Money
Reserve Bank is the only institution which can issue currency. When commercial banks need more funds in order to be able to create more credit, they may go to market for such funds or go to the Central Bank. Central bank provides them funds through various instruments. This role of RBI, that of being ready to lend to banks at all times is another important function of the central bank, and due to this central bank is said to be the lender of last resort. The RBI controls the money supply in the economy in various ways. The tools used by the Central bank to control money supply can be quantitative or qualitative. Quantitative tools, control the extent of money supply by changing the CRR, or bank rate or open market operations. Qualitative tools include persuasion by the Central bank in order to make commercial banks discourage or encourage lending which is done through moral suasion, margin requirement, etc.
Open Market Operations refers to buying and selling of bonds issued by the government in the open market. This purchase and sale is entrusted to the Central bank on behalf of the government. There is another type of operation in which when the central bank buys the security, this agreement of purchase also has specification about date and price of resale of this security. This type of agreement is called a repurchase agreement. The interest rate at which the money is lent in this way is called the repo rate. Similarly, instead of outright sale of securities the central bank may sell the securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement.
To discourage the lending by commercial bank which of the following tool can be used by Central Bank?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Increase Margin requirement.
A bank lending against goods or securities does not lend their full value; the part it keeps back is the margin. If the central bank raises the margin requirement from 20 to 40 per cent, goods worth Rs 100 fetch a loan of only Rs 60 instead of Rs 80, so raising the margin discourages lending. The passage names it among the tools used to make banks discourage or encourage lending.
Why the other options are incorrect
Option (1) Decrease Bank rate. — Incorrect. A lower bank rate makes it cheaper for banks to borrow from the central bank, so they lend more.
Option (3) Buy Government securities. — Incorrect. Buying securities adds to the reserves of the banks and so allows more lending.
Option (4) Decrease Statutory Liquidity Ratio. — Incorrect. A lower SLR means the banks must keep a smaller share of their deposits in liquid assets, leaving more to lend.