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What is Monetary Policy of RBI? Instruments of RBI Monetary Policy

What is Monetary Policy?

  • The policy by which the desired level of money flow and its demand is regulated by the RBI is known as monetary policy. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves).
The main objectives of Monetary Policy are,
  • To maintain price stability.
  • To ensure adequate flow of credit to productive sectors so as to assist growth.
  • Arrangement of full employment
  • Expansion of credit facility
  • Equality & Justice Stability in exchange rate
  • Promotion of Fixed Deposit
  • Equitable distribution of Credit

RBI use the following tools to regulate the monetary policy. They are,

  1. Open Market Operations
  2. Liquid Adjustment Facility
  3. Bank Rate
  4. Cash Reserve Ratio
  5. Statutory Liquidity Ratio
  6. Repo Rate
  7. Reverse Repo Rate

What is Monetary Policy of RBI? Instruments of RBI Monetary Policy

What are Open Market Operations (OMOs)?

  • Open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks.
  • OMOs are an effective quantitative policy tool in the armoury of the RBI, but are constrained by the stock of government securities available with it at a point in time.

What is meant by Liquid Adjustment Facility?

  • Liquidity adjustment facility (LAF) is a monetary policy tool which allows banks to borrow money through repurchase agreements.
  •  LAF operations help the RBI effectively transmit interest rate signals to the market.

What is meant by Bank Rate?

  • The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system on its long-term lendings.
  • The clients who borrow through this route are the GoI, State governments, Banks, Financial Institutions, Co-operative Banks, NBFCs, etc.
  • Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money.

What is meant by Cash Reserve Ratio? 

  • The cash reserve ratio (CRR) is the ratio (fixed by the RBI) of the total deposits of a bank in India which is kept with the RBI in cash form.
  • Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.
  • RBI is empowered to vary CRR between 15 percent and 3 percent.

What is meant by SLR?

  • The statutory liquidity ratio (SLR) is the ratio (fixed by the RBI) of the total deposits of a bank which is to be maintained by the bank with itself in non-cash form prescribed by the Government to be in the range of 25 to 40 per cent.
  • SLR rate is determined and maintained by RBI in order to control the expansion of the bank credit.
  • SLR is used to control inflation and propel growth. Through SLR rate the money supply in the system can be controlled effectively.

What is Repo Rate?

  • The rate of interest the RBI charges from its clients on their short-term borrowing is the repo rate in India which is at present 7.5 per cent.
  •  Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.
  • It has direct impact on the nominal interest rates of the bank’s lending. The repo rate was introduced in December 1992.

What is Reverse Repo Rate?

  • It is the rate of interest the RBI pays to its clients who offer short term loan to it. It was started in November 1996 as part of Liquidity Adjustment Facility (LAF) by the RBI.
  • The increase in Repo Rate and Reverse Repo Rate by the RBI is a symbol of tightening of the policy.

What is Marginal Standing Facility?

  • MSF is a very short term borrowing scheme for scheduled commercial banks. Banks may borrow funds through MSF during severe cash shortage or acute shortage of liquidity.
  • Banks often face liquidity shortfalls due to mismatch in their deposit and loan portfolios. These are usually very short term and banks can borrow from RBI for one day period by offering dated government securities.
  • MSF had been introduced by RBI to reduce volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system.
  • Under MSF, banks can borrow funds overnight up to 1% (100 basis points) of their net demand and time liabilities (NDTL) i.e. 1% of the aggregate deposits and other liabilities of the banks. NDTL liabilities represent a bank’s deposits and borrowings from others.
  • In a move to stem the continuing fall of rupee, the RBI raised the MSF rate to 300 basis points (i.e. 3%) above the repo rate in July 2013. Thus, both rate of borrowing and percent of borrowing allowed under MSF can be varied by RBI.

Introduction of MSF

  • The RBI had introduced the marginal standing facility (MSF) in its Monetary Policy (2011-12).
  • MSF came into effect on from May 9, 2011.
  • Banks used the facility for the first time in June 2011 and borrowed Rs.1 billion via the MSF.

Does a hike in MSF rate affect us?

  • Hiking MSF rate makes borrowing expensive for a bank which means loans become expensive for individual and corporate borrowers and this in turn translates to lesser availability of the rupee. RBI uses MSF and other measures to control money supply in the financial system.
  • MSF rate hike is being done to control excess availability of the rupee and to control its depreciation with respect to the dollar.

Borrowing under MSF

  • Banks can borrow through MSF on all working days except Saturdays, between 3:30pm and 4:30pm in Mumbai where RBI has its headquarters.
  • The minimum amount which can be accessed through MSF is Rs. 1 crore and in multiples of Rs. 1 crore.
  • The application for the facility can be submitted electronically also by the eligible scheduled commercial banks.
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