Monetary Policy - Non-Conventional Methods

 They are recently introduced tools as per the requirements of the economy, they are

1. Liquidity Adjustment Facility (2000).
2. Marginal Standing Facility (2011).
3. Standing deposit scheme (2018).
4. Market Stabilisation Scheme/ Bonds (2004).
5. Dollar-Rupee Buy/Sell Currency Swap Auction (2019).
6. Operation Twist (2019).
7. CRR Leeway (2020).
8. Long Term Repo Operations.
9. Targeted Long Term Repo Operations.

Liquidity Adjustment Facility

(Bank has G-Sec, If Bank need immediate liquidity/Liquidity crisis (money need), Bank can mortgager the G-Sec {Only G-Sec above the SLR} – to RBI/Other Bank for 1 to 14 days).

• The LAF is the key element in the monetary policy operating framework of the RBI (introduced in June 2000).
• A tool used in monetary policy that allows banks to borrow money through repurchase agreements.
• This arrangement allows banks to respond to liquidity pressures and is used by governments to assure basic stability in the financial markets.
• LAF consists of Repo and Reverse Repo operations.
• On daily basis, the RBI stands ready to lend to or borrow money from the banking system, as per the need of the time, at fixed interest rates (repo and reverse repo rates).
• Together with moderating the fund-mismatches of the banks, LAF operations help the RBI to effectively transmit interest rate signals to the market.

Repo Rate

(By Pledging G-Sec to RBI, interest given is bank to RBI is Repo Rate. By increasing Repo rate bank need to give more interest to RBI, so bank also increase the interest of Loan). – RBI has final decision to buy the G-Sec. RBI not always buy G-Sec.

Discount rate: If Bank Give G-sec worth 1000 Rupees. Ex: Repo rate is 5%, RBI give 950 rupees to bank, bank give back 1000 rupees to RBI and get back G-Sec. the interest subtracted and given the money called as discount rate.

• It is a rate at which commercial banks borrow by mortgaging their G-Secs with RBI
• Banks use this to manage short term liquidity crunch
• Repo means repurchase options
• Repurchase of Govt Securities
• Rate of interest the RBI charges from its clients on Short Term Borrowings
• Its actually Discount rate
• Its Discount on dated Government securities which are deposited by the Institutions for Short Term
• The loans are borrowed at discount and Full face value is paid on the maturity
• Under repo, loans are provided for just one day and banks should pledge their security holding that is held above the SLR (Statutory Liquidity Ratio) level to get one day loans.
• If there is no security holding over the SLR, banks can’t get loans under repo facility (MSF)
• Suppose the if the SLR is 18.5% and a particular bank is having the SLR security holdings exactly equal to 18.5%, it can’t get loans under repo.
• The working of repo thus necessitates that there should be eligible securities with the bank to avail money from the RBI by pledging them.
• Eligible securities are first class securities (including government bonds, T Bills, State Development Loans etc.) held by a bank over the SLR requirement.

Reverse Repo Rate

(Excess liquidity (money) in Bank, So Bank, lending money to RBI in short term of (1 to 14 days). RBI give interest to Bank [Sometime give G-sec]).

• It is the rate of interest the RBI pays to its clients who offer short-term loan to it
• It is reverse of the repo rate and this was started in November 1996 as part of liquidity Adjustment Facility (LAF) by the RBI.
• In practice, financial institutions operating in India park their surplus funds with the RBI for short-term period and earn money.
• It has a direct bearing on the interest rates charged by the banks and the financial institutions on their different forms of loans.
• This tool was utilised by the RBI in the wake of over money supply with the Indian banks and lower loan disbursal to serve twin purposes of cutting down banks losses and the prevailing interest rate.
• Increase of Reverse Repo Rate will suck out the excess money from the market because banks will prefer to deposit in RBI rather than giving as loans
• It has emerged as a very important tool in direction of following cheap interest regime—the general policy of the RBI since reform process started.
• (Reverse repo reduced at COVID 19)

Marginal Standing Facility

(Breaching SLR, pledging the G-Sec (up to 2% Available in SLR) to RBI on Marginal Standing Facility (High interest rate - 0.25% higher than repo rate) not able to pledge on repo rate).

