Monetary Policy of the Central Bank - Qualitative (Or Selective) Methods

Qualitative methods direct credit towards or away from specific sectors or purposes. They are targeted, not general.

Consumer credit regulation means controlling the use of bank credit by consumers to purchase expensive durable consumer goods (e.g., motor cars, computers) on hire-purchase or instalment plans.

How does it work?

• The consumer pays a cash down payment (a percentage of the price upfront)
• The remaining amount is financed by a bank loan
• The loan is repaid by the consumer in instalments over a fixed period

How does the central bank regulate it?
The central bank can change:

• The interest rate charged on such loans
• The amount of the down payment required
• The number of instalments
• The maximum repayment period

Imagine you want to buy a laptop on EMI. If the RBI wants people to borrow more, it makes EMIs easier (less upfront payment, more time to repay). If it wants to slow spending, it makes the loan harder to get (high down payment, fewer months to repay).
Remember: This method targets durable consumer goods purchased on hire-purchase finance.

A margin requirement is the difference between the market value of the security (collateral) offered by the borrower and the amount of loan granted against it by the bank.
Why do banks keep a margin?
To protect themselves against any fall in the value of the security.

Formula
Margin = Value of Security − Loan Amount Granted

Numerical Example (from source):

• Stock of foodgrains valued at = ₹10,000
• Margin requirement fixed by RBI = 10%
• Loan the trader can get = ₹10,000 − 10% = ₹9,000

How does the central bank use margin to control credit?

Credit Rationing aims to limit the maximum (ceiling) amount of bank loans and advances, and, in some cases, to fix the maximum limit of loans for specific purposes.

Two Forms of Credit Rationing:

Effect:

• ↑ RBI increases the ceiling → Banks can give more loans → Credit expands
• ↓ RBI decreases the ceiling → Banks can give fewer loans → Credit contracts

It is like telling a shopkeeper: "You can sell only up to ₹1 lakh worth of goods today." By raising or lowering this cap, RBI directly controls how much banks can lend.

Direct Action refers to various directives (orders) issued by the central bank to commercial banks to control and regulate their lending and investment activities.

Key Points:

• Not used against ALL banks — only against erring banks that don't follow RBI's policies
• It is a punitive / penalty-based method

Forms of Direct Action:

Moral Suasion (suasion = short for persuasion) is the method of persuasion, request, informal suggestion, and advice given by the central bank to commercial banks, without any legal force.

How does it work?

• The central bank convenes meetings with the heads of commercial banks
• It explains the need for a particular monetary policy
• It appeals to banks to voluntarily follow the policy
• Example: RBI may request banks not to grant loans for speculative purposes

 The central bank relies upon its moral influence as the head and leader of all financial institutions in the country.
It's like a respected school principal advising students. There's no punishment if you don't listen — but because everyone respects the principle, they usually do. RBI doesn't force banks; it persuades them.
Remember: Moral Suasion is the only informal / non-legal method among all credit control tools.

Publicity is the method by which the central bank publicly expresses its views on prevailing economic conditions — related to money supply, prices, production, and employment — to exert moral pressure on banks and the public.

How does it work?

• RBI publishes facts and figures through the media and the press
• It communicates its views on the state of the economy
• This influences both:
  The credit policies of commercial banks
  The public opinion in the country

When RBI publicly announces that inflation is rising and banks must be careful about lending, banks feel the pressure to act responsibly — even without being given a direct order.
Remember: Publicity works on two levels — it influences banks AND the general public.

• Selective methods control who gets credit and for what, not how much credit exists in total
• Margin Requirement is the most important selective instrument
• Moral Suasion is the only informal, non-legal method — it relies on persuasion
• Direct Action is used only against erring (non-compliant) banks — it is punitive
• Publicity works on both banks, and the general public
• Credit Rationing fixes a ceiling on total loans or the ratio of loans to deposits
• Consumer Credit Regulation targets hire purchase finance for durable goods