EconomicsISC Class 12 · Commercial Banks and Central Bank

Central Bank: Functions and Quantitative and Qualitative Methods of Credit Control

Updated 17 October 2026 · Fact-checked

The central bank (the RBI in India) issues currency, acts as banker to the government and banker to banks, is the lender of last resort and controls credit. Its quantitative tools (CRR, SLR, bank rate, repo and reverse repo rates, open market operations) change the volume of credit; its qualitative tools (margin requirements, moral suasion, direct action and others) regulate its direction and use.

Understand Central Bank: Functions and Methods of Credit Control

1. Functions of a central bank.

Issue of currency: it is the sole (or main) authority to issue notes, giving uniformity and control over the money supply.
Banker to the government: it keeps the government's accounts, receives and makes payments, manages public debt and gives short-term advances.
Banker to banks (bankers' bank): commercial banks keep part of their reserves (the CRR) with it, and it provides funds and clearing facilities.
Lender of last resort: it lends to banks facing a shortage of funds when no one else will, to prevent bank failures.
Controller of credit: it regulates the quantity and cost of credit in line with the economy's needs.
Regulator and supervisor of the banking system and custodian of foreign exchange reserves (in India the RBI manages foreign exchange as well).

The syllabus asks for its regulatory role and the way it controls the flow of credit.

2. Quantitative methods (control the total volume of credit).

Cash reserve ratio (CRR): the fraction of a bank's deposits that must be kept as cash with the central bank. A higher CRR reduces the funds available for lending (and the credit multiplier); a lower CRR does the opposite.
Statutory liquidity ratio (SLR): the fraction of deposits that banks must hold in liquid assets, such as cash, gold or approved government securities, with themselves. A higher SLR also reduces lendable resources.
Bank rate: the rate at which the central bank lends to commercial banks (a long-term policy rate). A rise makes borrowing costlier for banks, who raise their lending rates, discouraging loans.
Repo rate: the rate at which the central bank lends to banks for the short term against government securities (the bank sells securities with an agreement to repurchase them). A higher repo rate raises banks' cost of funds.
Reverse repo rate: the rate at which the central bank borrows from banks for the short term. A higher reverse repo rate makes it attractive for banks to park surplus funds with the RBI rather than lend.
Open market operations (OMO): the sale and purchase of government securities by the central bank. Selling securities withdraws reserves from banks (contracting credit); buying securities releases reserves (expanding credit).

3. Qualitative (selective) methods (control the direction and use of credit).

Margin requirements: the difference between the value of the security offered and the loan granted; raising the margin reduces the loan against that security.
Credit rationing: limiting the amount of credit to certain sectors or banks.
Moral suasion: persuasion and requests to banks to follow its policy.
Direct action: penalties or restrictions on banks that do not follow its directions.
Selective controls on consumer credit and priority sector lending guidelines.

4. Policy stance. To fight inflation (excess demand) the central bank tightens: raises CRR, SLR and the policy rates, sells securities and tightens margins. To fight a slump (deficient demand) it eases: the reverse. A brief mention of the methods is sufficient for ISC; learn what each does and its direction of effect.

Central Bank: Functions and Methods of Credit Control: key facts

Funds available for lending: Lendable funds = deposits - CRR amount - SLR amount
CRR amount: CRR amount = CRR x deposits
Margin: Loan = value of security x (1 - margin)
OMO effect on deposits: Potential change in deposits = change in reserves x 1 / LRR

How to answer Central Bank: Functions and Methods of Credit Control questions

Credit-control numericals convert ratios into amounts and trace the effect on lending.

1Convert each ratio (CRR, SLR, margin) to a fraction and multiply by deposits or security value.
2Lendable funds = deposits less CRR amount less SLR amount.
3For a change in CRR or SLR, recompute and take the difference.
4For OMO, the change in bank reserves multiplied by the credit multiplier gives the potential change in deposits.
5State whether the policy is contractionary or expansionary and why.

Central Bank: Functions and Methods of Credit Control in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

A rate rise and a home loan

Suppose the central bank raises its policy rate and, as a result, a bank raises the interest rate on a Rs 20,00,000 loan from 9% to 9.5% a year (simple interest for illustration).

By how much does the yearly interest rise, and how might it affect borrowing?

Try it first, then show the solutionSolution

Interest at 9% = 20,00,000 x 0.09 = Rs 1,80,000.
Interest at 9.5% = 20,00,000 x 0.095 = Rs 1,90,000.
Rise = Rs 10,000 a year.

Answer: The yearly interest rises by Rs 10,000, so some borrowers postpone loans, and total credit and spending grow more slowly.

Memory hook: Dearer money, less borrowing.

