Central Bank performs many functions in to development and prosperity of the nation. It is promote the business activities and acts as an adviser to the government. Central bank follows such tools or methods to achieve their objectives.
- Bank Rate Policy
- Open market Operation
- Change in Reserve Ratio
- Rationing of credit
- Moral and legal persuasion
Bank Rate Policy
The central bank increases the bank rate During inflation. The banks increase the lending rate and deposit rate. Credit becomes dear. It affects the demand for loan. The banks create lesser loan, money in circulation contract. Rises in deposit rate discourages consumption. It encourages saving. The supply of money is controlled. Price come down and value of money rises. There are good affect on investment, G.N.P, employment, export and revenue. The success of this policy depends upon the following condition.
- The bank rate, lend rate, call rate and deposit rate should be change ate the same time.
- All the banks should be scheduled they should be under the direct control of the central bank
- People should be cooperative and bank minded
- They should be borrowing less at the higher lending rate and save more at the higher deposit rate.
Open Market Operation
In case banks have large deposit, they do not borrow from the contract bank. People do not cooperative with the control bank. They borrow more from the banks. The banks do not increase the lending and deposit rate. The central bank hits the credit power of the banks. It sells the government securities in the open market. People them by reducing their consumption. They also withdraw from their banks account. It reduces the size of bank primary deposit. It cuts down the power of the bank to create credit.
- Success of this policy depends upon following condition.
- Government publicizes the importance of securities before selling them in ht open market
- People should withdraw money from their bank to purchase their securities.
- They should have trust and confidence in the government.
- The rate of profit on the securities should be higher then the deposit rate.
Change in the Reserve Ratio
In case people do not trust government. They do not buy the securities and drawn upon their banks. The primary deposit remain, interest. The central bank increases the reserve ratio. It reduces the bank power to create credit. Central bank also increase the cash reserve ration which also affects the ability of the bank to lend loan. It is essential that the entire bank is scheduled. They obey the central bank.
Rationing of Credit
If bank has enough primary deposit, the above policies will not succeed. Central bank introduces the rationing of credit policy. A quota is fixed for every sector of the economy. Bank is asked not to lend against personal securities. They are direct to submit the balance sheet regularly. Again the success of this policy depends upon the co operative of the people and the banks.
Moral and legal persuasion
The Central bank is last resort for all the banks. It provides them credit by re-discounting their bill of exchange. It advises them on money matter. Central Bank provides them literature about the importance of their rule. It may threaten them on disobedience. It may ask to wind up to their business in extreme cash.