Selective credit control, directed credit and macroprudential policy

Detail

1. Quantitative vs qualitative tools: the basic split

• Quantitative (general) tools change the total amount of credit in the economy. Examples are the repo rate, CRR, SLR and open market operations.
• Qualitative (selective) tools of monetary policy decide where credit goes and what it is used for. They do not change the total amount.

• Example: the RBI may want less lending for hoarding sugar, but the same or more lending to farmers.

• Qualitative tools are useful when prices rise in one sector (for example foodgrains or shares), while the rest of the economy needs normal credit.

2. Margin requirement

• Margin requirement: the part of a security's value that a bank cannot lend against. The borrower must bring this part from their own money.
• Formula: Maximum loan = Value of security × (1 − margin)
• Worked example:
• Shares worth ₹100 with a 40% margin → the bank lends at most ₹100 × 0.60 = ₹60.

• The RBI raises the margin to 60% → the bank lends only ₹40.

• Effect of a higher margin:

• The borrower must put in more of their own money.
• Speculative borrowing (borrowing to bet on price rises) against shares or commodities becomes harder.

• Demand for those assets cools, and their prices stop rising so fast.

• A lower margin does the opposite. It encourages credit to that sector.

3. Credit ceilings

• Credit ceiling: an upper limit on how much banks can lend to a certain sector or borrower group.
• It works directly on quantity. The price of credit (the interest rate) does not have to change.

4. Selective credit controls (SCCs)

• Selective credit controls: RBI directions that limit bank lending against sensitive commodities. These are essential goods that traders may hoard, such as foodgrains, sugar, oilseeds and pulses.
• Legal base: used from 1956 under Section 21 of the Banking Regulation Act, 1949. This section lets the RBI decide banks' advance policy, including the purpose of loans, margins and interest rates.
• How it worked:
• Traders borrowed from banks against their stock of grain.
• With cheap loans they could hold back stock → supply in the market fell → prices rose.

• SCCs raised margins and set ceilings on such loans → hoarding became costly → prices eased.

• Decline: SCCs were largely dismantled after the 1990s. After liberalisation, markets became better connected, food policy changed and the RBI moved to market-based tools.

5. Moral suasion

• Moral suasion: the RBI persuades banks, without a legal order, through letters, meetings and speeches.
• Examples:
• Pressing banks to pass on repo rate cuts faster to borrowers (rate pass-through).

• Urging caution on fast-growing unsecured loans (loans with no collateral behind them, such as personal loans and credit cards).

• It works because the RBI is the banks' regulator, and banks do not want to displease it.

6. Direct action

• Direct action: penalties or business restrictions on banks that do not follow RBI directions.
• Examples: monetary penalties, a ban on issuing new credit cards, or limits on opening new branches.
• It is the "stick" that stands behind moral suasion.

7. Directed credit: priority sector lending (PSL)

• Directed credit: the state or central bank tells banks to send a set share of their loans to chosen sectors.
• Root in NCERT: Class 10 notes that the RBI "sees that banks give loans … to small cultivators, small scale industries, to small borrowers". This idea grew into priority sector lending (PSL).
• PSL: banks must lend a fixed share of their credit to sectors that the market would otherwise underserve. These borrowers are small, risky or far away, but important for jobs and growth.
• History:
• Began in 1974 (after bank nationalisation in 1969).

• The target reached 40% of ANBC for domestic commercial banks by 1985.

• ANBC (Adjusted Net Bank Credit): the base on which PSL targets are measured.

• ANBC = Net Bank Credit + banks' investments in non-SLR bonds held in the HTM (held-to-maturity) category.
• The target applies to ANBC or to the Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, as on 31 March of the previous year [4].

Current framework: Master Directions on PSL, issued 24 March 2025, effective 1 April 2025 (last updated 11 September 2026) [2]

Bank type	Overall PSL target
Domestic commercial banks (excluding RRBs and SFBs)	40% of ANBC [2]
Foreign banks, 20 or more branches	40% of ANBC [2]
Foreign banks, fewer than 20 branches	40% of ANBC, of which up to 32% can be export credit [2]
Regional Rural Banks (RRBs)	75% of ANBC [2]
Small Finance Banks (SFBs)	60% of ANBC [2]
Urban Co-operative Banks (UCBs)	60% [2]

• The scaffold notes that RRBs and SFBs have higher targets. This is confirmed above: 75% and 60%.

