Monetary Policy: RBI and Commercial Banks

Study Notes

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.

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 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 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.

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.