Question

What are the instruments of monetary policy of RBI?

What are other instruments of monetary policy?

Answer 1

The monetary policy (credit policy) of RBI involves the two instruments given in the flowchart below:

1. Quantitative Measures: Quantitative measures refer to those measures that affect the variables, which in turn affect the overall money supply in the economy.
   Instruments of quantitative measures:
   1.  Bank rate: The rate at which a central bank provides loans to commercial banks is called the bank rate. This instrument is a key in the hands of RBI to control the money supply.
      An increase in the bank rate will make the loans more expensive for the commercial banks, thereby pressurizing the banks to increase the rate of lending. The public capacity to take credit will gradually fall, leading to the fall in the volume of credit demanded. The reverse happens in the case of a decrease in the bank rate. The increased lending capacity of banks as well as increased public demand for credit will automatically lead to a rise in the volume of credit.
   2. Varying reserve ratios: The reserve ratio determines the reserve requirements, wherein banks are liable to maintain reserves with the central bank. The three main ratios are:
      1. Cash Reserve Ratio (CRR): It refers to the minimum amount of funds that a commercial bank has to maintain with the Reserve Bank of India in the form of deposits. For example, suppose the total assets of a bank are worth Rs.200 crores and the minimum cash reserve ratio is 10%. Then the amount that the commercial bank has to maintain with RBI is Rs.20 crores. If this ratio rises to 20%, then the reserve with RBI increases to Rs. 40 crores. Thus, less money will be left with the commercial bank for lending. This will eventually lead to a considerable decrease in the money supply. On the contrary, a fall in CRR will lead to an increase in the money supply.
      2. Statutory Liquidity Ratio (SLR): SLR is concerned with maintaining the minimum reserve of assets with RBI, whereas the cash reserve ratio is concerned with maintaining cash balance (reserve) with RBI. So, SLR is defined as the minimum percentage of assets to be maintained in the form of either fixed or liquid assets with RBI. The flow of credit is reduced by increasing this liquidity ratio and vice versa. In the previous example, this can be understood as a rise in SLR that will restrict the banks from pumping money into the economy, thereby contributing towards a decrease in money supply. The reverse case happens if there is a fall in SLR, as it increases the money supply in the economy.
   3. Open Market Operations (OMO): Open market operations refer to the buying and selling of securities in an open market in order to affect the money supply in the economy. The selling of securities by RBI will wipe out the extra cash balance from the economy, thereby limiting the money supply, whereas in the case of buying securities by RBI, additional money is pumped into the economy, stimulating the money supply.
2. Qualitative Measures
   The measures that affect the credit qualitatively are
   1. Marginal Requirements: The commercial banks’ function to grant loans rests upon the value of security being mortgaged. So, the banks keep a margin, which is the difference between the market value of security and the loan value. For example, a commercial bank grants a loan of Rs. Rs.80,000 against security of Rs. 100,000. So, the margin is calculated as 100,000 − 80,000 = 20,000. When the central bank decides to restrict the flow of money, then the margin requirement of loans is raised and vice versa in the case of expansionary credit policy.
   2. Selective Credit Control (SCC): An instrument of the monetary policy that affects the flow of credit to particular sectors positively and negatively is known as selective credit control. The positive aspect is concerned with the increased flow of credit to the priority sectors. However, the negative aspect is concerned with the measures to restrict credit to a particular sector.
   3. Moral Suasion: A persuasion technique followed by the central bank to pressurize the commercial banks to abide by the monetary policy is termed asmoral suasion. This involves meetings, seminars, speeches and discussions, which explain the present economic scenario and thereby persuade the commercial banks to adapt to the changes needed. In other words, this is an unofficial monetary policy that exercises the power of talk.

Answer 2

Bank rate, open market operations and selective credit control instruments.