Monetary Policy Tools and Mechanisms

Monetary Policy Tools

• The Reserve Bank of India (RBI) formulates, implements, and monitors monetary policy.
• RBI's aim is to maintain price stability and ensure adequate credit flow.
• Monetary policy tools include: Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Bank Rate, and Open Market Operations (OMOs).

Cash Reserve Ratio (CRR)

• CRR is the cash that all banks must maintain with the RBI.
• It's a percentage of their demand and time liabilities (DTL).
• Decreasing CRR increases loanable funds, potentially lowering call rates.
• Increasing CRR reduces lending and potentially raises call rates.

Statutory Liquidity Ratio (SLR)

• SLR is a liquid reserve requirement for banks.
• It's maintained in cash, current accounts with designated banks, unencumbered securities, or gold.
• The RBI sets SLR between 25% and 40% of DTL.
• Increasing SLR restricts bank lending, potentially increasing lending rates.
• Decreasing SLR expands lending, potentially decreasing lending rates.

Bank Rate

• Bank Rate is the standard interest rate at which the RBI rediscounts bills of exchange or other eligible commercial papers from banks.
• It influences the cost and availability of refinance, affecting interest rate of loans and deposits throughout the banking system.

Open Market Operations (OMOs)

• OMOs are the sale or purchase of government securities by the RBI in open market transactions.
• RBI uses OMOs to manage liquidity in the banking system.
• Selling securities reduces liquidity, while buying securities increases liquidity.

Banks Supervision

• The RBI's Financial Supervision Department (BFS) oversees various financial institutions, including commercial banks, state cooperative banks, financial institutions, and non-banking finance companies.
• The BFS aims to develop and maintain a sound banking system by issuing licenses, setting minimum capital and reserve requirements, inspecting banks, conducting investigations, and controlling appointments.