Tricks to remember Central Bank: Functions and Methods of Credit Control

Short memory aids. Say each one aloud once, then use it on a question the same day.

CRR with RBI, SLR with yourself
CRR is cash kept with the central bank; SLR is liquid assets kept by the bank itself.
Use it when: Distinguishing CRR and SLR.
Repo: Re-purchase, bank borrows; Reverse: RBI borrows
Repo = RBI lends to banks; reverse repo = RBI absorbs banks' surplus.
Use it when: Direction of lending.
Hawk and dove
Raise rates and reserves to cool inflation; lower them to heat up a slump.
Use it when: Choosing measures.

Central Bank: Functions and Methods of Credit Control: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Qualitative instrument · 1 mark · MCQBoard level

Which of the following is a qualitative method of credit control?
(a) cash reserve ratio
(b) open market operations
(c) margin requirement
(d) bank rate

Try it first, then show the solutionSolution

CRR, OMO and bank rate change the volume of credit (quantitative); margin requirements regulate the use of credit against a specific security.

Answer: (c) margin requirement

Example 2: CRR and SLR in rupees · 3 marks · Short answerBoard level

A bank has deposits of Rs 800 crore. CRR is 4% and SLR is 20%. Find the amounts kept as CRR and SLR and the funds available for lending. If the CRR is raised to 6%, find the new lendable funds and the fall. (3 marks)

Try it first, then show the solutionSolution

CRR amount = 4% of 800 = Rs 32 crore; SLR amount = 20% of 800 = Rs 160 crore.
Lendable = 800 - 32 - 160 = Rs 608 crore.
At CRR 6%: 48 crore; lendable = 800 - 48 - 160 = Rs 592 crore.
Fall = 608 - 592 = Rs 16 crore.

Answer: CRR Rs 32 crore, SLR Rs 160 crore, lendable funds Rs 608 crore; after CRR rises to 6% lendable funds fall by Rs 16 crore to Rs 592 crore.

Example 3: Open market operations · 4 marks · Short answerHarder board level

The central bank sells government securities worth Rs 500 crore to commercial banks. The legal reserve ratio is 10%. Explain the effect on reserves and the potential effect on deposits, and name the type of policy. (4 marks)

Try it first, then show the solutionSolution

Banks pay by drawing on their reserves, so reserves fall by Rs 500 crore.
Credit multiplier = 1/0.10 = 10.
Potential contraction of deposits = 500 x 10 = Rs 5,000 crore.
Selling securities withdraws reserves: a contractionary (tight) policy used to curb inflation.

Answer: Reserves fall by Rs 500 crore and deposits can contract by up to Rs 5,000 crore: a credit-contracting policy against inflation.

Example 4: Cost of borrowing · 4 marks · Short answerHarder board level

The central bank raises its policy rate and a bank raises its lending rate from 9% to 9.5% on a Rs 20,00,000 loan (simple interest for one year). Find the extra interest and explain how the transmission reduces demand. (4 marks)

Try it first, then show the solutionSolution

Interest at 9% = Rs 1,80,000; at 9.5% = Rs 1,90,000; extra = Rs 10,000.
Higher policy rate raises banks' cost of borrowing from the RBI and of funds.
Banks pass this on in higher lending rates; loans for housing, vehicles and business become costlier.
Borrowing and spending fall, reducing aggregate demand and inflation pressure.

Answer: Extra interest is Rs 10,000 a year; dearer credit lowers borrowing, investment and consumption, cooling demand.

Example 5: A package of measures · 4 marks · Short answerHOTS / competency

Inflation is rising. The central bank wants to cut credit, including loans against stored goods. (a) Name three quantitative and two qualitative measures. (b) If the margin on loans against goods worth Rs 10,00,000 is raised from 20% to 40%, find the fall in the permissible loan. (4 marks)

Try it first, then show the solutionSolution

(a) Quantitative: raise CRR or SLR; raise the repo rate or bank rate; sell securities (OMO). Qualitative: raise margin requirements; moral suasion.
(b) Loan at 20% margin = 10,00,000 x 0.8 = Rs 8,00,000; at 40% margin = 10,00,000 x 0.6 = Rs 6,00,000.
Fall = Rs 2,00,000.

Answer: A mix of higher CRR/SLR, higher policy rates and securities sales (quantitative) and higher margins and moral suasion (qualitative); the permissible loan falls by Rs 2,00,000.

Where students lose marks in Central Bank: Functions and Methods of Credit Control

The slips examiners see most often, and what to write instead.

