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Monetary policy

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i)the supply of money, (ii) availability of money, (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals).

The Reserve Bank of India (RBI, )


The Reserve Bank of India is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion (2010) of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. Reserve Bank of India plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Reserve Bank of India was nationalized in the year 1949.

Repo rate

Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

Reverse Repo rate

Reverse Repo rate is the rate which is paid by RBI to banks on Deposit of funds with RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. To borrow from RBI bank have to submit liquid bonds / Govt. Bonds as collateral security ,so this facility is a short term gap filling facility and bank does not use this facility to Lend more to their customers.

Bank Rate

The rate at which a central bank is prepared to lend money to its domestic banking system. Current bank rate 6.0%

Prime rate

prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case. Some variable interest rates may be expressed as a percentage above or below prime rate.

CRR(Cash Reserve Ratio)


Cash reserve Ratio (CRR) is the amount of Cash(liquid cash like gold) that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks. If RBI decides to increase the percent of this, the available amount with the banks comes down and if RBI reduce the CRR then available amount with Banks increased and they are able to lend more. Current CRR is 6.0%

Statutory Liquidity Ratio

SLR is the amount of liquid assets, such as cash, or gold or govt. approved securities (Bonds), that a financial institution must maintain as reserves other than the Cash with the Central Bank. The statutory liquidity ratio is a term most commonly used in India. The objectives of SLR are: To restrict the expansion of bank credit. To augment the investment of the banks in Government securities. To ensure solvency of banks. A reduction of SLR rates looks eminent to support the credit growth in India.

Difference between SLR & CRR


SLR restricts the banks leverage in pumping more money into the economy. On the other hand, CRR, or Cash Reserve Ratio, is the portion of deposits that the banks have to maintain with the Central Bank. The other difference is that to meet SLR, banks can use cash, gold or approved securities whereas with CRR it has to be only cash. CRR is maintained in cash form with central bank, whereas SLR is maintained in liquid form with banks themselves.

Difference between bank rate and repo rate


Whenever the banks have any shortage of funds they can borrow it from the central bank. Repo rate is the rate at which banks borrow currency from the central bank. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from the central bank becomes more expensive. It is more applicable when there is a liquidity crunch in the market. The reverse repo rate is the rate at which the banks park surplus funds with reserve bank, while the repo rate is the rate at which the banks borrow from the central bank. It is mostly done when there is surplus liquidity in the market.

Current Monetary Scenario

time in 18 months period, extending the longest streak of monetary tightening in decade. RBI raised the repo rate by 25 basis point, to 8.25 percent and reverse repo rate was revise to 7.25. RBI raised repo and reverse repo to contain inflation and anchor inflationary expectation by curbing demand side pressure. RBI governor D. Subbarao made it clear that the Central Bank is in no mood to stop the journey of raising its key rates taking the note of high inflationary pressure in the economy, and willing to risk a short-run slowdown in growth to curb price pressure in economy.

RBI raised repo and reverse repo rate for 12th

The rates hike measures could lead to increase in funding of costs for banks and in lending rates. most banks are looking to increase their lending rates to ease pressure on their margins, which have been squeezed because of a series of policy rate rises in the past 18 months.

Rates Rises in 2010-11


Date Reverse Repo (in %) 3.75 4 4.5 5 5.25 5.25 5.5 5.75 6.25 6.5 7 7.25 Change ( basis point) 25 25 50 50 25 0 25 25 50 25 50 25 Repo (in %) 5.25 5.5 5.75 6 6.25 6.25 6.5 6.75 7.25 7.5 8 8.25 Chang e 25 25 25 25 25 0 25 25 50 25 50 25

April 20, 2010 July 2, 2010 July 27, 2010 September 16, 2010 November 2, 2010 December 16,2010 January 25, 2011 March 17, 2011 May 3, 2011 June 16,2011 July 29, 2011 September 2011

Latest Key Rates of RBI ( as on September 2011)


Bank Rate Cash Reserve Ratio Statutory Liquid Ratio Repo Rate Reverse Repo Rate Source RBI 6.0% ( w. e. f. April 30, 2003) 6.0% ( w. e. f. April 24, 2010) 24% ( w. e. f. December 18,2010) 8.25 ( w. e. f. September 2011) 7.25 ( w. e. f. September 2011)