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Which of the following is a qualitative method of credit control of a central bank?

Which of the following is a qualitative method of credit control of a central bank?

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Which of the following is a qualitative method of credit control of a central bank?

    1. Bank rate
    2. Open market operation
    3. Rationing of Credit
    4. All of the above

Correct Answer: Rationing of credit

  Answer Explanation

An economy’s credit flow is regulated qualitatively through rationing of credit. It is one of the methods used by central banks to control credit. In order to curb inflation and stabilize the financial system, the central bank imposes specific criteria and guidelines on commercial banks’ lending practices.

The central bank aims to direct credit towards specific sectors of the economy or restrict excessive lending. By rationing credit, the central bank limits how much credit commercial banks can extend to certain sectors, industries, and borrowers. This is done to ensure that credit is allocated to priority sectors or areas that require financial support for development and growth.

By influencing the allocation of credit, the central bank can shape the overall economic activity and achieve targeted policy objectives.

Credit rationing is primarily intended to control inflation and prevent the economy from overheating as a result of excessive credit expansion. A rapid economic growth period coupled with high inflation may cause commercial banks to extend credit indiscriminately, leading to excessive borrowing and spending. The central bank can curb credit growth and mitigate inflationary pressures by imposing credit limits and guidelines.

Why the other options are not correct

a. Bank rate:

This is a quantitative method of credit control, not a qualitative one. It is the rate at which the central bank lends to commercial banks and influences their borrowing costs. Through the adjustment of the bank rate, the central bank affects the overall interest rate in the economy, influencing borrowing and spending habits as well as the cost of credit.

In order to make borrowing more expensive for commercial banks, the central bank increases its bank rate. Due to this, commercial banks raise their loan rates, which discourages borrowing and reduces the amount of money available. Conversely, a decrease in the bank rate makes borrowing cheaper for commercial banks, resulting in lower lending rates and an increase in borrowing and spending.

b. Open market operation:

Central banks use open market operations to control credit. The central bank influences money supply and interest rates by buying or selling government securities on the open market. By purchasing government securities, the central bank injects money into the banking system, resulting in increased liquidity and lowered interest rates. Alternatively, when it sells securities, it withdraws money from the banking system, reducing liquidity and raising interest rates.

With open market operations, the central bank can control the money supply and stabilize interest rates. By managing money supply in the economy, the central bank can influence inflation, interest rates, and overall economic activity.

d. All of the above:

This option is incorrect because only option (c) “Rationing of Credit” is a qualitative method of credit control, while options (a) “Bank rate” and (b) “Open market operation” are quantitative methods.

Conclusion

To influence the allocation and distribution of credit in the economy, central banks employ qualitative credit control methods. In order to manage inflation and direct credit to priority sectors, the central bank sets specific criteria and guidelines for lending practices. Rationing of credit is one such method.

In contrast, quantitative methods such as the bank rate and open market operations are used to control the money supply, interest rates, and overall liquidity of the economy.

It is critical for policymakers and market participants to understand the difference between qualitative and quantitative credit control methods. It is possible for central banks to maintain a balanced and sustainable growth trajectory, control inflation, and promote economic stability using these tools effectively.

Which of the following is not a function of Central Bank?

Bibisha Shiwakoti
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