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Unit 2: Monetary Policy/Credit Policy

The document summarizes monetary policy and the tools used by the Reserve Bank of India (RBI) to influence money supply and credit conditions. It discusses that monetary policy aims to control inflation and stabilize prices through bi-monthly policies that impact interest rates and money supply. The key monetary policy tools used by RBI include repo rate, cash reserve ratio, statutory liquidity ratio, open market operations, and refinance facilities to banks. These tools allow RBI to pursue contractionary or expansionary monetary policy stances.

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Yash Chaudhary
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62 views19 pages

Unit 2: Monetary Policy/Credit Policy

The document summarizes monetary policy and the tools used by the Reserve Bank of India (RBI) to influence money supply and credit conditions. It discusses that monetary policy aims to control inflation and stabilize prices through bi-monthly policies that impact interest rates and money supply. The key monetary policy tools used by RBI include repo rate, cash reserve ratio, statutory liquidity ratio, open market operations, and refinance facilities to banks. These tools allow RBI to pursue contractionary or expansionary monetary policy stances.

Uploaded by

Yash Chaudhary
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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UNIT 2

MONETARY POLICY/CREDIT
POLICY
MONETARY POLICY
■Monetary policy refers to the policy of the central
bank i.e Reserve Bank of India – in matters of
interest rates, money supply and availability of
credit.
■It is through the monetary policy, RBI
controls inflation & deflation in the country.
■It is bi-monthly policy means it changes in every
2 months i.e 6 times in a year.
■RBI is vested with the responsibility of conducting
monetary policy. This responsibility is explicitly
MONETARY POLICY
COMMITTEE (MPC)
■MPC is a six-member committee
constituted by the RBI (Section 45B
of the amended RBI Act, 1934).
■The MPC is required to meet at
least four times in a year. 
TYPES OF MONETARY POLICY

1. CONTRACTIONARY POLICY: RBI use this to


reduce inflation. It is focused on decreasing
the money supply in the economy like raising
interest rates.
2. EXPANSIONARY POLICY: RBI use this to
lower unemployment & avoid recession. It is
focused on increasing the money supply in
the economy like lower interest rates.
OBJECTIVES

■Growth: If RBI opts for a cheap or


easy credit policy by reducing
interest rates, the investment level in
the economy can be encouraged.
This increased investment can be
speed up economic growth.
OBJECTIVES

■Price Stability: All the economies


suffer from inflation (Condition
where Demand increases, supply
decreases & Price increases) &
deflation (Condition where
Demand decreases, supply
increases & Price decreases). Both
OBJECTIVES

■Employment: If the monetary


policy is expansionary then credit
supply can be encouraged. It
could help in creating more jobs in
different sectors of the economy.
INSTRUMENTS
DIRECT INDIRECT
INSTRUMENTS INSTRUMENTS
Refinance Facility Repo Rate-6.25%

Cash Reserve Ratio


Bank Rate-6.5%
(CRR)-4%
Statutory Liquidity Marginal Standing
Ratio (SLR)-19.25% Facility-6.5%
Reserve Repo
Rate-6%
Open Market
Operation (OMO)
DIRECT INSTRUMENTS
■ CASH RESERVE RATIO (CRR)- 4%: The share of Net Demand &
Time Liability that bank must maintain with RBI is CRR. Bank deposit
CRR i.e 4% to RBI on daily basis. The portion or % of liabilities (Net
Demand & Time Liability Deposit A/C) of commercial banks that they
need to keep with the RBI so that RBI can help them with cash at the
time of need. When the CRR is reduced banks have more money in
deposit, whereas when the CRR is increased banks have lesser
amount to invest.
■ NDTL is whatever amount left after deposits & withdrawal on daily
basis is NDTL.
Suppose Total Deposit in XYZ Bank in a day is Rs. 100000/-
Total withdrawal in XYZ Bank in a day is Rs. 75000/-
So Money left in bank in a day is Rs. 100000-75000=Rs. 25000/- (NDTL)
BANK

Assets Liability

Deposits
Loan
(A/C)

