Instruments of Monetary Policy used by the RBI
Direct regulation:
For example, if the RBI reduces the CRR from 5% to 4%, it means that commercial banks will now have to keep a lesser proportion of their total deposits with the RBI making more money available for business. Similarly, if RBI decides to increase the CRR, the amount available with the banks goes down.
Indirect regulation:
The RBI issues annual and quarterly policy review statements to control the availability and the supply of money in the economy. The Repo Rate has traditionally been the key instrument of monetary policy used by the RBI to fight inflation and to stimulate growth.
Direct regulation:
Cash Reserve Ratio (CRR):
Commercial Banks are required to hold a certain proportion of their deposits in the form of cash with RBI. CRR is the minimum amount of cash that commercial banks have to keep with the RBI at any given point in time. RBI uses CRR either to drain excess liquidity from the economy or to release additional funds needed for the growth of the economy.For example, if the RBI reduces the CRR from 5% to 4%, it means that commercial banks will now have to keep a lesser proportion of their total deposits with the RBI making more money available for business. Similarly, if RBI decides to increase the CRR, the amount available with the banks goes down.
Statutory Liquidity Ratio (SLR):
SLR is the amount that commercial banks are required to maintain in the form of gold or government approved securities before providing credit to the customers. SLR is stated in terms of a percentage of total deposits available with a commercial bank and is determined and maintained by the RBI in order to control the expansion of bank credit. For example, currently, commercial banks have to keep gold or government approved securities of a value equal to 23% of their total deposits.Indirect regulation:
Repo Rate:
The rate at which the RBI is willing to lend to commercial banks is called Repo Rate. Whenever commercial banks have any shortage of funds they can borrow from the RBI, against securities. If the RBI increases the Repo Rate, it makes borrowing expensive for commercial banks and vice versa. As a tool to control inflation, RBI increases the Repo Rate, making it more expensive for the banks to borrow from the RBI with a view to restrict the availability of money. The RBI will do the exact opposite in a deflationary environment when it wants to encourage growth.Reverse Repo Rate:
The rate at which the RBI is willing to borrow from the commercial banks is called reverse repo rate. If the RBI increases the reverse repo rate, it means that the RBI is willing to offer lucrative interest rate to commercial banks to park their money with the RBI. This results in a reduction in the amount of money available for the bank’s customers as banks prefer to park their money with the RBI as it involves higher safety. This naturally leads to a higher rate of interest which the banks will demand from their customers for lending money to them.The RBI issues annual and quarterly policy review statements to control the availability and the supply of money in the economy. The Repo Rate has traditionally been the key instrument of monetary policy used by the RBI to fight inflation and to stimulate growth.
