What is moral suasion?

Moral suasion refers to the persuasive approach of the central bank towards the commercial banks in making the latter follow and implements the policies of the former. Though the central bank is empowered to take direct action on the erring or violating commercial banks, yet it exercises that option only rarely. In its place, the central bank takes efforts to explain to the commercial banks the need for following certain policies. This is done either through periodical conference with commercial banks, or by appealing to the sentiments of the commercial banks. In effect this method aims at bringing to commercial banks into line through use of moral force instead of resorting to the legal powers. It should be noted that this method has no legal back up or support. It is merely applied using the conventional relationship between the commercial banks and the central bank. It has been quite successful in countries like UK, France, Holland and others. But it has not been very effective in USA under the unit banking system. In India, the RBI has found this to be very effective as there exists a very cordial relationship between the central bank and commercial banks. Of course, the success of this policy depends on the prestige, influence and leadership of the central bank Further since it has no legal back up in times of credit expansion it is not effective.

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