RBI and its monetary policy

Monetary policy is micro economic policy laid down by Reserve bank of India (RBI). This policy targets money supply in the market and various interest rates, which ultimately led to control of inflation and price stability in the economy.

Monetary policy is completely a demand side economic policy. It can never be suppply side economic policy.

2 components of monetary policy :-

1) Cheap money policy :- Here the aim is to increase the liquidity or supply of money in the market. It is also called as expansionary policy.

2) Dear money policy :- Here the aim is to decrease the liquidity or supply of money in the market. It is also called as contractionary policy.

Various instruments of monetary policy used by RBI are :-

1) Bank rate :- It is the rate at which RBI gives loans to commercial banks. Bank rate is used as a signal by RBI to commercial banks on RBI’s thinking of what the rate of interest should be. This lending taken by banks from RBI is for long term(more than 90 days). For this lending, RBI do not ask for any collaterals or guarantee.

2) Repo rate :– It is also called as Re-purchase option. Here, RBI gives loan to banks for short terms by taking government securities from these banks as a collateral or guarantee. In this, there is an agreement between RBI and banks to re-purchase these government securities.

Or, we can say that banks will re-purchase their government security.

By repo rate, RBI injects money/liquidity into the system or in the market.

3) Reverse repo rate :- It is the rate at which RBI borrows money from these banks for short term by giving government securities to these banks as a collateral or guarantee. In this transaction, there is an agreement to re-purchase back these government securities by RBI from the banks.

Note :– These borrowing and lending are done by auctions called repo auctions or reverse repo auctions and repo and reverse repo rates are decided by RBI on its own discretion.

Important Note :- Repo rate always > Reverse repo rate

Difference between Repo rate and Reverse repo rate

Repo rate	Reverse repo rate
It is the rate at which RBI lends money to the commercial banks.	Under it, RBI borrows money from banks by lending securities
It is always higher than reverse repo rate	It is always lower than the repo rate.
It is used to control inflation.	It is used to control money supply in the economy.

4) M.S.F (Marginal standing facility) :- It was created by RBI in its credit policy of 2011. M.S.F is the rate at which banks are able to borrow overnight funds from RBI. Here also government securities used as a collateral.

M.S.F always > Repo rate

5) CRR (Cash reserve ratio) :- It is to be maintained by banks only in form of cash. It is to be kept with RBI. It is calculated in term of NDTL(Net demand and time liability) of banks. RBI is not liable to pay interest on it. It is maintained on daily basis. There is no specified range of it. CRR is fixed by RBI and it is mandatory in nature which mean banks have to maintain CRR.

Current CRR is 4.5%

Important note :- CRR is maintained because, if in future there is an insolvency problem or bank is in trouble, so RBI can help these banks to cope up with the situation by using the CRR funds availabe with the RBI.

6) SLR (Statutory liquidity ratio) :- It can be in the form of cash/gold/govt. securities. It is kept with the banks themselves. It is also mandatory in nature. It is calculated in terms of NDTL(Net demand and time liability). There is a range of it i.e 0-40%. SLR is to be maintained on daily basis.

7) Open market operations :– In it there is a selling and buying of government securities and treasury bills between RBI and commercial banks takes place. Its aim is to control the money supply in the economy.