Here are the highlights of the RBI’s Monetary Policy Committee ( MPC) second bi-monthly statement for

fiscal 2018-19:

* RBI hikes key lending rate (repo) by 0.25 per cent to 6.25 per cent

* Rate hike is the first in four-and-half-years

* Reverse repo rate stands at 6 per cent, bank rate at 6.50 per cent

* Growth projection retained at 7.4 per cent for 2018-19

* Projects retail inflation at 4.8–4.9 per cent for April-September, 4.7 per cent in H2

* Major upside risk to the inflation path as price of crude rose by 12 per cent

* Volatile crude oil prices adds to uncertainty to the inflation outlook

* Investments recovering well; to get boost from swift resolution under IBC

* Geo-political risks, financial market volatility, trade protectionism to impact domestic growth

* Adherence to budgetary targets by the Centre and states will ease upside risks to the inflation outlook

* All members of the monetary policy committee voted for 0.25% rate hike

The MPC will meet on on July 31 and later on August 1.

Repo rate also known as the benchmark interest rate is the rate at which the RBI lends money to the banks
for a short term. When the repo rate increases, borrowing from RBI becomes more expensive. If RBI wants
to make it more expensive for the banks to borrow money, it increases the repo rate similarly, if it wants to
make it cheaper for banks to borrow money it reduces the repo rate. Current repo rate is 6.25%

Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks. The Reserve
bank uses this tool when it feels there is too much money floating in the banking system. An increase in the
reverse repo rate means that the banks will get a higher rate of interest from RBI. As a result, banks prefer
to lend their money to RBI which is always safe instead of lending it others (people, companies etc) which
is always risky.

Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse
Repo rate signifies the rate at which the central bank absorbs liquidity from the banks.

CRR - Cash Reserve Ratio - Banks in India are required to hold a certain proportion of their deposits in
the form of cash. However Banks don't hold these as cash with themselves, they deposit such cash(aka
currency chests) with Reserve Bank of India , which is considered as equivalent to holding cash with
themselves. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the
RBI and is known as the CRR or Cash Reserve Ratio.

When a bank's deposits increase by Rs100, and if the cash reserve ratio is 9%, the banks will have to hold
Rs. 9 with RBI and the bank will be able to use only Rs 91 for investments and lending, credit purpose.
Therefore, higher the ratio, the lower is the amount that banks will be able to use for lending and
investment. This power of Reserve bank of India to reduce the lendable amount by increasing the CRR,
makes it an instrument in the hands of a central bank through which it can control the amount that banks
lend. Thus, it is a tool used by RBI to control liquidity in the banking system.
SLR - Statutory Liquidity Ratio - Every bank is required to maintain at the close of business every day, a
minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold
and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known
as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR
also restricts the bank's leverage position to pump more money into the economy.

Net Demand Liabilities - Bank accounts from which you can withdraw your money at any time like your
savings accounts and current account.
Time Liabilities - Bank accounts where you cannot immediately withdraw your money but have to wait
for certain period. e.g. Fixed deposit accounts.

Call Rate - Inter bank borrowing rate - Interest Rate paid by the banks for lending and borrowing funds
with maturity period ranging from one day to 14 days. Call money market deals with extremely short term
lending between banks themselves. After Lehman Brothers went bankrupt Call Rate sky rocketed to such
an insane level that banks stopped lending to other banks.

MSF - Marginal Standing facility - It is a special window for banks to borrow from RBI against approved
government securities in an emergency situation like an acute cash shortage. MSF rate is higher than Repo
rate. Current MSF Rate: 6.75%

Bank Rate - This is the long term rate(Repo rate is for short term) at which central bank (RBI) lends
money to other banks or financial institutions. Bank rate is not used by RBI for monetary management
now. It is now same as the MSF rate. Current bank rate is 6.75%

Base Rate: The Reserve Bank of India sets a minimum rate below which banks in India are not allowed to
lend to their customers. This minimum rate is called the Base Rate in banking terms. It is the minimum rate
of interest the banks are permitted to charge their customers. The new Base Rate as fixed by RBI is
8.75% to 9.45% p.a.

Marginal Cost of Funds based Lending Rate (MCLR): RBI made changes to the existing Base Rate
system this year. They have introduced Marginal Cost of Funds based Lending Rate or MCLR which is a
new methodology to set the lending rates for commercial banks. Previously, banks used to lend as per the
Base Rate fixed by The Reserve Bank of India but with the introduction of MCLR, banks will have to lend
using rates linked to their funding costs. Simply put, bank raises their funds through deposits, bonds and
other investments. For the banks to function smoothly, there are costs involved like salaries, rents and other
bills. Considering that banks also need to make profits every year, RBI has included the expenses of the
bank and have come up with a formula which can be used by banks to determine their lending rate. With
the reduction of repo rate, some banks have reduced MCLR up to 90 basis points. The current MCLR
(overnight) fixed by the RBI stands at 7.90% to 8.05%

By using credit control methods RBI tries to maintain monetary stability. There are two types of methods:

1. Quantitative control to regulates the volume of total credit.

2. Qualitative Control to regulates the flow of credit.

(i) Bank Rate:

The bank rate, also known as the discount rate, is the rate payable by commercial banks on the loans from
or rediscounts of the Central Bank. A change in bank rate affects other market rates of interest. An increase
in bank rate leads to an increase in other rates of interest and conversely, a decrease in bank rate results in a
fall in other rates of interest.