• MSF is a new scheme announced by the RBI in its Monetary Policy, 2011–12 which came into effect from May, 2011.
• Under this scheme, banks can borrow overnight upto 2 per cent of their net demand and time liabilities (NDTL) from the RBI, at the interest rate 0.25 per cent (25 basis points) higher than the current repo rate.
• MSF, being a penal rate, is always fixed above the repo rate. The MSF would be the last resort for banks once they exhaust all borrowing options including the liquidity adjustment facility by pledging government securities, where the rates are lower in comparison with the MSF.
• Now suppose that the bank has pledged all of its securities above SLR norm to the RBI for getting funds (means no eligible securities). Then, what the bank can do to get immediate money from the RBI?
• The MSF would be a penal rate for banks and the banks can borrow funds by pledging government securities within the limits of the statutory liquidity ratio.
• The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system.
• MSF represents the upper band of the interest corridor with repo rate at the middle and reverse repo as the lower band.
• To balance the liquidity, RBI uses the sole independent "policy rate" which is the repo rate (in the LAF window) and the MSF rate automatically gets adjusted to a fixed per cent above the repo rate (MSF was originally intended to be 1% above the repo rate now its 0.25% or 25 basis points).
• MSF is at present aligned with the Bank rate.
• (Because of COVID, MSF 2% to 3% bank can breach)

Reverse Repo Rate < Repo Rate < MSF rate

Difference between Liquidity Adjustment Facility and Marginal Standing facility

Liquidity Adjustment   Facility	Marginal Standing Facility
Banks can borrow as long as   they have G-secs in excess of SLR.	Banks can borrow upto 2% NDTL using G-secs from SLR.
Minimum bidding amount is 5 crore	Minimum bidding amount is 1 crore
All clients of RBI are eligible under LAF like Scheduled   commercial banks, Governments	Only Scheduled commercial banks can borrow

Monetary Policy Corridor

• (Reverse Repo Rate < Repo Rate < MSF rate.
• Symmetrical corridor (before COVID): 0.25 – 4.25 < 4.5 < 4.75
• Asymmetrical Corridor (from COVID): 0.65 for Reverse Repo rate & .25 on MSF – 3.75 < 4.40 < 4.65) – for discourage Reverse Repo.

Monetary Policy Corridor refers to the area between the lower reverse repo rate and the upper ceiling rate of MSF rate.

• Reverse repo rate will be the lowest of the policy rates whereas Marginal Standing Facility is something like an upper ceiling with a higher rate than the repo rate.
• On March 27th, 2020, as part of the COVID 19 response package, the RBI reduced the policy rate of repo by 75 basis points from 5.15% to 4.40%.
• An even higher reduction in reverse repo rate: The reverse repo rate has a been reduced by 90 basis points to 4 per cent.
• The marginal standing facility (MSF) rate reduced to 4.65%.
• So, the difference between Reverse repo rate and MSF rate widened from 50 bps to 65 bps.
• This widened the gap or corridor between the two rate is quite asymmetrical according to the RBI.
• In August 2020, RBI reduces repo rate by 40 basis points from 4.4% to 4%, reverse repo to 3.35%, Widening the corridor from 65 basic points to 90 bps

Current Rates (As of May 2022)

Bank Rate	5.65%
CRR	4.5%
SLR	18%
Repo Rate	5.40%
Fixed Reverse Repo Rate	3.35%
Marginal Standing Facility Rate	5.65%
Standing Deposit Facility Rate	5.15%

Standing Deposit Facility (2018)

(To control inflation RBI sell G-Sec and get Cash. But RBI need to control 1000 crore cash in economy but RBI has only 500 crores worth G-Sec to sell, that time use Standing Deposit Facility – Tell the bank to deposit 500 crore cash in RBI in return RBI does not give interest or G-Sec. After some time, RBI return only deposited cash.) – Use this at the time of Demonetization, RBI ask the bank to deposit the old 500, 1000 to RBI, they return new notes (only equivalent amount, not interest) after the flow of new note is getting normal.

• It allows the RBI to absorb liquidity (deposit) from commercial banks without giving government securities in return to the banks.
• Government in the Budget’s (2018) Finance Act included a provision for the introduction of the Standing Deposit Facility (SDF).
• In the present situation, the main arrangement for the RBI to absorb excess money with the banking system is the famous reverse repo mechanism.
• Under reverse repo (which is a part of the Liquidity Adjustment Facility), banks will get government securities in return when they give excess cash to the RBI.
• An interest rate of reverse repo rate is also provided to banks.
• The inconvenience with this arrangement is that the RBI has to provide securities every time when banks provides funds.
• As per the stand of the RBI, when the central bank has to absorb tremendous amount of money from the banking system through the reverse repo window, it will become difficult for the RBI to provide such volume of government securities in return. This situation was occurred during the time of demonetisation.
• In this sense, the Standing Deposit Facility (SDF) is a collateral free arrangement meaning that RBI need not give collateral for liquidity absorption.
• Under the existing liquidity framework, liquidity absorption through reverse repos, open market operations and the cash reserve ratio (CRR) are at the discretion of the Reserve Bank. But SDF will enable banks to park excess liquidity with the Reserve Bank at their discretion.
• As a standing facility, the SDF supplements Marginal Standing Facility or the MSF (SDF for liquidity absorption whereas MSF for liquidity injection).

