What are the various instruments of RBI’s monetary policy

Instruments of RBI’s Monetary Policy *INTRODUCTION ~The Reserve Bank Of India is the apex bank of the country. ~It plays an instrumental role on the financial markets of the country through its monetary policy. ~There are various instruments of RBI’s Monetary policy. *INSTRUMENTS OF MONETARY POLICY: ~The RBI aims to achieve its objectives of economic growth and control of inflation through various methods. ~These methods can be grouped as: ^General or Quantitative Methods. ^Selective or Qualitative methods. 1) GENERAL OR QUANTITATIVE METHODS: ^ These methods maintain and control the total quantity or volume of credit or money supply in the economy. ^They are also called as credit control measures. ^The following are the different credit control measures adopted by the RBI: i)BANK RATE: ^Bank rate (also known as discount rate)is the rate at which RBI rediscounts eligible papers like approved securities, bill of exchange and commercial papers held by the commercial banks. ^Thus it is the rate at which the RBI lends money to the commercial banks for their liquidity requirements. ^Changes in the bank rate affect the bank’s borrowing rate from the RBI which in turn influences the bank’s lending rates. Thus bank rate acts as a guideline to the banks for fixing their interest rates. ^Inflation leads to increase in the bank rate recession causes it to decline. ^In April 2010 the bank rate was fixed at 6%p.a. ii)OPEN MARKET OPERATIONS: ^Open Market Operations indicate the buying/selling of government securities in the open market to balance the money supply in the economy. ^During inflation, RBI sells the government securities to the commercial banks and other financial institution. This reduces their cash lending and credit creation capacities. Thus, Inflation can be controlled. ^During recessions, RBI purchases government securities from commercial banks and other financial institution. This leaves them with more cash balances for lending and increases their credit creation capacities. Thus, recession can be overcome. iii)REPO RATES AND REVERSE REPO RATES: ^ Repo rate and Reverse Repo rate are gaining significance in determining interest rate trends of commercial banks. ^Repo (SALE AND REPURCHASE AGREEMENT): ~ Repo is a swap deal involving immediate sale of securities and a simultaneous re purchase of those securities at a future date at a predetermined price. ^ Such deals take place between the RBI and other commercial banks and financial institution. ^ Commercial banks and financial institution also park their funds with RBI at a certain rate This rate is called the reverse Repo Rate. ^Repo rates and reverse repo rate used by RBI to make liquidity adjustments in the market. ^ At present, the Repo rate is 6.25% and the Reverse Repo rates is 3.75%. iv) CASH RESERVE RATIO: ^ The money supply in the economy is influenced by the cash reserve ratio. ^ It is the ratio of a bank’s time and demand liabilities to be kept in reserve with the RBI. ^ The RBI is authorised to vary the CRR between 3% and 15%. ^ A high CRR reduces the flow of money in the economy and is used to control inflation. ^ A low CRR increases the flow of money and is used to overcome recession. ^ At present, the CRR ratio is 5.75%. v)STATUTORY LIQUIDITY RATIO: ^SLR is the ratio requirement peculiar to India. ^Under SLR, banks have to invest a certain percentage of its time and demand liabilities In Government approved securities. ^The present level of SLR is 24%. ^The reduction in SLR enhances the liquidity of commercial banks. vi) DEPLOYMENT OF CREDIT: ^The RBI has taken various measures to deploy credit in different of the economy. ^The certain percentage of bank credit has been fixed for various sectors like agriculture, export, etc. 2) SELECTIVE / QUALITATIVE MEASURES: ~The RBI directs commercial banks to meet their social obligations through selective/ qualitative measures. ~These measures control the distribution and direction of credit to various sectors of the economy. ~The following are the various selective measures: i) CEILING ON CREDIT: ^ The RBI has imposed ceiling on bank credit against the security of certain commodities/ Securities. ^This imposes a limit on the amount of credit to different sectors. ^Such measures ensure financial discipline in the banking sector. ii) MARGIN REQUIREMENTS: ^A loan is sanctioned against collateral security. ^Margin is that proportion of the value of the security against which loan is not sanctioned. ^ Higher margin indicates lesser amount of loan. ^The margin (that varies from 20% to 80%) can be increased /decreased to encourage/discourage the flow of credit to a certain sector. iii) DISCRIMINATORY RATES OF INTEREST: ^ The RBI has introduced differential rates of interest for different use of credit. ^Through this method, resources can be directed to priority sectors and speculative use of bank finance can be avoided. iv) DIRECTIVES: ^RBI uses strict disciplinary action against banks that fail to follow its directives. ^The directives may be related to: ~Minimum margin requirement ~Maximum limit on advances to borrowers ~% of CRR and SLR ~Minimum lock-in period, etc. v) MORAL SUASION: ^This is the most actively used technique of monetary control. ^The RBI issues periodic letters and discussions to the banks about the trends in the economy, especially in money and credit. ^Thus the RBI acts as a reminder to the banking sector to follow credit control norms and meet its social obligation.