Monetary Policy: RBI and Commercial Banks

Monetary Policy

• RBI provides loans to commercial banks without collateral at a bank rate of 6.75%.
• RBI buys or sells government securities for short-term liquidity management through Repurchase Agreements (Repo) and Reverse Repo.
• Repo rate is the rate at which RBI lends to banks, while Reverse Repo rate is the rate at which banks lend to RBI.
• These rates are part of the Liquidity Adjustment Facility (LAF).
• Banks can borrow up to 2% of their Net Demand and Time Liabilities (NDTL) from RBI overnight.
• Failure to maintain Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) results in penalties and loans.
• Banks can use their Statutory Liquidity Ratio (SLR) quota to pledge government securities as collateral.
• During inflation, RBI increases CRR, SLR, Bank Rate, and Repo Rate to reduce money supply and curb inflation.
• During deflation, RBI reduces these rates to increase money supply and stimulate growth.

Commercial Bank Balance Sheet

• A commercial bank's balance sheet consists of liabilities and assets.
• Liabilities include initial investments, borrowings from RBI, deposits (savings, current, fixed, recurring), and other liabilities.
• Assets include share capital, loans taken from RBI, vault cash, deposits with RBI, loans, and investments in government securities.

Fiscal Policy

• Fiscal policy is used by the Government of India to control inflation or deflation.
• Tools of fiscal policy include subsidies, Minimum Support Prices (MSP), and taxes, which affect disposable income.

Monetary Policy Tools

• Monetary policy tools are classified into quantitative and qualitative tools.
• Quantitative tools include Open Market Operations (OMO) and Marginal Standing Facility (MSF).
• Qualitative tools include Rationing of Credit, Regulation of Consumer Credit, and Moral Suasion.
• Rationing of Credit involves fixing credit limits for industrial, household, and other purposes.
• Regulation of Consumer Credit involves fixing installment amounts, down payments, and loan durations in advance.
• Moral Suasion involves imposing credit limits for each sector through rules and regulations.
• The Money Multiplier (MM) is the maximum amount of new money created by banks for every dollar of reserves, and it is inversely proportional to the Cash Reserve Ratio (CRR).
• In cases of inflation or deflation, RBI regulates money supply using monetary policy tools.

Net Demand and Time Liabilities (NDTL)

• NDTL is the total deposits held by a commercial bank.
• RBI keeps a part of NDTL as a reserve, which includes:
  • Cash Reserve Ratio (CRR): a reserve in the form of cash, on which banks do not earn interest.
  • Statutory Liquidity Ratio (SLR): a reserve in the form of cash, gold, and government securities, on which banks earn interest.