Market Stabilisation Scheme (2004)

(Sterilization – To Absorb the excess foreign exchange (Mainly export), only if leading to inflationary effect. Through Releasing Special Bond and absorb excess money).

• Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling Special bonds called Market stabilisation bonds (MSBs) in the economy.
• The MSS was introduced in April 2004. To control the surge of US dollars in the Indian market, RBI started buying US dollars while pumping in rupee. This eventually led to over-supply of the domestic currency raising inflationary expectations. MSS was introduced to mop up this excess liquidity.
• Whenever foreign exchange or excessive dollars enter the economy, the RBI has to give equivalent rupees.
• In this way, high selling of rupees leads to excess liquidity (rupee) and thereby creating a potential for inflation.
• To overcome this situation, the RBI has sold government bonds (MSBs) on a general basis depending upon the volume of excess liquidity in the system.
• Here bonds go to financial institutions and money goes back to the RBI. This withdrawal of excess liquidity is called sterilisation.
• The money raised under MSS is kept in a separate account called MSS Account and not parked in the government account or utilised to fund its expenditures.
• As per the latest policy, the government has increased the amount of MSBs to be issued to Rs 6 lakh crores from just 0.3 lakh crores in the context of demonetisation. Why the MSS is needed to manage the demonetised situation?
• After demonetisation, huge deposits were put into the banking system. At the same time, banks can’t lend it to customers as it is just temporary money. The RBI has instructed banks to keep all the additional deposits as CRR. But here, the banks will suffer losses as they have to pay interest to the depositors.
• To compensate banks, the MSS policy is revived. Here, banks can put the excess money obtained from deposits in MSBs. They can get an interest payment as well.

Dollar-Rupee Currency Swap (2019)

1. Due to foreign exchange crisis (Due to High import) in 2016, RBI spent Dollars form their forex reserves to control inflation

2. Bank give more loan in 2014 (because economy in boom) but loans are not get back. So bank has no money to give as loan in 2016, 2017, 2018.

In the scenario Bank need cash to give loan & RBI need dollars to maintain forex reserve. So the Rupee-Dollar currency swap auction between RBI and Other Banks through Auction – RBI give Indian rupee to bank & Bank give dollar to RBI.)

Bank has NRI Account (Foreign lived Indian have NRI account in Indian bank maintain in dollars, also bank invest in dollars and buy some dollars and store in the bank.

Example of Auction – RBI get dollar form bank on value of 70 rupees per dollar, only to the bank who coat dollar value above 78 rupees on return after 3 years and get back the dollars they give.

• 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 facility became operational on March 26th, 2019; when the first US Dollar-Rupee Buy/Sell Swap auction was made by the central bank for $5 billion.
• 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
• It is both liquidity management tool and Foreign Exchange management tool
• Under the swap, the RBI conducts auction for getting dollars from banks while exchanging rupees.
• The rate at which dollar is exchanged for rupee is based on the spot exchange rate on the auction day. Swap is for a specific period say, three years and on that day, the banks have to buy back dollars from the RBI while paying rupee back.
• An important part of the auction is the premium that banks are ready to pay ie., a higher price for dollars while buying back dollars from the RBI at the end of the swap period (say, three years).
• For example, if the RBI gives Rs 70 for each dollars now, the banks may be willing to pay Rs 75 per dollars after three years (Rs 5 as premium). The premium amount is auctioned and banks quote them in paisa (here, 500 paisa)
• The purpose of the swap is to give liquidity (rupee) to banks as a process of liquidity management operation

Currency Swap – Not only exchange between India banks. Also between Country exchange, if country need of Foreign Exchange.

Outcomes of Swap

1. A unique feature of the Dollar-Rupee swap is that it will increase the foreign exchange reserves of the RBI. RBI’s forex reserves increased to $412 billion after the 23rd April 2019 auction.
2. Reduced dependence on bond buying: it will reduce bond-buying by the Reserve Bank of India.
3. Injection of liquidity into the system: Through the two auctions (March and April 2019), the central bank infused around Rs 69,000 crore of liquidity in the banking system. For further details, Refer: https://www.indianeconomy.net/splclassroom/rbis-dollar-rupee-swap-auction/

Operation Twist

(Buy long term G-Sec in Bank and Sell equivalent value of short term G-Sec. Through this action bank get cash in short term and give loan).

• The RBI has experimented the monetary policy method of Operation Twist.
• It has conducted three rounds of Operation Twist– on December 19th 2019, December 23rd, 2019 and 6th of January 2020.
• Operation twist is a monetary policy intervention by the central bank, conducted through Open Market Operations (OMOs), where the central bank is buying long term bonds of the government and at the same time selling short term securities of the government.
• Buying long term securities and selling short term securities will reduce the yield of long term securities compared to that of the short term ones.
• This yield impact is the objective of Operation Twist.

