TOOLS TO REGULATE MONETARY POLICY

QUANTITATIVE CREDIT CONTROL METHOD

      These methods are designed to control the overall volume of credit created in an Economy.

1. STATUTORY LIQUIDITY RATIO

      It is a ratio of total deposits of a bank in which it has to maintain itself in the form of liquid funds comprising cash and mainly government securities. Objective of SLR is to enable the government to borrow from banks against its securities. Under this all the commercial banks operating in the country are supposed to maintain a part of their total deposits

(i.e. their NDTL with themselves in non-cash form i.e. liquid assets), the ratio is fixed by RBI.

The present SLR (March 2020 is 18.25% of the NDTL of the banks.

2. CASH RESERVE RATIO (CRR)

      It is ratio of the total deposits of a bank in which a bank has to keep in cash with the RBI at any given point of time. CRR deposits don’t earn any interest for banks. CRR is a tool to manage credit and inflation. It fixes the rate between 3% to 15%.

The present CRR is 3%

For E.G. : The bank has the total deposit of Rs.100 cr. has to keep Rs.3 r with RBI, It this ratio goes up, banks have less money to lend or Vice – Versa.

3. REPO RATE

      Repo means Repurchase operations under which RBI lends to bank for a very short period against G-secs with an implicit condition that banks will repurchase these securities after that period. In simple, Repo Rate is the interest rate charged by the central banks from other banks for short – term borrowing. If RBI wants to make it expensive for banks for borrowing money, Repo Rate will be higher. If RBI wants to make it cheaper for banks for borrowing money, Repo Rate will be lower. The present repo rate is 4.4% in March 2020.

4 . REVERSE REPO RATE

      It is the rate at which central bank (RBI) borrows from the market. This is called reverse Repo Rate. In simple, Banks lends to the RBI for a very short period against (G-Secs. with condition that RBI will repurchase these securities after that period. Prevailing rate is 4%.  These are the operations carried out by the RBI to adjust short term liquidity with banks under RBI’s liquidity Adjustment facility.

5. OPEN MARKET OPERATION (OMO)

      It refers to buying and selling of government securities in open market in order to expand or contract the amount of money in the banking system.

      Purchase of securities injects money in to banking system and sale of securities crowd out the money in the bank to lend to others (absorb excess liquidity lying with bank).

6.BANK  RATE

Bank rate is the interest rate at which RBI provides long term credit facility to commercial banks. A deliberate manipulation of the bank rate by the Reserve bank to influence the flow of credit created by the commercial banks is known as Bank rate policy. Bank rate is also referred as discount rate. When RBI increases the bank rate, the cost of borrowing for bank rises and credit volume gets reduced leading to decline in money supply. When RBI reduces the bank rate, (i.e.) borrowing becomes cheaper.

7. MARGINAL STANDING FACILITY (MSF)

      It is emergency facilities under which the RBI lends to any bank facing emergency of funds on a given day. These loans are given by RBI only for overnight against G Sec. MSF rate automatically adjusts to 1% above Repo rate.

It was introduced in 2011-12, under this scheme, the banks can borrow overnight upto 1% of their NDTL from the RBI, at the interest rate 1% higher than current repo rate.

8. DOLLAR SWAP:

Adding to these existing tools, the RBI has introduced a new liquidity instrument in the form of US Dollar-Rupee buy/sell swap auction. The Dollar-Rupee Swap is a liquidity management tool that is operated through a swap (exchange) between the US Dollar and the Rupee; aimed to facilitate comfortable liquidity situation in the economy.

A bank shall sell US Dollars to the Reserve Bank and simultaneously agree to buy the same amount of US Dollars at the end of the swap period.” The new facility is its connection with foreign currency management at the same time dealing with rupee liquidity in the financial system.

9. CALL MONEY MARKET – It is a part of money market where borrowing and lending happens overnight, only scheduled commercial banks can participate in it. The RRBs, cooperatives are excluded from this system.
10. OPEN MARKET OPERATIONS – The sale/purchase of government securities to/from the market with the primary aim of modulating rupee liquidity conditions in the market.
11. LIQUIDITY ADJUSTMENT FACILITY –introduced in 2000, it is a key element in monetary policy.

Liquidity Adjustment Facility (LAF) is a tool used in monetary policy by the RBI, that allows banks to borrow money through repurchase agreements (repos) or for banks to make loans to the RBI Through Reverse Repo Agreements.

12.MARKET STABILIZATION SCHEME – the surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short dated bills.