There are a number of methods by which the central bank controls the commercial banks but first of all we must understand what we mean by controlling a bank. As we all know that extending credit or lending is the main business of a bank, the central bank can only control a commercial bank by keeping a check on the amount of credit issued by a commercial bank. This function of the central bank is known as Credit Control.The different measures used by the central bank to control credit are divided into two main heads:
QUANTITATIVE TOOLS:All those methods which attempt to control the volume of credit money circulation come under this head. The following methods are included:
- Bank Rate Policy: Bank rate is the rate of interest charged by the Central Bank on the re discounting of bills of exchange. Bank Rate Policy is to increase or decrease the interest rate according to the inflationary or deflationary situation.
When the rate is increased, the banks have to pay a large amount to the central bank in the form of interest and don't have enough funds for the purpose of lending.
- Open Market Operation: Under this method, the central banks issue Government Securities to the commercial banks for which they have to pay to the central bank. This results in limitation of funds for the commercial banks and they cannot lend further.
- Variable Reserve Requirement: In every country, all the scheduled commercial banks are compulsorily required to keep fixed percentage of their reserves with the central bank. In Pakistan, the ratio is 5%. The are various uses of these reserves and the most important is Credit Control.
- Credit Ceiling: It is to keep an upper limit of loans to be extended by the commercial banks, the breach of which results in severe financial sanctions.
QUALITATIVE TOOLS:With the help of these tools, the central bank can make sure that credit is being extended to the right economic sectors in the right amount. There are four qualitative tools:
- Selective Credit Control: The central bank ensures that the credit money is going into the deserving hands.
- Moral Persuasion: The Central bank morally persuades the commercial banks to work in the interest of national prosperity and the country's economic strength.
- Publicity: The central bank informs all the scheduled banks about the nations economic needs and the procedures to be followed in order the cater to them.
- Direct Action: In case the commercial banks do not work in accordance with the central bank's charter, the central bank takes direct action in the form of financial sanctions and other punishments.