Monetary Policy - Convectional Method

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Bank Rate

(Bank borrow from RBI at long term credit. Interest given to RBI - Bank Rate.
If RBI increase interest rate, bank also increase interest rate. High interest rate less loan. Credit flow control.)
  • The interest rate which the RBI charges on its long-term lendings is known as the Bank Rate.
  • The clients who borrow through this route are the Government of India, state governments, banks, financial institutions, co-operative banks, NBFCs, etc.
  • The rate has direct impact on long-term lending activities of the concerned lending bodies operating in the Indian financial system.
  • When Inflation is high RBI Increases in bank rate → Increase in lending rate by banks → Discourages credit flow → hence money supply is reduced → Inflation is controlled
  • When inflation is low, vice versa
  • Currently Bank rate is at 4.25% (as on May 2022)
Cash Reserve Ratio (CRR)
(Reserves maintain with RBI)
  • The cash reserve ratio (CRR) is the ratio of the total deposits of a bank in India which is kept with the RBI in the form of cash.
  • This was fixed to be in the range of 3 to 15 percent.
  • Amendment in (2007) has removed the 3-15 per cent floor and provided a free hand to the RBI in fixing the CRR.
  • At present CRR is 4.5 % (as on May 2022).
  • 1% change in it today affects the economy with Rs. 1.4 Lakh crore—an increase sucks this amount from the economy, while a decrease injects this amount into the economy.
  • Payment of interest by the RBI on the CRR money to the scheduled banks started in financial year 1999–2000 (in the wake of the banking slow down). Though the RBI discontinued interest payments from mid-2007.
  • Net demand and Time Liability (Demand deposit & Time Deposit).
  • Using above example CRR is 10% - Bank give only 90 Crore as loan, If CRR is 15% bank give only 85 Crore as loan. Credit control by RBI by make change in CRR to control Inflation.
Statutory Liquidity Ratio (SLR)
(Reserves maintain by Bank themselves in Bank Locker. SLR is 18% so keep 18% liquidity in Bank. Balance give as loan. If SLR increase, Amount given as loan decrease).
  • The statutory liquidity ratio (SLR) is the ratio (fixed by the RBI) of the total deposits (Net demand and Time liabilities [NDTL]) of a bank which is to be maintained by the bank with itself in their vault
  • It prevents bank from lending all its deposits which is too risky
  • It can be maintained in the form of Cash, Gold and Government securities (G-Sec) – these 3 are easy liquidity things.
  • Why SLR is needed - There are three purposes to keep SLR.
    • It is an instrument of credit control
    • It works as a cushion against the possibility of bank failures
    • It is a conduit for financing government deficits.
  • Hence it is also called both quantitative and qualitative tool since by mandating banks to maintain G-Secs, RBI directs the flow of credit towards government Currently SLR is 18% of NDTL (May 2022)
Open Market Operations (OMO)
(RBI also have G-Sec, Sell G-Sec to the bank/Private and get cash. Action to control Inflation. If RBI need to boost money in Economy, buy G-sec and Give money to bank/Private) – The buy/Sell to bank is voluntary or force able.
  • In the operation RBI not release new bond, only buy/sell of existing bonds.
  • OMOs are conducted by the RBI via the sale/ purchase of government securities (G-Sec) to/from the market with the primary aim of modulating rupee liquidity conditions in the market.
  • OMOs are an effective quantitative policy tool in the armory of the RBI to regulate inflation, but are constrained by the stock of government securities available with it at a point in time.
  • Other than the institutions, now individuals will also be able to participate in this market (the decision was taken in 2017 while it is yet to be implemented
The working of OMOs is defines as
  • When RBI sells government security in the markets, the banks purchase them. When the banks purchase Government securities by paying to RBI, they have a reduced ability to lend to the firms or other commercial sectors. This reduced surplus cash, contracts the rupee liquidity and consequently credit creation / credit supply.
  • This operation of selling of G-secs by RBI Controls Inflation
  • When RBI purchases the securities, the commercial banks find them with more surplus cash and this would create more credit in the system and boosts Inflation
  • Thus, in the case of excess liquidity, RBI resorts to sale of G-secs to suck out rupee from system. Similarly, when there is a liquidity crunch in the economy, RBI buys securities from the market, thereby releasing liquidity.
  • There is no Repurchase in case of OPEN MARKET OPERATIONS as opposed to Liquidity adjustment facility
Government Security Acquisition program
  • Previously Government OMO tell only on the day, recently nowadays tell before the OMO date and amount it make easy to bank.

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