Explain any two methods of credit …

The Central Bank acts as a controller of money supply and credit, using the following methods:

1. Margin requirement: Changes in margin requirements are designed to influence the flow of credit against specific commodities. The commercial banks generally advance loans to their customers against some security or securities offered by the borrower and acceptable to banks. More generally, the commercial banks do not lend up to the full amount of the security but lend an amount less than its value. The margin requirements against specific securities are determined by the Central Bank. A change in margin requirements will influence the flow of credit. A rise in the margin requirement results in a contraction in the borrowing value of the security and similarly, a fall in the margin requirement results in an expansion in the borrowing value of the security.
2. Open market operations: Under open market operations, RBI purchases or sells government securities to the general public for the purpose of increasing or decreasing the stock of money in an economy.  The purchase or sale of securities controls the money in the hands of the public as they deposit or withdraw the money from Commercial Banks.
   Thus, money creation by Commercial Banks gets affected. Suppose, the Central Bank purchases securities of Rs.1,000 from a bondholder with issuing a cheque. The seller of the bond produces this cheque of Rs.1,000 to his Commercial Bank. The Commercial Bank credits the account of the seller by Rs.1,000 and the deposits of the bank go up by Rs.1,000, which increase the credit creation capacity of the banks. Thus, the purchase of security increases the money creation of Commercial Banks and similarly, the sale of securities decreases the credit creation of Commercial Banks. Thus, the Central Bank controls the process of money creation by Commercial Banks by open market operations.