Varying Reserve Requirements

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Varying Reserve Requirements

When it is sought to restrict credit, the central bank may raise the reserve ratio. In 1960, for instance, the Reserve Bank of India required the scheduled banks to maintain with it additional reserve equivalent to 25 per cent of the increase in their bank deposits (later raised to 50 per cent). The Reserve Bank Act was amcnded in 1962 which requires all banks to maintain at the close of business on any day a minimum amount of liquid assets equal to not less Ulan 25 per cent of their total demand and time liabilities exclusive of the balances already maintained with the Reserve Dank. Also, the Reserve Dank was empowered to vary the cash ratio from the minimum requirement of 3 per cent to 15 per cent of the aggregate liabilities. Van tions of reserve requirements affect the liquidity po: ilion of the banks and hence their ability to lend. The raising of reserve requirements is an antiinflauon ry measure in as much as it reduces the excess reserves of member-banks for potential credit expansion. The lowering of the reserve ratios has the opposite effect.

Limitations. There are, however, limitations to the success of this weapon of credit control: (a) The banks may have very large excess reserves and it may not be easy to alter legal reserve requirements; (b) the banks have ready access to reserve funds which may nullify the rise in reserve requirements; (c) a large net inflow of gold in payment of persistent export surplus may increase the banks’ power to lend and (d) the government policy of keeping interest rates low and stable would keep large reserves in the banks and may discourage too drastic increases in reserve requirements.

Selective Credit Controls: Varying Margin Requirements Another weapon in the hands of ihe central bank for controlling credit is to vary the margin requirements. While lending money against securities, the banks keep a certain margin. They do not advance money to the full value of the security pledged for the loan. In case it is desired to curtail bank advances, the central bank may issue directives that higher margin be kept .In 1960, for instance, the Reserve Bank of India raised to 50 per cent the minimum margin requirement for bank advance against equity shares. The raising of margin requirements is designed to check speculation in the stock markets and to prevent the typical ‘boom-bust’ pattern in the stock markets. In this way, the demand for speculative credit is controlled. The higher the margin required, the less credit one would obtain for the purchase of stocks.

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Varying Reserve Requirements