Demand Term
Deposit Deposit
A/C A/C
Recurring
Saving Fixed
Current A/C Deposit
A/C Deposit A/C
A//C
DIRECT INSTRUMENTS
■ STATUTORY LIQUIDITY RATIO (SLR)- 19.25%: The share of
NDTL that bank must maintain in cash, gold & government
SLR
securities. Bank reserves SLR i.e 19.25% to itself on daily basis.
(19.25%
)
Govt.
Cash Gold securitie
s
Ex: Suppose Total Deposit in XYZ Bank in a day is Rs. 100000/-
Total withdrawal in XYZ Bank in a day is Rs. 75000/-
So Money left in bank in a day is Rs. 100000-75000=Rs.
25000/- (NDTL)
Now Bank will pay 4% of this Rs. 25000/- i.e Rs. 1000/- to RBI. This
DIRECT INSTRUMENTS
■ REFINANCE FACILITY: For achieving sector (Agriculture,
Education, Housing, Business & Industries) specific
objectives liquidity or money supply is being injected through
sector-specific refinance facilities.

Finance to BankRBI

Refinance to differentBANK
sectors

Agricult Educati Housi Busin Industri


ure on ng ess es
INDIRECT INSTRUMENTS
■ REPO RATE- 6.25%: Full form of REPO RATE is Repurchase
Offer Rate/ Repurchase Option.
The fixed interest rate at which the banks can borrow money from
the RBI by lending their surplus government securities is known
as the Repo Rate. The more the repo rate, the costlier are
the loans for the customers.
■ RBI give loan for 15 days & it can be extended 5 more times i.e
5*15 = 75 more days at the same interest rate.
Loan
BAN
•
• RB
Short Term, For Max. 90 Days
•
I
Min Amount Rs. 5Cr
• Max Amount 0.5% of NDTL K
INDIRECT INSTRUMENTS
■ BANK RATE OR PENALTY RATE- 6.5%: Whenever the
banks have any shortage of funds they can borrow it from
RBI. Repo rate is the rate at which our banks borrow rupees
from RBI. A reduction in the repo rate will help banks to get
Money at a cheaper rate. When the repo rate increases
borrowing from RBI becomes more expensive.

• Loan
RB
BANK
• 90 Days+ Extended Days
• It is a Penalty to banks after 90 days.
I
• Min Amount Rs. 5Cr
• Max Amount 0.5% of NDTL
INDIRECT INSTRUMENTS
■BANK RATE- 6.5%
Ex: Suppose Loan Amount = Rs. 5 Cr
Time= 90 days
Bank extended loan term for another
60 days.
So, Loan for 150 Days = 90 Days (Repo
Rate-6.25%) + 60 Days (Bank Rate-
INDIRECT INSTRUMENTS
■MARGINAL STANDING FACILITY (MSF)-
6.5%
■It was introduced in the year 2011 by Mr. G.
Mahalingam.
■This is a facility under which scheduled
commercial banks can borrow additional
amount of overnight money from the RBI.
Min Amount- Rs. 1Cr
Max Amount- 2% of NDTL
INDIRECT INSTRUMENTS
■REVERSE REPO RATE- 6%
This is the rate of interest that RBI offers to the
banks for borrowing their surplus funds for a
short period of time. 

Bank In return RBI


deposits its gives interest
surplus to Bank.
funds in RBI
INDIRECT INSTRUMENTS
■LIQUIDITY ADJUSTMENT FACILITY
(LAF)
It is combined operation of RBI when
they use both Repo Rate (6.25%) &
Reverse Repo Rate (6%) together to
control inflation or deflation.
The difference between Repo Rate &
Reverse Repo Rate is called LAF Corridor
INDIRECT INSTRUMENTS
■OPEN MARKET OPERATION (OMO)
(Brahmastra of Monetary Policy)
These include both, outright
purchase/sale of government securities
(for injection/absorption of liquidity). By
purchasing bonds through OMO, the
RBI introduces money in the system &
reduces the interest rate.

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