Monetary Policy Or Credit Control

Monetary Policy or Credit Control is a set of tools by which the Central Bank (RBI) controls the flow of money in the market to combat Inflation or Deflation.

RBI has a set of monetary tools which are used to control the money supply in the market. These tools are:- ( Quick Link – Click on the particular topic which you want to read.)

Cash Reserve Ratio (CRR)

The cash reserve ratio is a ratio of NDTL (Net Demand And Time Liability) of a bank which is kept with the RBI in the form of cash. The CRR is decided by the RBI and at present, it is 3%. Every PSB and Scheduled Comercial Banks have to maintain the CRR and the amount which is kept in the form of CRR cannot be lent or invested by the banks. Time to time the rate of CRR is revised according to the market scenario.

What happens when CRR increased?

  • Banks have less money to lend.
  • It controls inflation.
  • It increases the loan interest.
  • Money becomes dearer.

What happens when CRR decreased?

  • Banks have more money to lend.
  • It controls deflation.
  • It decreases the loan interest.
  • Money becomes cheaper.

Statutory Liquidity Ratio (SLR)

The statutory liquidity ratio is a ratio of NDTL (Net Demand And Time Liability) of a bank which is kept either in the form of cash or most liquid assets. The SLR is decided by the RBI and at present, it is 18%. Every PSB and Scheduled Comercial Banks have to maintain SLR and the amount which is kept in the form of SLR cannot be lent but it can be invested by the banks in the most liquid assets (Govt. Security or Gold). Time to time the rate of SLR is revised according to the market scenario.

What happens when SLR increased?

  • Banks have less money to lend.
  • It controls inflation.
  • It increases the loan interest.
  • Money becomes dearer.

What happens when SLR decreased?

  • Banks have more money to lend.
  • It controls deflation.
  • It decreases the loan interest.
  • Money becomes cheaper.

Bank Rate

Bank rate is a rate of interest which is charged by RBI on its long-term lending from its borrowers. The clients of RBI who borrow through this route are PSB, Scheduled Commercial Banks, Government of India State Governments, financial institutions, co-operative banks, NBFC etc. The current bank rate is 4.25%.

What happens when Bank Rate increased?

  • The loan becomes costly for financial institutions and Govt.
  • It decreases the money supply from the market.
  • Long term loans become costly for the public.
  • It controls inflation.

What happens when Bank Rate decreased?

  • The loan becomes cheaper for financial institutions and Govt.
  • It increases the money supply in the market.
  • Long term loans become cheaper for the public.
  • It controls deflation.

Repo Rate

Repo rate is a rate of interest which is charged by RBI from its clients for short-term lendings. Basically, it is a collateralised short-term borrowing and lending through sale or purchase of dated RBI approved securities (Govt. securities, PSU’s bonds, private corporate securities, etc.) at a discounted rate. The main purpose of this tool is to suck out money from the market and stabilise money flow. Repo rate is always lower than the bank rate and currently, the repo rate is 4%.

What happens when Repo Rate increased?

  • It sucks out liquidity from the market
  • Loan and loan products become costly for the public.
  • It controls inflation.

What happens when Repo Rate decreased?

  • It injects liquidity in the market
  • Loan and loan products become cheaper for the public.
  • It controls the deflation.

Reverse Repo Rate

Reverse repo rate is a rate of interest which is paid by the RBI to its clients for short-term lending. It is a reverse of repo rate and it started as a part of liquidity adjustment facility (LAF) by the RBI. The main concept behind the reverse repo rate is to save banks and financial institution losses by taking their surplus money. The current reverse repo rate is 3.35%.

Marginal Standing Facility (MSF)

Marginal Standing Facility (MSF) was announced by the RBI in its Monetary Policy, 2011-2012 and its came into effect from May 2011. In MSF banks can borrow up to 1% of their Net Demand And Time Liabilities (NDTL) from RBI. Initially, it was said that the MSF interest rate will be 1% higher than the repo rate but by the end of April 2016, it has aligned equally to the bank rate.

Call Money Market

The call money market is a money market where borrowing and lending of funds take place on over night basis. All the scheduled commercial banks (excluding RRBs), co-operative banks (excluding land development banks) and insurance companies can participate in this market. Banks can borrow only 1% of their NDTL through call money market at repo rate and other entities rest than banks can borrow only 0.75% of their NDTL.

Open Market Operation (OMO)

Open Market Operation (OMO) is a situation when the Central Bank (RBI) buy or sell their treasure securities in the open market to increase or decrease the money supply. Open market Operation (OMO) is a Central Bank’s primary step for implementing monetary policy to maintain liquidity and to deal with inflation and deflation in the market. It is also used to decrease or increase loan rates by selling or purchasing treasure securities through OMO. All financial institutions and individuals can participate in this market.

Liquidity Adjustment Facility (LAF)

Liquidity adjustment facility was introduced by the RBI in 2000. LAF is a key element of monetary policy and according to the time RBI borrows or lends money from the banking system through this route at a fixed rate of interest (repo rate or reverse repo rate). LAF operations help banks in moderating their cash mismatch and it also helps the RBI to effectively transmit interest rate signals to the market.

Market Stabilisation Scheme (MSS)

Market Stabilisation Scheme (MMS) was introduced in 2004. With the help of this monetary management instrument surplus liquidity of a more enduring nature is absorbed by selling short-dated government security and treasury bills.

Base Rate

Base rate is the prime lending rate below which banks cannot lend loan to its customers. The main aim behind base rate is to provide transparency in lending rates of banks and enabling better assessment of transmission of monetary policy. Banks are allowed to decide their own base rate.

Revised Liquidity Adjustment Facility (LAF)

In order to regulate the inter-bank call money market in an effective manner, the Reserve Bank of India (RBI) announced a revised liquidity management framework.

The inter-bank call money market is a place where banks borrow short-term funds from each other to bridge their liquidity gaps.

Starting from September 5 2014, the RBI has been conducting 14-day term Repo auctions four times in a fortnight, up to 0.75 per cent of the system’s deposit base also known as net demand and time liabilities (NDTL). Unlike earlier, RBI has announced a strict schedule for these 14-day term repo operations, which can be used by banks for their day-to-day liquidity requirements. According to RBI’s statement, One-fourth of the entire amount of 0.75 per cent of NDTLs would be put up for auction in each of the four auctions. Banks can currently borrow up to 0.25 per cent of their deposit base or NDTL from the Liquidity Adjustment Facility (LAF) window.

Overnight variable rate re-purchase auctions – Further, it also conducts overnight variable rate repo auctions based on an assessment of liquidity in the banks and government cash balances available for auction for the day.

Middle String Now On Different Social Media Join Us On FACEBOOK | TELEGRAM | TWITTER | For Latest News Update.

Leave a Comment

%d bloggers like this: