Monetary Policy of RBI

www.rbi.org.in
Monetary Policy: Meaning
Monetary
Policy

Involves
Policies
That influences
the cost(interest rate )
and
availability of money and credit.
Monetary Policy
➢ is essentially a program of action undertaken by the monetary authorities,
generally the Central Bank,
➢ to control and regulate the cost and supply of money & credit with the
public
➢ with a view to achieving predetermined macroeconomic goals.
Monetary Policy: Objectives

Annual GDP increase Unemployment below 6 %

2 to 3 % Per year

2 to 3 % inflation
Monetary Policy: RBI
RBI was established on April 1, 1935 with RBI Act 1934, the
recommendations of Hilton-Young Commission. It was
nationalized in 1949.

Main Role of RBI

1. Supply of Money to the Economy

2. Lender of Last Resort

3. Regulator of Financial system

4. Financial advisor to State Governments

Monetary Policy: Making Process in India
Headed by In recent years Monetary
• The RBI Governor Policy is formulated by
Monetary Policy
Assisted by Committee(MPC)
• The RBI Deputy Governors
Guided by
• The Board of Directors
• Several Standing Committees or Groups of the Board
• Technical Advisory Committees and Standing Committees
• Ad-hoc Working Groups
• Board of Financial Supervision
Formulates Monetary Policy once in 6 month.
1. April –September : Slack Season Policy
2. October- March : Business Season Policy
Review the same on quarterly basis
LAF and MSS done daily basis during the office hrs.
Monetary Policy: Types
Expansionary ( Easy) Policy
Aim
Encouraging spending on
goods and services by
expanding supply of credit and
money. Lower unemployment and
control recession
Tools
• Lowering the Policy Rate
(bank rate or repo rate)
• Lowering the reserve
requirements ( CRR, SLR)
• Purchasing the Govt. securities
from the market
Contractionary ( Tight) Policy
Aim
Preventing Inflation by
contracting the Money Supply.
Tools
• Increasing the Policy Rate
(bank rate or repo rate)
• Increasing the reserve
requirements ( CRR, SLR)
• Selling the Govt. securities from
the market
Monetary Policy: Types
Monetary Policy: Operating Framework
Monetary Policy: Operating Framework
• GDP,
Final Goal • Inflation
• Unemployment

• Monetary Aggregates such as M1, M2, M3

• Credit Aggregate
Intermediate • Multiple Target: Interest Rate, Inflation rate,
Target assets prices, Exchange Rate, fiscal deficit etc.

• Reserves Aggregates: such as Bank Reserves

Operating (=borrowed+ non-borrowed reserves), monetary
Target base ( M0).
• Short Term money Mkt Interest Rates : like
interbank rate, Treasury bill rate

Instruments
Such as, bank rate, repo rate, CRR, SLR, OMO etc.
Monetary Policy: Banking Structure in India
Monetary Policy: Instruments

Statutory Liquidity Ratio

(SLR)
Monetary Policy: 1. Quantitative Instruments
1.Bank Rate
➢ Is the minimum rate at which the Central Bank of a country
lends money to banks and financial institutions against
the govt. and other approved securities .

➢ Bank Rate is also known as discount rate, where

rediscounted eligible bills of exchange or commercial paper.
Not so well developed in India. RBI, NABARD, SIDBI
discounts bills of exchange.
↑BR→ ↓ FBR → ↓ CR → ↓MS

BR is Bank rate, FBR is Funds Borrowed by Banks, CR is

Credit, MS is Money Supply

As of today 06/11/2019. Bank rate is 5.40 %

Monetary Policy: 1. Quantitative Instruments
2. Cash Reserve Ratio (CRR)
• All Scheduled & Nonscheduled Commercial Banks {i.e..
Public Sector(27) & Private Sector(22), Foreign Banks (31)},
Urban Co-operative Banks(1721), Regional Rural Banks(86),
State Cooperative Banks( 31).
➢ They are required to hold as reserves either in cash vault or
as deposits with RBI, some amount of their total of Net
Demand and Time Liabilities (NDTL), on a fortnightly basis.
The amount of which shall not be less than 4% or greater
than 20% of the their NDTL.

↑CRR→ ↑ RR →↓ER→↓CR → ↓MS

(RR- required reserve, ER- excess reserve, CR- credit,)

CRR rule doesn't apply to Non Banking Financial Companies
(NBFC), Mutual funds or Insurance Companies

As of today 06/11/2019. CRR is 4%

Monetary Policy: 1. Quantitative Instruments
2. Cash Reserve Ratio (CRR)
• Cash deposits do not mean physical cash, but a
credit balance in a current account that every bank
maintains at RBI.

• They are required to maintain minimum CRR

balances upto 70 per cent of the total CRR
requirement on all days of the fortnight with effect
from the fortnight beginning December 28, 2002.

