RBI’s Monetary Policy and Control – RBI Grade B Phase 2

Monetary Policy

Monetary policy is the process by which monetary authority of a country, generally central bank controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth. In India, the central monetary authority is the Reserve Bank of India (RBI) . It is so designed as to maintain the price stability in the economy.

RBI’s Monetary Policy and Control

Monetary Policy Objectives are Price stability (control of inflation) , ensuring adequate availability of credit for growth and financial system stability (for ensuring smooth monetary policy transmission)

RBI adopts quantitative and qualitative tools – CRR, SLR, LAF, Bank Rate, OMO and MSS

DL include Current Deposits. DL portion of savings deposits, margins against LC/LG, Balances in overdue FD, outstanding cash certificate, RD, TT, MTs, and DDs, unclaimed Deposits, Cr balances in CC and deposits held as security for loan payable on demand

TL include FDs, cash certificate, cumulative and RDs, TL portion of savings bank deposits, staff security deposits, margins against LC not payable on demand, deposits held as securities for advances and India Development Bonds.

Cash reserve ratio:

– Objective – ensure liquidity and solvency of banks

– To be maintained at fortnightly average basis

– on a daily basis it should be minimum 95% of the average balance

– with Amendment to RBI Act – RBI can fix without minimum or max for CRR under RBI Act for Scheduled banks. For other banks it is fixed under Sec 18 of BR Act – minimum 3%.

– W.e.f January 2002 RRBs also to maintain CRR as applicable for SCB.

SLR impacts on the loan resources of a bank

– RBI prescribes limits – minimum at its discretion and maximum 40%- under Sec 24 of BR Act

– Assets approved by RBI – listed in 2009 are

1. Cash 2. Gold valued at not more than current market price 3. Unencumbered investments in

i) Dated securities issued by GOI under Mkt Borrowing or MSS

ii) Treasury Bills of GOI

iii) State Development Loans (SDL) of State Govts under Market borrowing programme

iv) deposit and unencumbered approved securities u/s 11 of BR Act by Foreign Banks

iv) Balances in excess of CRR maintained with RBI by a Schedules Bk

Note: Securities i) to iii) if acquired under LAF are not eligible for SLR.

An increase in CRR and SLR could lead to lesser bank credit and purchasing power in the economy resulting in reduction in price level or inflation. The opposite effect on inflation happens when RBI reduces these rates.

Liquidity Adjustment Facility:

Liquidity Adjustment Facility helps banks to manage their day to day liquid funds position due to seasonal and short term variations through short term borrowings from and investments with RBI.

– Introduced during June 2000 in phases

– objective – to ensure smooth transition and keeping pace with technological up-gradation

– Reverse Repo and Repo auctions are conducted daily except Saturdays

– Minimum bid 5 crores and multiples of 5 crores

– 7-day and 14-day Repo operations discontinued from Nov 2004

– Limit 0.25% of NDTL wef 1 Ap 2014

– All banks (except RRBs) and PDs having current account and SGL account with RBI are eligible

– Repos and Reverse Repos in transferable GOI dated securities and TBs are eligible as securities

New 7 day (non reporting Fridays) and 14 day (reporting Fridays) repo auctions are held on Friday sn introduced in October 2013 – auction conducted on e-Kuber

– eligibility – Max 0.75% of NDTL

– minimum bid Rs.1 crore and multiples

Repo rate:

REPO rate is the rate at which RBI gives short term loans to banks against the collateral of non SLR securities.

Reverse repo rate:

Reverse REPO is the rate of interest paid by RBI on short term deposits of banks for which RBI gives government securities as collateral.

RBI uses REPO rate to influence the bank’s cost of funds, which could influence the banks’ interest rates on loans to customers. An increase in REPO rate should therefore make loans costlier for borrowers and restrain bank credit expansion. This will reduce inflation through controlling money supply in the economy.

Reverse REPO helps RBI to absorb from the system excess short term liquid funds with banks and thus control inflation in the short term.

Marginal standing facility:

Marginal Standing Facility is an overnight loan facility to banks available upto a limit of 2% of NDTL and even SLR securities could be pledged for MSF.

– Introduced in May 2011

– On all working days except Saturdays

– Repayable next day – loan taken on Fridays on next Monday

– conducted as `Hold in Custody’ Repo similar LAF Repo.

Bank rate:

Bank Rate is the rate of interest at which RBI is prepared to buy or rediscount eligible Bills of Exchange or other commercial papers in specific sectors of bank finance. But RBI relies more on REPO and Reverse REPO for transmission effect of its policy rates.

Open Market Operations:

Open Market Operation is the outright sale and purchase of government securities by RBI to increase (through purchase) or decrease (through sale) liquidity position of banks in the medium term period of one to three years, respectively to increase or decrease bank credit and hence purchasing power in the economy to correspondingly increase or decrease price levels

Market stabilization scheme:

Market Stabilization Scheme is the arrangement for large flow of foreign exchange through borrowings or grants received by Government of India, which would be put is special accounts and released periodically as required by government.

– Launched in Feb 2004

– Issued as TBs and dated securities

Effective from 1 April 2015, RBI conducts bi monthly Monetary Policy review exercise and makes adjustments in the policy rates.

Before the implementation of the recommendations of the Dr. Urjit Patel Committee on Monetary Policy, RBI was following a multiple indicator approach. The Committee recommended that RBI’s policy rate should target control of inflation based on CPI and also recommended an inflation rate of 4% as ideal for India and a range of 4 +/- 2% as the range for RBI’s policy rates.

For the first time in India, as is the practice in several countries, RBI entered into an agreement with Government of India in February 2015, RBI should control inflation, through monetary policy, below 6% by January 2016 and below 6% from 1 April 2016 and all subsequent financial years. This approach is known as inflation targeting of Monetary Policy. A committee to supervise the implementation was also formed

– The provisions of amended RBI Act regarding constitution of MPC was brought into force on June 27, 2016

– The six-member Committee — tasked with bringing “value and transparency to monetary policy decisions” — will comprise three members from RBI, including the Governor, who will be the ex-officio chairperson, a Deputy Governor and one officer of the central bank.

– The other three members will be appointed by the Centre on the recommendations of a search-cum-selection committee to be headed by the Cabinet Secretary.

– “These three members of MPC will be experts in the field of economics or banking or finance or monetary policy and will be appointed for a period of four years and shall not be eligible for re-appointment,” according to the statement.

– The Committee is to meet four times a year and make public its decisions following each meeting.

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