Instruments of monetary control
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The Reserve Bank of India (RBI) uses various instruments of monetary policy to control the supply of money in the economy and maintain price stability. These include direct tools like the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), which require banks to hold certain percentages of deposits as cash reserves and government securities. Indirect tools include the repo rate and reverse repo rate, which are the interest rates at which the RBI lends to and borrows from commercial banks. By adjusting these rates, the RBI can increase or decrease the availability of funds in the economy in order to manage inflation and economic growth.
Instruments of monetary control
- 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.
- 3. Objectives of the monetary policy of India • Price Stability • Controlled Expansion Of Bank Credit • Promotion of Fixed Investment • Restriction of Inventories and stocks • To Promote Efficiency • Reducing the Rigidity
- 4. Instruments of Monetary policy 1. Direct regulation: -Cash Reserve Ratio (CRR) -Statutory Liquidity Ratio (SLR) 2. Indirect regulation: -Repo rate -Reverse repo rate
- 5. Cash Reserve Ratio (CRR): Commercial Banks are required to hold a certain proportion of their deposits in the form of cash with RBI. CRR is the minimum amount of cash that commercial banks have to keep with the RBI at any given point in time. RBI uses CRR either to drain excess liquidity from the economy or to release additional funds needed for the growth of the economy. For example, if the RBI reduces the CRR from 5% to 4%, it means that commercial banks will now have to keep a lesser proportion of their total deposits with the RBI making more money available for business. Similarly, if RBI decides to increase the CRR, the amount available with the banks goes down.
- 6. Statutory Liquidity Ratio (SLR): SLR is the amount that commercial banks are required to maintain in the form of gold or government approved securities before providing credit to the customers. SLR is stated in terms of a percentage of total deposits available with a commercial bank and is determined and maintained by the RBI in order to control the expansion of bank credit. For example, currently, commercial banks have to keep gold or government approved securities of a value equal to 23% of their total deposits.
- 7. Repo Rate: The rate at which the RBI is willing to lend to commercial banks is called Repo Rate. Whenever commercial banks have any shortage of funds they can borrow from the RBI, against securities. If the RBI increases the Repo Rate, it makes borrowing expensive for commercial banks and vice versa. As a tool to control inflation, RBI increases the Repo Rate, making it more expensive for the banks to borrow from the RBI with a view to restrict the availability of money. The RBI will do the exact opposite in a deflationary environment when it wants to encourage growth. Reverse Repo Rate: The rate at which the RBI is willing to borrow from the commercial banks is called reverse repo rate. If the RBI increases the reverse repo rate, it means that the RBI is willing to offer lucrative interest rate to commercial banks to park their money with the RBI. This results in a reduction in the amount of money available for the bank’s customers as banks prefer to park their money with the RBI as it involves higher safety. This naturally leads to a higher rate of interest which the banks will demand from their customers for lending money to them.