Mistake: Mixing repo and reverse repo
Not seeing who lends.
Wrong working
Repo rate is the rate at which the RBI borrows from banks.
Right working
Repo is the rate at which the RBI lends to banks; reverse repo is the rate at which it borrows from banks.
Do this: Reverse repo is the 'opposite' direction.
Usually costs: 2 marks.
Mistake: Calling CRR and SLR the same
Both are reserve ratios.
Wrong working
SLR is cash kept with the RBI.
Right working
CRR is cash with the RBI; SLR is liquid assets (cash, gold, government securities) held by the bank itself.
Do this: Learn where each is held.
Usually costs: 2 marks.
Mistake: Wrong direction of policy
Not linking the tool to the aim.
Wrong working
To control inflation, buy securities.
Right working
To control inflation, sell securities (withdraw reserves) and raise rates.
Do this: Tighten for inflation, ease for deflation.
Usually costs: 2 marks.
Mistake: Treating a quantitative method as qualitative
Misclassifying margin and OMO.
Wrong working
Open market operations are selective controls.
Right working
OMO is quantitative; margin requirements and moral suasion are qualitative.
Do this: Quantity or direction of credit?
Usually costs: 1 mark.

Exam tips

The syllabus asks for a brief mention of the credit-control methods, so keep each to one or two lines: meaning, and effect on credit.
Always give the direction: raising CRR/SLR/repo rate or selling securities reduces credit.
Learn the list: CRR, SLR, bank rate, repo, reverse repo, OMO (quantitative); margin, moral suasion, rationing and direct action (qualitative).
Link instruments to inflation (tighten) and slump (ease).
Use Indian terms (RBI, repo rate) and avoid quoting current rate values unless the question supplies them.

Practice questions on Central Bank: Functions and Methods of Credit Control

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
When the central bank wants to expand credit, it can:
(a) raise the CRR
(b) sell government securities
(c) lower the repo rate
(d) raise the bank rate
Hint
Make money cheaper and more plentiful.
Answer
(c) lower the repo rate
Q2 · 3 marks · Short answerBoard level
A bank has deposits of Rs 2,000 crore, CRR 5% and SLR 18%. Find the amounts kept as CRR and SLR and the funds available for lending. (3 marks)
Hint
Subtract both from deposits.
Answer
CRR = 5% of 2,000 = Rs 100 crore; SLR = 18% of 2,000 = Rs 360 crore; lendable funds = 2,000 - 100 - 360 = Rs 1,540 crore.
Q3 · 4 marks · Short answerHarder board level
The central bank buys government securities worth Rs 300 crore from banks. If the legal reserve ratio is 20%, find the rise in reserves and the potential expansion in deposits. Name the type of measure and when it is used. (4 marks)
Hint
Reserves rise by the payment.
Answer
Reserves rise by Rs 300 crore; the multiplier is 5, so deposits can expand by 300 x 5 = Rs 1,500 crore. This is an open market purchase (quantitative, expansionary), used in a slump or to fight deficient demand.
Q4 · 4 marks · Short answerHarder board level
A bank gives loans against gold worth Rs 5,00,000 with a margin of 25%. The central bank raises the margin to 40%. Find the loan before and after and say what type of control this is and why it is used. (4 marks)
Hint
Loan = value x (1 - margin).
Answer
Before: 5,00,000 x 0.75 = Rs 3,75,000. After: 5,00,000 x 0.60 = Rs 3,00,000, a fall of Rs 75,000. It is a qualitative (selective) control, used to restrict credit for a particular purpose (such as speculative holding of an asset) without changing credit for other uses.
Q5 · 3 marks · Short answerHOTS / competency
Suppose the reverse repo rate falls from 3.0% to 2.5% (hypothetical rates). A bank has Rs 1,000 crore of surplus funds. Find the annual income lost on parking funds with the central bank and explain how the change affects banks' behaviour. (3 marks)
Hint
Interest = principal x rate.
Answer
Income at 3.0% = Rs 30 crore a year; at 2.5% = Rs 25 crore; loss Rs 5 crore. The lower return on parking funds with the central bank encourages banks to lend the funds instead, expanding credit.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Who is the lender of last resort?Show answer
The central bank.
2.CRR is held with whom?Show answer
With the central bank.
3.Repo rate meaning?Show answer
Rate at which the central bank lends short-term to banks against securities.
4.Effect of selling securities by the RBI?Show answer
Reserves fall and credit contracts.
5.One qualitative method?Show answer
Margin requirement (or moral suasion).

Central Bank: Functions and Methods of Credit Control: frequently asked questions

What are the main functions of a central bank?

Issuing currency, banker to the government and banks, lender of last resort, and controller of credit.

What is the difference between CRR and SLR?

CRR is cash kept with the central bank; SLR is liquid assets that a bank keeps with itself.

What are open market operations?

Buying and selling of government securities by the central bank to change bank reserves.

What is a qualitative method of credit control?

A method that regulates the direction or use of credit, such as margin requirements and moral suasion.