Which of the following of credit control?a)Credit Rationingb)Change in Cash Reserves of Commercial Banksc)Publicity and Notificationsd)Regulation of Consumer Credit.Correct answer is option 'B'. Can you explain this answer?

Question

Answer

Under this system the Central Bank controls credit by changing the Cash Reserves Ratio. For example—If the Commercial Banks have excessive cash reserves on the basis of which they are creating too much of credit which is harmful for the larger interest of the economy. So it will raise the cash reserve ratio which the Commercial Banks are required to maintain with the Central Bank.

This activity of the Central Bank will force the Commercial Banks to curtail the creation of credit in the economy. In this way by raising the cash reserve ratio of the Commercial Banks the Central Bank will be able to put an effective check on the inflationary expansion of credit in the economy.

Similarly, when the Central Bank desires that the Commercial Banks should increase the volume of credit in order to bring about an economic revival in the country. The Central Bank will lower down the Cash Reserve ratio with a view to expand the cash reserves of the Commercial Banks.

With this, the Commercial Banks will now be in a position to create more credit than what they were doing before. Thus, by varying the cash reserve ratio, the Central Bank can influence the creation of credit.

Answer

Understanding Credit Control Instruments
Credit control refers to the measures taken by a central bank to regulate the availability and cost of credit in the economy. Among various instruments, option 'B', 'Change in Cash Reserves of Commercial Banks,' plays a significant role.
1. Cash Reserve Ratio (CRR)
- The Cash Reserve Ratio is the percentage of a bank's total deposits that must be kept in reserve with the central bank.
- By changing the CRR, the central bank influences the amount of money that banks can lend.
2. Impact on Lending Capacity
- An increase in the CRR means banks have to hold more funds in reserve, reducing their ability to lend.
- Conversely, lowering the CRR allows banks to lend more, increasing the money supply in the economy.
3. Influence on Interest Rates
- Adjusting the cash reserves directly affects interest rates.
- Higher reserves can lead to increased interest rates as banks have less money to lend, while lower reserves can decrease interest rates.
4. Economic Stabilization
- This tool is crucial for managing inflation and stimulating economic growth.
- By controlling the money supply through CRR adjustments, the central bank can stabilize the economy.
Conclusion
In summary, 'Change in Cash Reserves of Commercial Banks' is a fundamental instrument of credit control that directly affects lending capacity, interest rates, and overall economic health. Understanding this mechanism is essential for grasping how monetary policy is implemented.

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