Monetary policy is an instrument of economic policy which acts by influencing the cost and availability of money and credit in the economy to various sectors. To achieve a balance between economic growth and control over inflation, RBI has followed the policy of ‘controlled monetary expansion’.
Types of Monetary Policy
- Contractionary Monetary Policy – It seeks to reduce the liquidity in the economy by reducing the availability of credit to commercial sector, by reducing credit creation capacity of commercial banks and by increasing the cost of credit. In pursing contraction monetary policy, bank rate, CRR, SLR is increased and under open market operation, RBI sells government securities, Margin requirements are also increased.
- Expansionary Monetary Policy – Under this, it seeks to increae liquidity and consequently bank rate, SLR, CRR are decreased and RBI purchase government securities and margin requirements are also decreased.
Instruments of Monetary Policy
There are two broad instruments of the monetary policy of the RBI i.e. Quantitative methods and Qualitative methods :
Quantitative Methods or General Methods
Cash Reserve Ratio (CRR) – A per the RBI Act, 1934, banks have to keep a certain proportion or percentage of their total deposits (time and demand liabilities) with RBI. RBI can vary CRR in the range of 3 to 15%.
Statutory Liquidity Ratio – It is the ratio of total deposits of banks that they have to keep certain or maintain in the form of specified liquid assets with themselves. It can be varied in the range of 25 to 40%.
Bank Rate – It is the rate of interest charged by the RBI from commercial, banks by way of rediscounting their first class (approved) securities. In other words, it is the rate of interest at which RBI lends to commercial banks.
Marginal Standing Facility – The Reserve Bank of India in its monetary policy for 2011-12, introduced the marginal standing facility(MSF), under which banks could borrow funds from RBI at 1% above the liquidity adjustment facility – repo rate against pledging government securities. This measure has been introduced by RBI to regulate short-term asset-liability mismatches more effectively.
Open Market Operation (OMO) – It is also called the liquidity adjustment facility (LAF). It refers to buying and selling of government securities by the RBI in the open market by or from the public and banks. The open market operation in the short term government securities is called repo and reverse repo.
Repo Rate – Repurchase operation or repurchase agreement. It is carried out under the Liquidity Adjustment Facility (LAF) to stabilize short terms liquidity in the economy. Under this RBI buys government securities for a short period(usually a fortnight) with an agreement to sell it later.
Reverse Repo Rate – Under this RBI sells government securities with an agreement to buy them later.
RBI has switched over to the international usage of the terms ‘repo’ and ‘reverse repo’ effective from october 29, 2004.
As per the international usage absorption of liquidity by the RBI is termed as ‘Reverse Repo’ and injection as ‘Repo’.
Credit Control Rates(as on August 2019)
| CRR | 4% |
| SLR | 18.75% |
| Policy Repo Rate | 5.40% |
| Reverse Repo Rate | 5.15% |
| Marginal standing facility Rate | 5.65% |
| Bank Rate | 5.65% |
Qualitative or Selective Methods
Such measures are used to control the availability and cost of money and credit for a certain sector of the economy. They regulate both loans and purposes for which loans are given. They can be used for channeling, greater flow of credit into particular sectors and to restrict the flow of credit they have to keep or maintain in the form of specified liquid assets with themselves.
a) Changing the Margin Requirments – Margin requirements refer to the excess of the value of security required for a loan over the amount of loan sanctioned.
b) Fixation of ceilings of credits for the different sectors – RBI may fix the maximum limit of credit for various sectors.
c) Discriminatory rate of interest – fixing various rates of interest for different sectors.
d) Prohibition of discounting of Bills covering the sale of sensitive commodities – Restricting the flow of various sectors.
e) Credit Rationing – fixing of the quota of credit in respect of various sectors.
Other Measures
a) Moral Suasion – It refers to the persuasive methods used by RBI through the letter, conferences, periodicals, etc. to influence the operations of the banking sectors.
b) Direct Action – RBI may initiate disciplinary action against the banks in case these don’t comply with its directives. It may include the imposition of monetary penalty, derecognizing of banks, etc.
Recent Comments