The banking Regulation Act confers wide powers on the Reserve Bank of India to control the level and pattern of banks’ advances in general or on a selective basis. Under Section 21 of the banking Regulation Act, 1949, the Reserve Bank is empowered to issue directions to the banking companies to determine the policy in relation to advances to be followed by them either generally or by any of them in particular. The Reserve Bank’s directives may relate to any / or of the following:
1) The purposes for which advances may or may not be made.
2) The margins to be maintained in respect of secured advances.
3) The maximum amount of advances to any company, firm, individual etc.
4) The rate of interest and other terms and conditions on which advances and other financial accommodation may be given.
The Reserve Bank of India has been operating selective controls since 1956 in respect of certain commodities which have been sensitive or in short supply. These controls are being enforced with the objective to discourage the use of bank finance for the hoarding of such commodities so as to check an undue rise in their prices.
Advances against (1) Food grains, (2) Pulses, (3) Oilseeds, (4) Vegetable oils, (5) Cotton and Kapas and (6) Sugar, Gur and Khandsari have been covered by selective credit controls.
The framework of selective credit controls consists of the following three instruments:
Fixation of party wise ceiling on credit on credit: The ceilings are fixed keeping in view the crop prospects, supply position and price trends. After the fixation of ceiling of credit on a party wise basis since November 1972, banks are required to seek the prior permission of the Reserve Bank for (1) granting loans to new borrowers, and (2) increasing the credit limits in case of existing borrowers. Thus one bank cannot take over a commodity account which is subject to credit control from another bank without seeking prior approval of the Reserve Bank.
Imposition of minimum margin: In case of advances against commodities subject to selective control, higher margins are prescribed in order to restrict the borrowing capacity of the borrowers. With higher margin, a borrower can get less credit from banks against a certain quantity of stock and thus can finance only a smaller part of it through bank finance. Moreover, different margins may be prescribed for different types of borrowers against the security of the same commodity. A higher margin is generally for those borrowers whose need for credit is not so urgent or larger flow of credit to whom is likely to aggravate the price situation. For example, minimum margins were prescribed for advances against food grains, pulses and oilseeds (w.e.f 19th October, 1987) at 45% for processing units/mills and against warehouse receipts and at 60% for others.
Fixation of minimum lending rate: Though the Reserve Bank had prescribed the interest rates on various categories of commercial bank advances which include the maximum rates of interest to be charged in certain cases, the minimum lending rate was prescribed for advances for commodities subject to selective control.
In order to make selective credit controls more effective, clean credit facilities are not allowed to any borrower affected by selective credit controls. Appropriate exemptions from the requirements of the selective credit controls are, however, granted so as to avoid unnecessary hardship to the deserving borrowers. For example, advances granted to certain categories of borrowers e.g. State agencies like the Food Corporation of India and State Trading Corporation are exempted from the application of the directives. Exports are exempted from the purview of selective controls. These restrictions are generally less severe in respect of credit granted to the manufacturing and processing units and are tighter in case of traders. Similarly advance against the security of or by way of purchase of demand documentary bills drawn in connection with the movement of goods subject to selective controls are exempted, while usance bills are not.