- it is the process by which
- monetary authority of a country controls the supply of money
- by targeting a rate of interest for the purpose of promoting economic growth and stability
- goals
- stabilise the prices
- reduce the unemployment levels
- types
- Expansionary
- Contractionary
- Functions
- Custody and management of Foreign Exchange Reserves
- Acting as a bank to the banker
- Acting as a bank to the government
- Leader of the last resort
- Controller of credit
- exercises discretionary control over the monetary system of the country
- commands an imp. position in the monetary and banking structure of country
- Monetary policy
- Announced six times a year
- Determines the supply of money in the economy
- Determines the rate of interest charged by bank
- Contains an economic overview and presents future forecasts
- Instruments
- Quantitative
- bank rate
- statutory liquidity ratio
- cash reserve ratio
- repo rate
- reverse repo rate
- open market operations
- Qualitative
- Margin requirements
- Consumer credit regulation and guidelines
- moral suasion
- moral request by bank to control it or not
- direct action
- Quantitative
- Refers to the official interest rate at which RBI provides loans to the banking system
- It includes
- commercial/cooperative banks
- development banks etc.
- such loans are given out by
- direct lending
- rediscounting (buying back) the bills of commercial banks and treasury bills
- Bank rate is also known as discount rate
- Objective
- When RBI increases the bank rate, the cost of borrowing for banks rises
- this credit volume gets reduced leading to decline in supply of money
- thus, increase in bank rate reflects tightening of RBI monetary policy
- Repurchase rate
- Rate at which RBI lends to banks for short periods
- Done by RBI buying government bonds from banks with an agreement to sell them back at a fixed rate
- Objective
- inject liquidity in the system
- increased repo rate -> expensive for banks to borrow
- decreased repo rate -> cheaper for banks to borrow
- Repo rate is a short term measure and it refers to short-term lonas and used for controlling amount of money in market
- Bank rate is a long term measure and is governed by the long-term monetary policy of RBI
- Rate of interest at which the RBI borrows funds from other banks in the short term
- Done by RBI selling government bonds or securities to banks with commitment to buy them back at a future date
- Bank use reverse repo facility to deposit their short term excess funds with RBI and earn interest for it
- RBI can reduce liquidity in banking system by increasing the rate at which it borrows from banks
- Procedure
- When RBI increases the reverse repo, it means that now RBI will provide extra interest on the money which it borrows from the banks.
- An increase in reverse repo rate means that banks earn higher returns by lending to RBI
- This indicates a hike in deposit rates
- pushes up interest rates
- Purchase and Sale of the Government Securities by RBI from/to market
- When there is excess of liquidity RBI resorts to sale of G-secs to suck out rupee from system
- When there is liquidity crunch, RBI buys securities from the market in order to release liquidity
- Objective
- carried out to adjust liquidity condition of rupee in the economy
- when RBI sells g-secs to banks
- as soon as banks purchase g-secs, they have reduced money to lend to the industrial houses or other commercial sectors
- this reduces surplus cash, contracts the rupee liquidity
- contracts credit creation / credit supply
- It is the amount of funds that the banks are bound to keep with RBI as a percentage of their Net Demand and Time Liabilities (NDTL)
- CRR = Cash Deposited with RBI / NDTL
- CRR has to be maintained on a daily basis with RBI by every bank
- Objective
- Ensure adequate liquidity in financial system
- enough solvency for banks
- CRR is maintained fortnightly average basis
- CRR is altered by RBI
- RBI does not pay any interest on the CRR balances
- Reduction of CRR
- excess funds are available with banks for deploying in other businesses because they are required to keep lesser amounts with RBI
- banks would have more money to lend
- this leads to reduction of interest rates on loans provided by banks
- example
- SBI has balance of 100 crores
- CRR @5%
- SBI has to maintain atleast 5cr with RBI
- Only has 95cr to its disposal
- If CRR @4.5%
- SBI can lend more now outside as it has 95.5cr to its disposal
- Impact on inflation
- Reduction in CRR leaves more money in the hands of commercial banks and this leads to increase in money supply in system
- When money supply rises, too much money chases too few goods and this leads to rise in inflation
- Increase in CRR
- banks will have less money
- since banks don't earn any interest, banks are left with no option but to increase the interest rates
- hike in CRR sucks money out of system causing inflation to come down
- From 2006, RBI is empowered to fix the CRR on its discretion without any ceiling
- All banks have to keep a fraction of their total net time and demand liabilites in form of liquid assets such as
- G-secs
- precious metals
- approved securities amongst others
- Maintained with banks themselves
- SLR = Liquid Assets / NDTL
- Ratio was prescribed by Section 24(2A) of Banking Regulation Act 1949
- Original ratio mandated for a 23% SLR
- Presently 21% (August 2016)
- SLR deposits include
- Cash
- Gold reserves kept in bank
- Balances with RBI
- Net balance in current account
- Investment in G-secs(if any)
- SLR has to be maintained on a daily basis by every bank
- SLR is inversely proportional to money in market
| Key | CRR | SRR |
|---|---|---|
| Stored in form of | Cash | Liquid Assets |
| Stored With | RBI(in their premises) | Bank themselves |
| Ratio comparison | Less than SLR | More than CRR |
| Current Rates | 4% | 21.5% |
- This is the primary instrument of RBI for modulating liquidity and sending interest rate signals to the market
- It refers to the difference b/w the two key rates
- repo rate
- reverse repo rate
- Also known as Liquidity Corridor
- While repo infuses liquidity into the system, reverse repo absorbs liquidity from system
- RBI just announces Repo Rate
- Reverse repo rate is linked to repo rate and is 100 basis points (1%) below repo rate
- Created by RBI in its credit policy of may 2011
- MSF is the rate at which banks are able to borrow overnight funds from RBI against apporved government securities
- MSF is always 1% higher than Repo rate
- Those tools thru which the central bank not only controls the value of loans but also the purpose for which these loans are assigned by the commercial banks
- Moral suasion
- Rationing of credit
- Direct Action
- Margin requirements
- Suasion means request or persuasion
- To arrest inflationary situation central bank persuades and requests the commercial banks to refrain from giving loans for speculative and non-essential purposes
- To counter deflation, central bank persuades the commercial banks to extend credit for different purposes
- Periodic discussions are held with authorities of commercial banks in this respect from 1949
- Method by which the RBI seeks to limit the maximum amount of loans and advances
- Also in certain cases, fix ceiling for specific categories of loans and advances
- Priority Sector Landing - making credit flow to certain priority or weaker sectorsnby charging concessional rates of interest