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SPEEDY Railway Book (English)

Banking Notes: Monetary Policy



Monetary Policy is a macroeconomic policy laid down by the Central Bank. It refers to the use of instruments under control of the Central Bank to regulate the availability, cost and use of money and credit. It involves management of money supply and interest rate and is the demand side economic policy used by the Government of a country to achieve macroeconomic objectives like consumption, growth, inflation and liquidity.


To achieve specific economic objectives, such as low and stable inflation and promoting growth. Main objectives are

  •  Financial Stability
  •  Maintaining price stability
  • Ensuring adequate flow of credit to the productive sectors of the economy to support economic growth.
Direct Investments:

1.  Cash Reserve Ratio (CRR) - The share of net demand and time liabilities that banks must maintain as cash balance with the Reserve Bank.

2.  Statutory Liquidity Ratio (SLR) - SLR is a term used in the regulation of banking in India. It is the amount which bank has to maintain in the form of cash, gold or approved securities, balance in current account with other commercial bank.

Indirect Investments:

1. Liquidity Adjustment Facility (LAF) – Consists of daily infusion or absorption of liquidity on a repurchase basis, through Repo (Liquidity Injection) Reverse Repo (Liquidity Absorption) auction operation, using government securities as collateral.

2.  Repo/ Reverse Repo Rate- These rates under LAF determine the corridor for short-term money market interest rates. In turn, this is expected to trigger movement in other segments of the financial market and real economy.

3.  Open Market Operations (OMO) – Outright sales/purchase of government securities, in addition to LAF, as a tool to determined the level of liquidity over the medium term.

4.  Market Stabilization Scheme (MSS) – This instrument for monetary management was introduced in 2004. Liquidity of a more enduring nation arising from large capital flows is absorbed through sale of short-dated government securities and Treasury bill.

5.  Bank Rate – It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. It is also signals the medium-term stance of monetary policy.

6.  Base Rate- It is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the government, RBI rule stipulates that no bank can offer loans at a new lower than BR to any of its customers.


It is also called Capital to Risk (Weighted) Assets Ratio (CRAR), is a ratio of a bank’s capital to its risk. CAR is defined as
                       CAR= (Tier one capital+ Tier two capital) × 100
                                               Risk Weighted Assets

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