What is Credit Control: How Banks and Businesses Manage Lending

Credit control is the practice of managing how and to whom credit is given. Banks, financial institutions and businesses use it to lend responsibly and reduce the risk of defaults. To understand how credit control works, the role of RBI in it and more, keep reading this blog.

Key Highlights

• Credit control or credit policy management is a bank's practice of managing credit extension to customers while increasing sales and reducing bad debt.
• Users of credit control include banks, financial institutions, retailers, manufacturers and creditors.
• RBI controls credit using tools like repo rate, CRR, SLR, MSF, margin requirements and moral suasion.
• Individual-level credit control involves evaluating a customer’s creditworthiness. 

Who Uses Credit Control?

Banks and financial institutions use credit control policies to minimise loan default. Retailers and manufacturers use such policies to receive payment from vendors and customers on time. 

Creditors and lenders use these policies to avoid financial losses and ensure the timely repayment of credits. Usually, a dedicated risk management team manages credit control for the financial stability of the company and to maximise profits.

What are the Credit Control Policies by RBI?

RBI generally follows two credit control methods - Quantitative control and Qualitative control.

Quantitative Credit Control: This is measured by keeping in consideration the bank rate policy to control credit, inflation and money supply. Along with this, RBI keeps a check on open market operations to sell and purchase securities and bills. To ensure quantitative credit control, RBI keeps a check on cash reserve ratio and statutory liquid ratio.

Qualitative Credit Control: Under qualitative credit control measures, RBI tracks the margin requirements, lays down consumer credit regulations and controls the credit granted/allocated. 

Role of RBI in the Control of Credit

The Reserve Bank of India (RBI) regulates the credit creation by banks across the country. To do this effectively, it uses both quantitative and qualitative instruments as part of its credit control policy. 

Here are the quantitative instruments that RBI uses in its credit control policies:

1. Bank Rate: The rate at which the RBI lends to commercial banks for the long term is termed the bank rate. RBI increases the rate during inflation and decreases it during recessions. 
2. Cash Reserve Ratio (CRR): It is the ratio of cash that banks need to keep with the RBI on a day-to-day basis and receive it during a financial crisis. RBI increases the rate during a tight monetary policy and decreases it during a liberal monetary policy.
3. Statutory Liquid Ratio (SLR): Banks need to maintain 18% of their total assets as liquid assets, such as gold, government securities or cash, to use them during a financial crisis.
4. Repo and Reverse Repo Rate: The repo rate is the cost at which banks borrow money from the RBI. When the RBI raises the repo rate, banks often increase loan interest rates. In contrast, the reverse repo rate is the rate RBI pays banks for parking excess funds with it. When this rate rises, banks prefer to deposit money with the RBI rather than lend.
5. Marginal Standing Facility (MSF): Scheduled banks can borrow from the RBI overnight at the MSF rate by lowering their SLR rate up to 2% of the Net Demand and Time Liabilities (NTDL) at a panel interest rate of 0.25% above the repo rate.

The qualitative instruments employed by the RBI for credit control are as follows:

1. Margin Requirement: The RBI adjusts the margin requirement or the amount of loan sanctioned against the securities pledged as collateral. A lower margin increases borrowing while a higher margin decreases it.
2. Credit Rationing: It is the limit within which commercial banks can borrow funds. RBI regulates it to ensure a balanced credit control.
3. Moral Suasion: The RBI exerts informal pressure on Indian commercial banks to adhere to the strict monetary policies by implementing this strategy.

Why is Credit Control Important?

One of the key roles of credit control is to protect the financial stability of the lending entity. It ensures a steady and predictable cash flow, which is essential for smooth business operations. 

By closely monitoring lending and repayments, credit control helps reduce bad debts while maintaining adequate liquidity. After all, timely repayments from borrowers support profitability and reinforce financial discipline.

Final Word

Credit control operates at multiple levels, from the national economy to individual businesses. At the top level, central banks use monetary policy to regulate the overall supply of money and credit. 

For individual companies, credit control is an essential part of financial management. It helps boost sales by extending credit to reliable customers while minimising the risk of bad debts and ensuring a steady cash flow.