A deliberate manipulation of the bank rate by the Central Bank to influence the flow of credit created by
the commercial banks is known as bank rate policy. It does so by affecting the demand for credit the cost of
the credit and the availability of the credit. Likewise, a fall in the bank rate causes other rates of interest to
come down. The cost of credit falls, i. e., and credit becomes cheaper. Cheap credit may induce a higher
demand both for investment and consumption purposes. More money, through increased flow of credit,
comes into circulation.

(ii) Open Market Operations:

Open market operations refer to the sale and purchase of securities by the Central bank to the commercial
banks. A sale of securities by the Central Bank, i.e., the purchase of securities by the commercial banks,
results in a fall in the total cash reserves of the latter.

A fall in the total cash reserves is leads to a cut in the credit creation power of the commercial banks. With
reduced cash reserves at their command the commercial banks can only create lower volume of credit.
Thus, a sale of securities by the Central Bank serves as an anti-inflationary measure of control.

Likewise, a purchase of securities by the Central Bank results in more cash flowing to the commercials
banks. With increased cash in their hands, the commercial banks can create more credit, and make more
finance available. Thus, purchase of securities may work as an anti-deflationary measure of control.

(iii) Variable Reserve Ratios:

Variable reserve ratios refer to that proportion of bank deposits that the commercial banks are required to
keep in the form of cash to ensure liquidity for the credit created by them.

A rise in the cash reserve ratio results in a fall in the value of the deposit multiplier. Conversely, a fall in
the cash reserve ratio leads to a rise in the value of the deposit multiplier. A fall in the value of deposit
multiplier amounts to a contraction in the availability of credit, and, thus, it may serve as an anti-
inflationary measure.

The Reserve Bank employs two types of reserve ratio for this purpose, viz. the Statutory Liquidity Ratio
(SLR) and the Cash Reserve Ratio (CRR).

The statutory liquidity ratio refers to that proportion of aggregate deposits which the commercial banks are
required to keep with themselves in a liquid form. The commercial banks generally make use of this money
to purchase the government securities. Thus, the statutory liquidity ratio, on the one hand is used to siphon
off the excess liquidity of the banking system, and on the other it is used to mobilise revenue for the
government.

The cash reserve ratio refers to that proportion of the aggregate deposits which the commercial banks are
required to keep with the Reserve Bank of India.
Statutory Liquidity Ratio

SLR refers to that portion of deposits with the banks which it has to keep with itself as liquid assets(Gold,
approved govt. securities etc.) If RBI wishes to control credit and discourage credit it would increase CRR
& SLR.

QUALITATIVE MEASURES

Qualitative measures are used by the RBI for selective purposes. Some of them are

(i) Margin Requirements:

Changes in margin requirements are designed to influence the flow of credit against specific commodities.
The commercial banks generally advance loans to their customers against some security or securities
offered by the borrower and acceptable to banks.

More generally, the commercial banks do not lend up to the full amount of the security but lend an amount
less than its value. The margin requirements against specific securities are determined by the Central Bank.
A change in margin requirements will influence the flow of credit.

A rise in the margin requirement results in a contraction in the borrowing value of the security and
similarly, a fall in the margin requirement results in expansion in the borrowing value of the security.

(ii) Credit Rationing:

Rationing of credit is a method by which the Central Bank seeks to limit the maximum amount of loans
and advances and, also in certain cases, fix ceiling for specific categories of loans and advances.

(iii) Regulation of Consumer Credit:

Regulation of consumer credit is designed to check the flow of credit for consumer durable goods. This can
be done by regulating the total volume of credit that may be extended for purchasing specific durable
goods and regulating the number of installments through which such loan can be spread. Central Bank uses
this method to restrict or liberalise loan conditions accordingly to stabilise the economy.

(iv) Moral Suasion:

Moral suasion and credit monitoring arrangement are other methods of credit control. The policy of moral
suasion will succeed only if the Central Bank is strong enough to influence the commercial banks.

In India, from 1949 onwards, the Reserve Bank has been successful in using the method of moral suasion
to bring the commercial banks to fall in line with its policies regarding credit. Publicity is another method,
whereby the Reserve Bank marks direct appeal to the public and publishes data which will have sobering
effect on other banks and the commercial circles.

RBI Guidelines

RBI issues oral, written statements, appeals, guidelines, and warnings etc. to the banks.

Direct Action

This step is taken by the RBI against banks that don’t fulfil conditions and requirements. RBI may refuse to
rediscount their papers or may give excess credits or charge a penal rate of interest over and above the
Bank rate, for credit demanded beyond a limit.
Effectiveness of Credit Control Measures:

• well-organised money market