• It is used by RBI to control liquidity in the

banking system.
Monetary Policy: 1. Quantitative Instruments
2. Cash Reserve Ratio (CRR)

DEMAND LIABILITIES:

Demand Liabilities include all liabilities which are payable on demand:

• Current deposits,
• Demand liabilities portion of savings bank deposits,
• Margins held against letters of credit/guarantees, balances in overdue fixed
deposits,
• Cash certificates and cumulative/recurring deposits,
• Outstanding telegraphic transfers (TTS),
• Mail transfer (MTS),
• Demand drafts (DDS),
• Unclaimed deposits,
• Credit balances in the cash credit account and
• Deposits held as security for advances & payable on demand.
Monetary Policy: 1. Quantitative Instruments
2. Cash Reserve Ratio (CRR)

TIME LIABILITIES:

Time Liabilities are those which are payable otherwise than

on demand:
• Fixed deposits,
• Cash certificates,
• Cumulative and recurring deposits,
• Time liabilities portion of bank deposits, staff security
deposits
• Margin held against letters of credit,
• Gold deposits. .
Monetary Policy: 1. Quantitative Instruments
2. Cash Reserve Ratio (CRR)
Latest News On CRR
o Finance ministry wants RBI to pay 7% interest on CRR
deposits
o the central bank had stopped paying interest to banks on CRR in
2007
o SBI Chairman Pratip Chaudhuri for abolition of cash reserve
ratio
o costing the banking system about Rs 21,000 crore.
o Why is CRR not applied to insurance and other companies who are
mobilising deposits from the public?
o B Coz they don’t receive demand and time deposits
Monetary Policy: 1. Quantitative Instruments
3.Statutory Liquidity ratio (SLR)
• “Statutory” here means that it is a legal requirement and “liquid asset” means
assets in the form of cash, gold and other approved securities (government
securities)

• Besides CRR, Banks have to invest certain percentage of their deposits in

specified financial securities like Central Government or State Government
securities. This percentage is known as SLR.

• This money is predominantly invested in government approved securities

(bonds), Gold, which mean the banks can earn some amount as 'interest' on
these investments as against CRR where they do not earn anything.
• SLR in Govt Securities
Scheduled Com bank : 25%
Non-Scheduled Com bank :15%
Scheduled UCB (Cooperative bank ) : 25%
Non-Scheduled UCB (Cooperative bank ) : 10%
Monetary Policy: 1. Quantitative Instruments
3.Statutory Liquidity Ratio (SLR)
• All Commercial Banks (Scheduled and non scheduled- i.e. public & private
sector, foreign banks,), Primary (Urban) Co-operative Banks (UCBs), State and
Central Cooperative Banks, Regional rural banks are required to maintain
some percentage of the total of their Net Demand and Time Liabilities as
liquid assets in the form of cash, gold and approved Govt. securities at the
close of business every day either with RBI or themselves

• This percentage is fixed by RBI and SLR should lies in between 0-40%.
• No bank is an exception to the SLR, which is maintained on daily basis.
• The date which is taken to calculate the demand and time liabilities of the
bank is the last Friday of the preceding fortnight.
• SLR ensures solvency of a bank .
• It regulates the credit growth in India
↑SLR→ ↑ RR →↓ER→↓CR → ↓MS

As of today 06/11/2019. SLR is 18.50%

Monetary Policy: 1. Quantitative Instruments
Basis for
CRR SLR
Comparison
CRR is the percentage of money which The bank has to keep a certain percentage
Meaning the bank has to keep with the Central of their Net Time and Demand Liabilities in
Bank of India in the form of cash. the form of liquid assets as specified by RBI.
All Commercial Banks (Scheduled and
All Commercial Banks (Scheduled and non
non scheduled, i.e. public & private
scheduled- (i.e. public & private sector, foreign
sector, foreign banks,), Primary (Urban)
Who banks,), Primary (Urban) Co-operative Banks
Co-operative Banks (UCBs), State and
(UCBs), State and Central Cooperative
Central Cooperative Banks, Regional
Banks, Regional rural banks
rural banks
Cash and other assets like gold and
Form Cash or deposit government securities viz. Central and State
government securities.
It helps in meeting out the unexpected
It controls excess money flow in the
Effect demand of any depositor by selling the
economy.
bonds.
Maintainence
Central Bank of India i.e. RBI. Bank itself or maybe with RBI
with
Regulates Liquidity in the economy. Credit growth in the economy.
Interest paid of Govt Securities
Interest No interest paid
Monetary Policy: 1. Quantitative Instruments
4. Open Market Operations
Sale and purchase of a variety of asset such as foreign exchange, gold,
govt securities by the central bank

a. Out right OMO

- The outright sale of any of the assets by the Central bank from its
own account leads to absorption of the liquidity and reduction in
money supply from the market forever by impounding the resources of
financial institutions in these securities
- The outright purchase implies Injections of the liquidity

