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SPEEDY Railway Book (English)

Monetary Policy of RBI - Explained in Easy Language

Monetary Policy of RBI - Explained in Easy Language
Monetary Policy of RBI - Explained in Easy Language

  • The Monetary Policy means the Policy of the Reserve Bank of India (RBI) which it introduces to administer and control the money supply of the country including currency, demand deposits and foreign Exchange rates.
  • It is a policy which influences the public’s Stock of money substitutes or the public demands for such assets or both of these that influences Public Liquidity position.
  • Reserve Bank of India (RBI) controls the supply of money in the economy by controlling the interest rate to maintain stability in prices and achieve higher economic growth.
Objective of the Monetary Policy-
  • To maintain stability of the exchange rates and price.
  • Full Employment
  • Neutrality of Money
  • High rate of economic growth
  • Encourage savings and capital formation.
Limitation of the Monetary Policy-
  • Underdeveloped capital and money market.
  • No integrated rate of the interest structure.
  • Illiteracy and social obstacles.
  • Lack of Co-operation among the Banks.
  • Existence of Black Money
  • Government Policies.

Measurement of Monetary Policies-
The Monetary Policy can be implemented by two instruments of Credit Control i.e. Quantitative Measures and Qualitative Measures.
Quantitative Measures-
Bank Rate-
  • It is the minimum rate charged by the bank to discount approved bills of exchange.
  • The Central Bank rediscounts approved bills or lend money to the Commercial Banks and other Financial Institutions charging a certain interest rate without any security. This interest rate is known as bank rate.
  • If the bank rate increases, the interest rate of Commercial banks also increases. That leads to negative effect on demand and price increases.
Open Market Operation-
  • It is defined as the purchase and sale of the Government and various suitable securities by the Central Bank in order to control the flow of credit.
  • The purpose of the Open Market Operation is to contract or expand the supply of Bank-Reserves and provide a suitable market for Government securities.
  • Purchasing of Securities indicates more money in the economy and high rate of growth.
  • Selling of Securities indicates less money in the economy and low rate of growth.
Change in CRR (Cash Reserve Ratio)-
  • Cash Reserve Ratio refers to the proportion of total deposits which a Commercial Bank has to keep with Central Bank in the form of Cash Reserves.
  • If the CRR is increased, there would be less money in the Commercial Banks. It leads to less demand of goods and services and hence lower price. CRR is increased to control Inflation.
  • If the CRR is decreased, there would be more money in the Commercial Banks. It leads to more demand of goods and services and hence higher price.
Change in SLR (Statutory Liquidity Ratio)-
  • It refers to the portion of total deposits which a Commercial Bank must keep with itself as cash reserves.
  • If SLR is increased the Commercial Banks have to keep more liquid funds which prevent the banks to provide more loans to the people. Hence the demand of goods must be less and price would be low.
  • If SLR is decreased, the prices must be high.
Repo Rate and Reserve Repo Rate-
  • Repo Rate is the rate at which RBI gives loan to Commercial Banks and the Banks lends money to RBI at Reverse Repo Rate.
Marginal Standing Funding (MSF)-
  • By this MSF, the Commercial Banks get loan from RBI at emergency purpose.
  • The Commercial Banks can get loan up to 1% of the liabilities.
Qualitative Tools-
  • Moral Suasion- It involves the advices, persuasion and regulation by the Central Bank (RBI) to Commercial Banks for cooperating with it in implementing the credit policy. The RBI may use the moral influence on the banks and acts as the supplement to the other methods of credit control.
  • Loan to Value Ratio (LTV)- It is used by Commercial banks to provide the ratio of the first mortgage line as the percentage of the complete appraised value of a real property.
  • Fixation of Margin Requirement- The margin is the difference between loan value and market value. The RBI fixes the margin rate to control the credit. If margin rate is 40%, then the Commercial Bank can lend money up to 60% of the market value of securities.
  • Credit Rationing- It means the RBI fixes a limit upon its re-discounting facilities for the banks.
  • Regulation of Consumer Credit- Under this method, The RBI curtails or extends the limit to which the commercial banks can provide credit/ finance facility to the consumers or durable goods.
  • Publicity- Under this method, RBI provides the publicity about the good and bad in the credit system of the country.
  • Direct Action- RBI issues general instruction to the Commercial Banks and take action against the banks who do not confirm the credit policy directed by RBI.
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