RBI MONETARY POLICY

Credit control:

Credit control is an important tool used by RBI, a major weapon of the monetary policy used to control the demand and supply of money(liquidity) in the economy

Need for credit control:

• To encourage the overall growth of the priority sector

• To keep a cheque over the channelization of credit

• To achieve the objective of controlling inflation as well as deflation

• To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors

• Stability in exchange rate and money market of the country

Methods of credit control

There are two types of methods of credit control

Credit control

Quantitative credit control

The quantitative credit control consists of

1. Cash reserve ratio (CRR)

2. Statutory liquidity ratio (SLR)

3. Bank rate

4. Repo rate

5. Reverse repo rate

6. Open market operations (OMO)

1.Cash reserve ratio (CRR)

• Cash reserve ratio is a specific minimum percentage of net demand and time liabilities, which every commercial bank has to keep certain minimum cash reserves with RBI

• In section 42 (1) of RBI act prescribe CRR for scheduled banks between 0% and 15% of total of their demand and time liabilities

• No interest on CRR balances maintained with RBI

• RBI uses this tool to increase our decrease the rivers requirement depending on weather it wants to affect a decrease or increase in the money supply

• If the RBI wants to increase the liquidity in the market it will decrease the cash reverse ratio and vice versa

• An increase in CRR will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with RBI. This will reduce the size of their deposits and they will land less. This will in turn decrease the money supply

2.Statutory liquidity ratio (SLR)

• SLR is the ratio of liquid assets which all commercial banks have to keep in the form of cash, gold and government securities of their total demand and time liabilities

• The maximum limit of SLR is 40% and minimum limit of SLR is 0%

• Apart from the CRR banks are required to maintain liquid assets in the form of gold cash and approved securities. It has anti inflationary impact

• Higher liquidity ratio diverse the bank funds from loans and advances to investment in government and approved securities

• SLR has three objectives

• To restrict expansion of banks credit

• To increase banks investment in approved government securities

• To ensure solvency of banks

Solvency refers to an organization's capacity to meet its long term financial commitments

3.Bank rate

• RBI lens to the commercial banks through its discount with draw to help the banks to meet depositors demand and reserve requirements for long term. The interest rate the RBI charges the bank for this purpose is called bank rate

• Bank rate is also called the rediscount rate. It is the rate, at which the RBI allows finance to commercial banks

• Bank rate is the standard rate at which the RBI is prepared to buy or rediscount bills from banks. It is the basic cost of Rediscounting and refinance facilities provided by the RBI

• Change in bank rate effects the interest rates on loans and deposits in the banking system

• This is used as a tool to keep in check inflation or deflation periodically

4.Repo rate

• Repo rate is rate at which RBI lends short term money to the banks against securities. Repo rate injects liquidity in the market

• Repo is a short form of repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing

5.Reverse repo rate

• Reverse repo rate is the rate at which banks park Short term access liquidity with the RBI

• An increase in the reverse repo rate means that the RBI is ready to accept money from the banks at higher interest. Reverse repo rate withdraw a liquidity from the market

• The reverse repo is the complete opposite of a repo. A dealer buys government securities from an investor and then sells them back at later date for a higher price

• The rivers repo rate will be kept basis points lower than the repo rate; on the other hand marginal standing facility rate will be kept higher than the repo rate

6.Open market operations

• Reserve Bank of India uses open market operations to buying and selling of eligible securities in the money market to influence the volume of loans and advances

• This technique become fairly popular after World war 2

• The objective of open market operations has been to contain inflation

• This refers to the sale or the purchase of government securities (of Central or state governments or both) by the RBI in the open market

Marginal standing facility (MSF)

• Marginal standing facility was introduced in the year 2011

• Marginal standing facility refers to the penal rate at which banks can borrow money from the central bank over and what is available to them through the liquidity adjustment facility

• Marginal standing facility being a penal rate is always fixed above the repo rate. The marginal standing facility would be the last resort for banks once they exhaust all borrowings options including the liquidity adjustment facility by pledging through government securities which has lower rate of interest in comparison with the marginal standing facility

• The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the interbank market and to enable smooth monetary transmission in the financial system

Liquidity adjustment facility (LAF)

• Liquidity adjustment facility is a monetary policy tool which allows banks to baromani through repurchase agreements

• Liquidity adjustment facility is used to aid banks in adjusting the day to day mismatches in liquidity. Liquidity adjustment facility consist of repo and reverse repo operations

• Liquidity adjustment facility has emerged as the principal operating instrument for modulating short term liquidity in the economy. Repo rate has become the key policy rate which signals the monetary policy stance of the economy

Qualitative credit control

The qualitative credit controls consists of following:

1. Marginal requirements

2. Consumer credit regulations

3. RBI guidelines

4. Rationing of credit

5. Moral suasion

• Marginal requirements-  this refers to difference between the securities offered and amount borrowed by banks

• Consumer credit regulations-  this refers to issuing a rules regarding down payments and maximum maturities of installment credit for purchase of goods

• Rationing of credit-  the RBI controls the credit granted allocated by commercial banks

• Moral suasion-  an application of pressure but not force to get members to adhere to a policy RBI gives advices and suggestions to the bankers to follow the instructions given by it

Marginal cost of funds based lending rate (MCLR)

• The Reserve Bank of India has introduced a new methodology of setting landing rate by commercial banks under the name of marginal cost of funds based lending rate (MCLR). It replaced the existing base rate system from April 2016

• As per the new guidelines by RBI banks have to prepare MCLR, which will be the internal benchmark lending rates

• Based upon MCLR interest rate for different types of customers should be fixed in accordance with their riskiness

• The MCLR should be revised monthly by considering including repo rate and other borrowing rates

• As per new guidelines banks have to set 5 benchmark rates for different time periods ranging from overnight (one day) rates to 1 year. It is mandatory for banks to consider the repo rate while calculating their MCLR

Following are the main components of MCLR

1. Marginal cost of funds

2. Negative carry on account of CRR

3. Operating cost

4. Tenor premium

Market stabilization scheme

• Market stabilization scheme was introduced in April 2004 where in Government of India dated security / treasury bills are Being issued to absorb and during surplus liquidity

• Market stabilization scheme 6 to strengthen RBI'S ability to conduct exchange rate and monetary management operations in a manner that would maintain stability in the foreign exchange market and enable it to conduct monetary policy in accordance with its stated objectives

• Treasury bills and dated securities up to a specified ceiling, mutually agreed upon between the government and the Reserve Bank by way of MoU, are issued under the market stabilization scheme.

• The bills and securities issued for market stabilization scheme or matched by an equivalent cash balance held by the government with the Reserve Bank

• Thus, there will only be a marginal impact on revenue and fiscal deficit of the government to the extent of interest payment on bills / securities outstanding under the market stabilization scheme

• The Government of India has authorised the Reserve Bank of India to issue debt instruments up to a ceiling of 50,000 crore under the market stabilization scheme for the fiscal 2015-16

Term repo

• RBI introduced term repo auction in 2013

• Objective: RBI conducting term repo auction to keep overnight rates close to the repo rate and facilitate banks to do more efficient liquidity management

• Term repo under the liquidity adjustment facility for 14 days and 7 days tenors introduced for banks in addition to the existing daily liquidity adjustment facility (repo and reverse repo) and marginal standing facility

• The total amount of liquidity injected through term report limited to 0.25% of NDTL of the banking system

• Banks required to place their bids with the term repo rate that they are willing to pay to RBI for the tenor of the repo expressed in percentage terms up to two decimal places

• No bids accepted at or below the prevailing repo rate under LAF