BR-banks reserve, GS Govt Securities

b. Repo or reverse repo operation
It is a contract in which a participants acquires funds by selling the
securities , such as treasury bills, and simultaneously agrees to buy them
back or repurchase the same at a specified time and price/repo rate.
As of today 06/11/2019. Repo Rate is 5.15 and Reverse Repo is 4.90%
Monetary Policy: 2. Qualitative Instruments
Affects the types of credit extended by the banks affect the composition of
bank portfolio.
Monetary Policy: 2. Qualitative Instruments
Monetary Policy: Rates
Inflation vs interest rates since 2010

Repo CPI
Monetary Policy: Objective, Target and Instruments in India

Objective:
– Price Stability (P)
– Financial stability (F)
– Employment Growth (E)
– Real output Growth (Y)

Intermediate Target:
̶ Credit, money supply,
̶ Multiple target such as interest rate,
exchange rate, fiscal deficit, inflation rate etc.

Instruments:
̶ Pre independence: bank rate, OMO
̶ 1970s: CRR, SLR, OMO
̶ 1990s: Direct to indirect, repo, reverse repo
̶ 2000s: Emergence of LAF, MSS,MSF
 Monetary Policy: Evolution of Objective & Operating
Procedure in India Decade wise
Year MP Objectives Intermediate Instruments and steps
Target
1930- Regulates demand and Credit Aggregates Bank rate, Reserve Requirements, OMO
1950 supply of credit
1950s P stability with Growth Bank rate chief Instruments, Money & Credit
important for dev.
1960s Price Stability with Bank Rate, Priority sector lending , bank
Growth nationalization,
1970s Price Stability Monetary Targeting Increase in M0, Monetary expansion, CRR, SLR,
( M0, M1, M3 etc) OMO
1980s P stability, growth, Credit important, CRR, SLR is regulated, interest
employment: rate deregulated, Chakravarty Committee
Report (1985)-working of Monetary System
1990s P and Financial Stability, Shift from direct to Short term interest rate such as Bank rate, repo
(liberalization and Indirect Instruments rate, OMO, more flexibility in the operating
globalization policy, Multiple Indicator system
automatic monetization Approach, such as (Narasimham Committee Report on Banking
of fiscal deficit removed) interest rate, exchange Sector recommended LAF (1998) and MSS
2000s P and Financial Stability, rate, fiscal deficit,
inflation rate LAF, MSS: repo rate, reverse repo rate etc.
Growth
2010 P stability, growth and Thinking of Inflation LAF and MSF: repo rate, reverse repo rate , MSF
employment Targeting rate etc.
MP Operating Procedure: Liquidity Adjustment Facility (LAF)

Liquidity Adjustment Facility (LAF)

What is Liquidity ?

Central bank: Monetary base (C+R)

• LAF is a facility to inject and absorb liquidity on short term basis to even
out the mismatch between D & S in the short-term funds.

• Operates through repo rate, reverse repo rate which provide a corridor for
the call money rate and other short term interest rates, supported by
OMO.
• Repo: Injection of liquidity
• Reverse : Absorption of Liquidity.
• Collateralized borrowing and lending
(e.g.-T-Bills , etc)
• Call Money Rate- Short-tem funds
transfer between FIs-Inter bank rate
• No collateral
MP Operating Procedure: Liquidity Adjustment Facility (LAF)

LAF was introduced to

• Do away with the deficiencies of refinance system
• Multiplicity of the rates at which liquidity was made available
• The funds under LAF to be used by the banks for their day-to-day
mismatches in liquidity

Objective of LAF
i. Provision of adequate credit for growth and investment with
price stability
ii. Phasing out of non-bank financial intermediaries from call
market. (Aug 6,2005) and make call money market as pure
interbank market,
iii. Send policy signals and influence the interest rates in other
financial market
iv. Try to keep call money rate in between repo and reverse repo
rate.
 MP Operating Procedure: Liquidity Adjustment Facility (LAF)
Graph of Overnight Cash Rates
Ch a r t- 5 : M o ve m e n t o f C a ll M o n e y R a t e a n d L A F Co r r id o r

25.00

20.00
Ca ll Mo n e y Re v e r s e R e p o Re p o

15.00
Per cent

10.00

5.00

0.00
5-J un-0 2

5 -O ct-03
5-Jun-00

5-O ct-00

5-Jun-01

5-O ct-01

5-Jun-03

5-Jun-04

5-O ct-04

5-Jun-05
5-Oct-02

5-Oct-05
5-F eb-0 2

5-Feb -06
5-Feb-01

5-Feb-03

5-Feb-04

5-F eb-05
MP Operating Procedure: Liquidity Adjustment Facility (LAF)
Graph of Overnight Cash Rates
MP Operating Procedure: Liquidity Adjustment Facility (LAF)