Objectives

• The first objective is to reduce the yield of the long-term government securities. The real benefit of such a step is that the government need to pay only lower interest rates if it issues more securities in future as part of the borrowings. Given the current yield is lower, it may make more comfort for the government to issue long term securities in future.
• The second objective is to bring down long term interest rate so that higher credit, consumption, investment etc. can go up.
• Thirdly, the RBI is tired of using the repo rate without much result. The central bank is complaining that banks are not following the repo signal by adjusting their lending rates.
• In this context, the RBI was searching for new instruments of monetary policy transmission. The operation twist is test of a new option through which the RBI can influence market interest rate by selling and purchasing government bonds.
• For Further read, Click: https://rb.gy/zrih6i

CRR Leeway

(RBI steps for COVID 19 – Reduce CRR 4% to 3% fir 1 year.

Give New formula NDTL is Given.

New NDTL = NDTL – Loan given to Automobile, Housing & MSME). The New NDTL is used to keep CRR.

Ex: Bank has 1000 Rs Give loan to Automobile, Housing & MSME each 10% (Rs 100 each). So New NDTL is 700 Rupees maintain 28 Rupees as CRR is enough. If old NDTL keep CRR as 40 rupees. So bank has additional 12 rupees to give as loan.

• Reserve Bank of India (RBI) asked banks to avail cash reserve ratio (CRR) exemption on incremental retail loans given to MSME, housing and auto sectors between January 31 and July 31, 2020 for a period of five years.
• Banks can deduct the equivalent amount of incremental credit disbursed by them as retail loans to these sectors, over and above the outstanding level of credit to these segments as on January 31, 2020, from their net demand and time liabilities (NDTL) for maintenance of the CRR.
• All Scheduled Commercial Banks are at present required to maintain with RBI a Cash Reserve Ratio (CRR) of 3% of the Net Demand and Time Liabilities (NDTL) (excluding liabilities subject to zero CRR prescriptions) under Reserve Bank of India Act, 1934.
• Non-maintenance of CRR on new loans for specified condition implies that Banks can claim deduction equivalent to these loans from their Net Demand and Time Liabilities (NDTL).
• This is only for the purpose of computing the CRR for a period of five years from the date of origination of the loan.
• Also, the leeway is given only on new loans (i.e. incremental credit) in these sectors post specified date- 31 January 2020. (Loans before this date under these sectors are not eligible.)
• This step could indirectly decrease interest rates for auto, housing and MSME sector due to monetary room provided by non-maintenance of CRR on such loans.

Long Term Repo Operations

• RBI has announced a new liquidity facility under Long Term Repo Operations (LTRO) to inject liquidity in the banking system.
• The new policy tool comes in the context of the RBI’s limitations in cutting its policy Rate (Repo Rate) as well as its desire to enhance liquidity of the banking system and promote lending activities of banks.
• An interesting feature of the RBI’s new effort is that the central bank will be injecting Rs 1 lakh crore into the banking system through auctions with long term maturity periods (compared to one day repos) of 1 year and 3 years.
• Funds through LTRO will be provided at the repo rate. This means that banks can avail one year and three-year loans at the same interest rate of one-day repo.
• Usually, loans with higher maturity period (here like 1 year and 3 year) will have higher interest rate compared to short term (repo) loans.
• If the RBI is ready to give one-year and three year loans at the low repo rate, then there will be a clear pressure on banks to reduce their lending rates.
• Hence, the most important effect of the LTRO in the system will be a decline in short term lending rates of banks.
• There are two clear effects of LTROs: (a) it will enhance liquidity in the banking system by Rs 1 lakh crore (b) since the interest rate is comparatively low, there will be a downward pressure on short term lending rates.
• These two will bring the effect of a slightly easy monetary policy.

Targeted Long Term Repo Operations

(RBI borrow long term Credit at Repo Rate. Before COVID 19 Long term credit given only at Bank Rate.

Bank Rate > Repo Rate. Because of it bank give less interest to RBI & had more money to give as loan also bank reduce interest rate of loan.

• Targeted Long-Term Repo Operations are Long term repo operations (LTROs) conducted by the RBI to ensure adequate liquidity at the longer period for specific sectors.
• Under LTROs, the RBI will auction funds to banks for making investment in prescribed corporate and other instruments. In the initial phase, the RBI instructed banks to invest funds availed from TLTRO to invest in investment-grade corporate debt.
• Purpose of the TLTRO is to ensure that there is enough liquidity in markets like corporate market and their yield are not going up in the context of the Covid set back.

Why TLTRO?

• Corporate are finding difficult to mobilise funds as there are large sell off corporate bonds and other instruments in the context of the Covid 19 pandemic and the incoming economic risks. So, providing liquidity to the corporate bond market is the sharp objective of the TLTRO mission.