Explanation:

Qualitative Tools of Monetary Policy is a set of instruments used by the Reserve Bank of India (RBI) that discriminate the use and allocation of credit to different sectors of the economy. The qualitative tools are also known as Selective Tools of Monetary Policy. For instance, the RBI guidelines to incentivize lending to certain sectors like small businesses, the housing sector and the automotive sector is a kind of Qualitative tool.

Types of Qualitative Tools

The following are the qualitative tools used by the RBI for credit control:

1. Change in Marginal Requirement

• The term "margin" refers to the percentage of a loan that is not offered or financed by the bank.
• A change in the loan size can be caused by a change in the marginal requirement.
• This device is used to boost credit supply for necessary sectors while discouraging it from non-essential ones.
• This can be accomplished by raising the marginal of unneeded sectors while lowering the marginal of other sectors in need.
• If the RBI believes that additional credit should be available to the agricultural sector, the margin will be reduced, and 80-90 percent of the loan will be available.
  • For instance, if the marginal requirement for the agricultural sector is 10% and if someone pledges collateral worth 10 crores for a loan of 10 crores, then the sanctioned loan would be a maximum of 9 crores.
  • On the other hand, if the automotive sector has a marginal requirement of 20%, for the same collateral and loan the sanctioned amount will be 8 crores.

2. Regulation of Consumer Credit

• Consumer credit supply is regulated by the installment of sale and hire purchase of consumer goods.
• Features such as installment amount, down payment, loan period, and so on are all pre-determined, which aids in the control of credit and inflation in the country.
• For instance, for a home loan, the RBI can set a minimum downpayment limit of 15%. Therefore for a home loan of 1 crore, Rs. 15 lakhs must be paid as a downpayment and avail 85 lakhs as a loan.

3. Rationing of Credit

• The Reserve Bank of India sets a credit limit for commercial banks. The quantity of credit accessible to any commercial bank is limited.
• The higher credit limit might be set for certain objectives, and banks must adhere to it.
• This reduces the bank's credit exposure to unfavorable industries. This device also regulates bill rediscounting.
• For instance, the banks might be instructed by the RBI not to lend to traders of Onion and Potato despite having eligibility and collateral pledging capacity.
  • This is to ensure there is no hoarding of essential commodities by using bank loans.

4. Moral Suasion

• Moral suasion refers to the RBI's recommendations to commercial banks that aid in the restraint of credit during inflationary periods.
• The Reserve Bank of India (RBI) exerts pressure on the Indian banking system without taking any concrete steps to ensure compliance with the rules.
• Commercial banks are informed of the RBI's expectations through monetary policy.
• Under moral suasion, the RBI can offer orders, recommendations, and suggestions to commercial banks to reduce loan supply for speculative purposes.
• For instance, the Governor of RBI made a press statement that the reduction in repo rates has not been transferred to the consumers. This will nudge the banks to reduce their interest rates.

5. Direct Action

• The central bank (RBI) can punish and impose sanctions on banks for not following the guidelines provided under the monetary policy.
• For instance, the imposition of the Prompt Corrective Action Framework is one such Direct Action measure.