, exports) rather than speculative or non-essential activity.
2. It is employed in extreme monetary tightening situations, such as a severe credit crunch or an economic crisis.
3. It is commonly used to contract credit (but cannot be used for credit expansion).