Central Bank of India, i.e., Reserve Bank of India (“RBI”) is responsible for forming Monetary Policies. Under Monetary policies, RBI uses various tools to control supply of money in the market so that inflation can remain in control and for the purpose of sustainable Economic Development also.
Therefore, RBI controlling inflationary trends in the economy not only boost economic growth but also ultimately leads to increase in real national income stability.
1. Objectives of Monetary Policy
The main objectives of Monetary Policy are:
- To maintain price stability.
- To ensure adequate flow of credit to productive sectors so as to assist growth.
- Arrangement of full employment.
- Expansion of credit facility
- Equality & Justice Stability in exchange rate.
- Promotion of Fixed Deposit.
- Equitable distribution of Credit.
2. New RBI Monetary Policy, 2020
2.1 In new Monetary policy, 2020 announced on 4th December, 2020, RBI has decided on following points:
- Repo rate under the liquidity adjustment facility (LAF) shall remain unchanged at 4%.
- Reverse Repo rate under the Liquidity Adjustment Facility (LAF) shall remain unchanged at 3.35%.
- Marginal Standing Rate (MSF) and Bank Rate will be 4.25%.
- These rates are decided for the purpose of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2 %, while supporting growth.
- For the purpose of promoting digital payments, RTGS (Real Time Gorss Settlement) facility was made available round the clock from 14th December, 2020.
- RBI proposed to reduce settlement and default risk in the system by facilitating settlement of AePS, IMPS, NETC, NFS, RuPay, UPI transactions on all days of the week.
2.2 Other changes by RBI in New RBI Monetary Policy, 2020
Apart from new monetary policy, RBI has made various other changes to make electronic Banking channel more secure such as:
- To reduce cases related to banking fraud, the Reserve Bank of India has implemented new rules related to Debit and Credit Card with effect from 01.10.2020. Following are the synopsis of such changes:
- All credit cards and debit cards issued going forward will only be enabled for use within India. However, customers can then request the banks to activate that facility on the card.
- Those who already own debit and credit cards will have three options to choose from:
- Disable the card, not present transactions (domestic and international)
- Disable card, present transactions (only international)
- Contactless transaction rights
- If you happen to own a debit or credit card that you haven’t once used, it will likely be disabled soon. All card issuing companies have been asked to disable online payments for such cards by the RBI.
- Customers will have more options to customize their card usages like setting a spending limit, opt-in or opt-out services, and contactless transactions.
- Users will have around the clock access to change their preferences at any time through any mode of access — mobile app, internet banking, ATMs and interactive voice response (IVR).
3. Tools of the monetary policy
Under Monetary policy, RBI uses following tools:
3.1 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. CRR is computed as a % of total deposits of the bank.
- This reserve is maintained so that if any liquidity crunches arise in bank, then RBI can use such an amount.
- RBI uses CRR either to drain excess liquidity from the economy or to release additional funds needed for the growth of the economy. Therefore, an increase in CRR means less funds available with Banks and reduced flow of funds in market.
- The RBI has the authority to set the cash reserve ratio between 3% and 15%.
3.2 Statutory Liquidity Ratio (SLR):
- SLR is the amount that commercial banks are required to maintain in the form of liquid assets such as cash, 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.
- SLR is required to be maintained in addition to the Cash Reserve Ratio.
- Therefore, if RBI wants to reduce flow of funds in market, it increase SLR.
3.3 Bank Rate
- It is a rate at which RBI lends loans to commercial banks. Therefore, whenever banks fall short of funds they approach commercial banks for providing funds.
- Bank rate is a tool which RBI uses for maintaining money supply.
- Any revision in bank rate by RBI is a signal to banks to revise deposit rates as well as prime lending rate (PLR is the rate at which banks lend to the bank customers).
- If RBI increases Bank rate then Bank in turn increases Prime Lending Rate and accordingly, demand of funds decreases in the market.
3.4 Repo Rate
- The rate at which the RBI is willing to lend loans to commercial banks is called Repo Rate. However, in case of Repo rate, loan is provided against collateral of securities issued by RBI.
- Whenever commercial banks have any shortage of funds they can borrow from the RBI, against securities.
- Therefore, Bank rate caters long term financial requirement of banks, whereas, repo rates are used for short term financial needs.
- 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.
3.5 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.
3.6 Marginal Standing Facility (MSF)
- MSF is a very short term borrowing scheme for scheduled commercial banks.
- Banks may borrow funds through MSF during severe cash shortage or acute shortage of liquidity.
- Banks often face liquidity shortfalls due to mismatch in their deposit and loan portfolios.
- These are usually very short term and banks can borrow from RBI for one day period by offering dated government securities.
- MSF had been introduced by RBI to reduce volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system.
3.7 Base Rate
- Base Rate is the interest rate below which Scheduled Commercial Banks (SCBs) will lend no loans to its customers—its means it is like prime lending rate (PLR) and the benchmark prime lending Rate (BPLR) of the past and is basically a floor rate of interest.
- Base rate is decided by the Central Bank and commercial banks are not allowed to lend funds at any interest rate less than Base Rate.
3.8 Call Money Market
- The call money market is an important segment of the money market where borrowing and lending of funds take place on overnight basis.
- Participants in the call money market in India currently include scheduled commercial banks (SCBs)—excluding regional rural banks), cooperative banks (other than land development banks), insurance.
- Prudential limits, in respect of both outstanding borrowing and lending transactions in the call money market for each of these entities, are specified by the RBI. Current Rate: 4.90 % – 6.10%
3.9 Open Market Operations (OMOs)
- OMOs are conducted by the RBI via the sale/purchase of government securities (G-Sec) to/from the market with the primary aim of modulating rupee liquidity conditions in the market.
- OMOs are an effective quantitative policy tool in the armory of the RBI, but are constrained by the stock of government securities available with it at a point in time.
- The mobilized cash is held in a separate government account with the Reserve Bank.