Modus Operandi of LAF

• Tenor :Under the scheme, Reverse Repo auctions (for absorption ) and Repo
auctions (for injection ) are conducted on a daily basis (except Saturdays).
• Minimum bid Size : Rs. 5 cr and in multiple of Rs.5 cr
• Eligible securities: Repos and Reverse Repos in transferable Central Govt.
dated securities and treasury bills.
• Major Players
• Banks: All commercial banks (except RRBs) having substantial Treasury
Bills, Central/State Government securities approved by RBI
• Primary Dealers having current account and Security General Ledger
(SGL) account with RBI
• Discount and Finance House of India ( DFHI):Est in April 1988. It is an
authorized institution by RBI to undertake repo transactions ( both buying
and selling) in treasury bills and all eligible dated government securities to
impart greater liquidity to these instruments. Since November 13, 1995,
DFHI is an accredited primary dealer
MP Operating Procedure: Market Stabilization Scheme (MSS)

Market Stabilization Scheme (MSS)

• MOU signed between GOI and RBI on MSS on March 25, 2004

• MSS is Operational since April 1, 2004.

• Absorb excess liquidity in the market which might arises due to

heavy inflow of foreign capital (FII) through both Govt Treasury
Bills and dated Govt. Securities (Adhoc treasury bills) on daily
basis.

• Unlike OMO, under MSS the govt securities are not owned by
RBI. The GOI issue T Bills and or dated securities under the
MSS in addition to its normal borrowing to absorb liquidity from
the system.
• Sale of these securities are held under MSS account
 MP Operating Procedure: Marginal Standing Facility (MSF)

Marginal Standing Facility (MSF)

1. The weighted average overnight call money rate was explicitly recognized as the
operating target of MP. Repo rate was made the only one independently varying
policy rate.

2. A new Marginal Standing Facility ( MSF) was introduced since May 9, 2011,
under which scheduled commercial banks could borrow overnight at their discretion
up to 1% (2% (wef 17/4/2012))of their NDTL outstanding at the end of the second
preceding fortnight at 100 basis point above the repo. But for the intervening
holidays, the MSF facility will be for one day except on Fridays when the facility
will be for three days or more, maturing on the following working day. In the event,
the banks’ SLR holdings fall below the statutory requirement up to one per cent of
their NDTL, banks will not have the obligation to seek a specific waiver for default
in SLR compliance arising out of use of this facility .

3. The Facility will be available on all working days in Mumbai, excluding Saturdays
between 3.30 P.M. and 4.30 P.M.

As of today 06/11/2019. MSF Rate is 5.40%

 MP Operating Procedure: Marginal Standing Facility (MSF)

4. Revised corridor is fixed with 200 basis point at which lower corridor is reverse repo
and upper one is MSF rate and mid one is repo rate.
Monetary Policy: LAF and MSF
Monetary Policy: Difference Between LAF and MSF

LAF MSF
Liquidity adjustment facility Marginal standing facility
Minimum bidding amount is 5 cr. 1 cr.
Only scheduled commercial banks can
All clients of RBI are eligible to bid.
bid.

Bank cannot sell

Bank can sell the Government security
Government security to RBI that is
from its SLR quota to RBI.
part of bank’s SLR quota.

Bank can borrow any amount of

Bank can maximum borrow upto 2% of
money as long as it has the
its NDTL.
securities to sell.

Suppose repo rate is “r%” MSF lending rate is always (r+1)%

Monetary Policy and Economic Activity

Meaning: “the general conceptual framework within which the

analysis of monetary policy disturbance may be undertaken is
known as MPTM, whereas the routes through which this
disturbance influence goal variables (real economy) are its
channel”.

Types: money supply, interest rate, other assets price, credit

and uncertainty and expectations.
 1. Money Supply Money supply M  Y
Mechanism channel

. 2. Interest Rate Interest rate

channel i) M r I Y
Mechanism

3. Assets Price
Exchange rate M r E TI Y
Mechanism

Stock market
M   e  Pe  I  Y
channel
4. Credit Bank Lending M  bank depositsbank
Mechanism channel loans I Y
Balance sheet M  i net cash flowadverse
channel selection and moral hazard 
Lending I Y.
Monetary Policy and Economic Activity

Monetary Transmission Mechanism in India

Upto 1980s : both money supply and credit
Since 1989 :Interest rate
After 1990s : Financial sector Reforms
: multiple channel: interest rate channel,
exchange rate channel and other assets
price channel become prominent.

• Shifts in instruments from direct to indirect,

• Bank rate, CRR, SLR, OMO loosed efficiency
 References
• Handout Supplied to you
• Monetary Policy Chapter of Olivier
Blanchard text book
• Monetary policy section of Mankiw and
Taylor text book.
Thank You