Sub-targets for domestic commercial banks (share of ANBC) [2]

• Agriculture: 18% (NCERT: 18%). Within it:
• Small and marginal farmers (SMFs): 10% [2]

• Non-corporate farmers (NCFs): 14% [2]

• Micro enterprises: 7.5% [2][4]

• Weaker sections: 12% [2]

Worked example: a bank has ANBC of ₹1,000 crore on 31 March 2025. For 2025-26 it must lend:

• Total PSL = 40% → ₹400 crore
• Agriculture = 18% → ₹180 crore, of which small and marginal farmers get at least ₹100 crore
• Micro enterprises = 7.5% → ₹75 crore
• Weaker sections = 12% → ₹120 crore
• One loan can count under more than one head. For example, a loan to a small farmer counts under agriculture, SMF and weaker sections. So the sub-targets overlap and do not add up in a simple way.

Eight PSL categories [2]

1. Agriculture
2. MSMEs
3. Export credit
4. Education
5. Housing
6. Social infrastructure
7. Renewable energy
8. Others

Key loan limits under the 2025 Directions [2]

• Housing: ₹35 lakh to ₹50 lakh per loan, depending on city population. The cost of the house is capped at ₹44 lakh to ₹63 lakh.
• Education: up to ₹25 lakh per person.
• Renewable energy: up to ₹35 crore for projects, and ₹10 lakh per borrower for household installations such as rooftop solar.
• Priority sector lending certificates (PSLCs) and co-lending → see banking-regulation-npas.

8. Macroprudential policy

• Microprudential regulation checks that each bank is safe on its own.
• Macroprudential policy uses regulatory tools to limit risk to the whole financial system, not just one bank.
• It exists because all banks can be safe one by one and still create a system-wide problem. This happens if every bank lends heavily to the same risky sector, such as housing or unsecured loans.

8.1 Countercyclical capital buffer (CCyB)

• CCyB: extra capital that banks must build in good times (when credit grows fast). They can use it in bad times to absorb losses and keep lending.
• Chain:
• Credit boom → the RBI switches on the CCyB → banks must hold more capital
• → fast lending slows, and a cushion builds up

• → in a downturn the RBI releases the buffer → banks keep lending instead of cutting loans.

• The framework has existed since 2015. It has not yet been activated.

8.2 Sectoral risk weights

• Risk weight: a number that tells a bank how much capital to hold against a loan. A riskier loan gets a higher weight.
• Risk-weighted asset (RWA) = Loan amount × Risk weight

• Capital needed = RWA × required capital ratio

• Worked example (for illustration, assume a 9% capital requirement):

• A ₹100 personal loan at 100% risk weight → RWA ₹100 → capital needed ₹9.
• At 125% risk weight → RWA ₹125 → capital needed ₹11.25.

• Each loan now uses more of the bank's own money → the loan becomes costlier for the bank → the bank lends less to that segment or charges more.

• RBI circular of 16 November 2023 on consumer credit and bank credit to NBFCs [3]:

• Banks' consumer credit (new and existing loans): risk weight raised from 100% to 125%. Housing, education and vehicle loans, and loans secured by gold, were left out [3].
• NBFCs' retail consumer credit: 125%. Microfinance and SHG loans were also left out [3].
• Credit card receivables: scheduled commercial banks went from 125% to 150%, and NBFCs from 100% to 125% [3].
• Bank loans to NBFCs: risk weight raised by 25 percentage points above the rating-based weight, wherever that weight was below 100%. Housing finance companies, core investment companies and NBFC loans that count as priority sector were left out [3].
• Lenders also had to set Board-approved limits for each segment of consumer credit, especially unsecured loans. They had to meet these credit standards by 29 February 2024 [3].

• Top-up loans against assets that lose value, such as vehicles, must be treated as unsecured [3].

• February 2025: these measures were partly rolled back (NCERT scaffold).

• This is a clear case of macroprudential policy together with moral suasion. The RBI first warned publicly about unsecured loans, then used risk weights.

8.3 Loan-to-value (LTV) caps

• LTV ratio = Loan amount ÷ Value of the asset × 100
• Worked example: with a 75% LTV cap on a ₹1 crore house, the bank can lend at most ₹75 lakh. The buyer pays ₹25 lakh from their own money.
• The RBI applies LTV caps to housing loans and gold loans.
• Why they help: if house or gold prices fall, the borrower's own money absorbs the first loss. The loan stays covered, so the bank is protected.
• LTV caps are the macroprudential version of the old margin requirement.

8.4 Provisioning norms

• Provisioning: money a bank sets aside from its profits to cover loans that may go bad.
• Higher provisioning on risky or stressed sectors makes the bank build a loss cushion early. It also makes lending to those sectors less attractive.

9. Financial stability: the goal and the institutions

• Financial stability: banks, markets and payment systems work smoothly and can absorb shocks without disrupting credit and payments.
• Financial Stability Report (FSR): the RBI publishes it twice a year, in June and December. It includes system-wide stress tests of banks.
• Financial Stability and Development Council (FSDC): set up in 2010, and chaired by the Finance Minister.
• It coordinates the regulators: RBI, SEBI, IRDAI, PFRDA and IBBI.

10. Tinbergen logic: one instrument per goal

• Tinbergen rule: to reach N independent goals, a policymaker needs at least N independent instruments.
• Applied to India:
• The policy rate (repo rate) targets price stability (inflation).

• Macroprudential tools target financial stability.

• Why keep them separate:

• Suppose unsecured loans are booming but inflation is on target.
• Raising the repo rate would hurt every borrower in the economy.
• Raising the risk weight on unsecured loans cools only the risky segment.

11. Old vs new: how selective control has changed

Old selective credit control (1956 to 1990s)	Modern macroprudential policy (2010s to present)
Goal: control commodity prices and hoarding	Goal: prevent risk to the whole financial system
Tools: margins and ceilings on loans against commodities	Tools: risk weights, LTV caps, CCyB, provisioning
Used by direct order under BR Act s.21	Works through capital costs, so banks still decide how to adjust
Largely dismantled after the 1990s	Active, e.g. the November 2023 risk-weight increase [3]

Prelims Hooks

• Qualitative tools affect the direction of credit. Quantitative tools (CRR, SLR, repo, OMO) affect its volume. Trap: margin requirement is a qualitative tool.
• Margin requirement: maximum loan = value × (1 − margin). With a 40% margin, ₹100 of shares gives a loan of ₹60.
• Selective credit controls were used from 1956 under Section 21 of the Banking Regulation Act, 1949. They covered sensitive commodities such as foodgrains, sugar and oilseeds.
• ANBC = Net Bank Credit + non-SLR bonds in the HTM category. The PSL target applies to ANBC or CEOBE, whichever is higher [4].
• PSL targets in the 2025 Master Directions [2]:
• Domestic commercial banks: 40%
• RRBs: 75%
• SFBs: 60%
• UCBs: 60%
• Agriculture: 18%, including small and marginal farmers 10%
• Micro enterprises: 7.5%

• Weaker sections: 12%

• Foreign banks with fewer than 20 branches may count up to 32% export credit within their 40% target [2].

• November 2023 [3]:
• Consumer credit risk weight went from 100% to 125%.
• Bank credit card receivables went from 125% to 150%.

• Housing, education, vehicle and gold loans were excluded.

• The CCyB framework dates from 2015 and has not yet been activated.

• The FSDC (2010) is chaired by the Finance Minister, not the RBI Governor. The FSR is published twice a year by the RBI.
• The Tinbergen rule says you need one instrument per goal: the repo rate for price stability, macroprudential tools for financial stability.

Mains Points

• Targeted tools vs a blunt rate: the repo rate affects every borrower. Sectoral risk weights and LTV caps can cool a boom in one segment, such as unsecured consumer loans in 2023 [3], without choking credit to MSMEs or farmers. This is Tinbergen logic in practice. It is also why India separates the inflation-targeting MPC from the RBI's financial stability tools.
• The PSL debate:
• For: it sends credit to farmers, micro firms and weaker sections that the market underserves. The higher targets for RRBs (75%) and SFBs (60%) [2] support financial inclusion.
• Against: it can weaken credit quality and may lead to "evergreening" or loans made only to meet targets. It also reduces banks' freedom to allocate credit.

• Reforms: PSLCs and newer categories such as renewable energy and social infrastructure [2] aim to meet the goal more efficiently.

• From command to prudence: India moved from direct controls (SCCs under BR Act s.21) to price-based prudential tools (risk weights, provisioning). This matches the post-1991 shift to market-based monetary policy. Banks still choose how to adjust, but the regulator changes their incentives.

• Timing risk: macroprudential tightening such as the 2023 risk weights slows credit growth. The partial rollback in February 2025 shows these tools are adjusted up and down over the credit cycle. The CCyB was designed for exactly this, but it has never been switched on.