I.P.

S ACADEMY
2019-20

Banking law and practice

TOPIC :- Monetary policy of rbi

Submitted to :- SUBMITTED BY:-

Mr. KSHITIJ KHARE ANUSHKA GHARPURE
B.COM (HONS.) 3RDYR.
 Definition

Monetary policy is concerned with the changes in the

supply of money and credit. It refers to the policy
measures undertaken by the government or the
central bank to influence the availability, cost and use
of money and credit with the help of monetary
techniques to achieve specific objectives. Monetary
policy aims at influencing the economic activity in the
economy mainly through two major variables, i.e., (a)
money or credit supply, and (b) the rate of interest.
In India, RBI controls the monetary policy. It is
announced twice a year, through which RBI regulate
the price stability of economy.
 Objectives of
monetary policy:

The goals of monetary policy refer to its objectives such as

reasonable price stability, high employment and faster rate of
economic growth. The targets of monetary policy refer to such
variables as the supply of bank credit, interest rate and the supply of
money.

1. Stabilising the Business Cycle:

Monetary policy has an important effect on both actual GDP and
potential GDP. Industrially advanced countries rely on monetary
policy to stabilise the economy by controlling business. But it
becomes impotent in deep recessions.
Keynes pointed out that monetary policy loses its effectiveness
during economic downturn for two reasons:
(i) The existence of liquidity trap situation (i.e., infinite elasticity of
demand for money) and
(ii) Low interest elasticity of (autonomous) investment.

2. Reasonable Price Stability:

Price stability is perhaps the most important goal which can be pursued
most effectively by using monetary policy. In a developing country like
India the acceleration of investment activity in the face of a fall in
agricultural output creates excessive pressure on prices. In such a
situation, monetary policy has much to contribute to short-run price
stability.

3. Faster Economic Growth:

Monetary policy can promote faster economic growth by making credit
cheaper and more readily available. Industry and agriculture require
two types of credit—short-term credit to meet working capital needs
and long-term credit to meet fixed capital needs.
Role of monetary policy
in developing countries

The monetary policy in a developing economy will have to be

quite different from that of a developed economy mainly due to
different economic conditions and requirements of the two types
of economies. A developed country may adopt full employment
or price stabilisation or exchange stability as a goal of the
monetary policy.

But in a developing or underdeveloped country, economic

growth is the primary and basic necessity. Thus, in a developing
economy the monetary policy should aim at promoting economic
growth.
Instruments / tools of
monetary policy

Instruments
/tools of
monetary
policy

Quantitative/ Qualitative /
Traditional Selective
Measures measures
 Quantitative
measures

Open
market Discount Cash
rate/Bank Reverse others
operations(
omo) rate Ration
1.Open Market Operations ( OMO)

• Open market operations refer to sale and purchase of securities in

the money market by the central bank of the country.

• When prices start rising and there is need to control them, the
central bank sells securities. The reserves of commercial banks are
reduced and they are not in a position to lend more to the business
community or general public.

• Further investment is discouraged and the rise in prices is checked.

Contrariwise, when recessionary forces start in the economy, the
central bank buys securities.

• The reserves of commercial banks are raised so they lend more to

business community and general public. It further raises Investment,
output, employment, income and demand in the economy hence the
fall in price is checked.
2) Discount Rate / Bank Rate (5.40%)

Bank rate is the minimum rate at which the central bank

provides loans to the commercial banks. It is also called the
discount rate.
or
Is the interest rate charged on borrowings ( Loans and
Advances) made by the commercial bank from the central
bank.
• Central Bank can change this rate – depending upon
Expansion or Contraction of credit flow.
• A fall in Bank Rate- Expansionary Monetary Policy
• A rise in Bank Rate – Contractionary Monetary Policy
 3) Cash Reserve Ratio (CRR) ( 4% )

All commercial banks are required to keep a certain amount of its

deposits in cash with RBI. This percentage is called the Cash Reserve
Ratio.

• To prevent shortage of cash

• To control Money supply
In Contractionary policy the bank raises the CRR
• In Expansionary policy bank reduces the CRR
• A hike in CRR will lead to high interest rate, credit rationing, huge
decline in investment and large reduction in National Income and
Employment

Other methods
1.) Statutory liquidity Ratio (19.5%)
2.) Reporate(6.25%)
3.) Reverse Repo Rate (4.90%)
Qualitative measures

Qualitative
measures
Change in Direct
Credit landing
Moral
rationing margin suasion control
 1.) credit rationing
• Shortage of funds, priority and weaker industries get
starved of necessary funds.
• Central Bank does credit rationing
• Imposition of upper limits on the credit available to
large industries.
• Charging higher interest rate on bank loans beyond a
limit
2.) Change in Lending
Generally, commercial banks give loan against
‘stocks or ‘securities’. While giving loans against
stocks or securities they keep margin. Margin is the
difference between the market value of a security
and its maximum loan value. Let us assume, a
commercial bank grants a loan of Rs. 8000 against
a security worth Rs. 10,000. Here, margin is Rs.
If central bank feels that prices of some goods are rising
due to the speculative activities of businessmen and traders
of such goods, it wants to discourage the flow of credit to
such speculative activities. Therefore, it increases the
margin requirement in case of borrowing for speculative
business and thereby discourages borrowing. This leads to
reduction is money supply

3) Moral Suasion
To arrest inflationary situation central bank pursuades and
request the commercial banks to refrain from giving loans for
speculative and non-essential purposes. On the other hand, to
counteract deflation central bank pursuades the commercial
banks to extend credit for different purposes.
Central bank also appeals commercial banks to extend their
wholehearted co-operation to achieve the objectives of monetary
policy. Being the monetary authority directions of the central bank
are usually followed by commercial banks.
 3.) direct control
• Where all the methods become ineffective
• Central bank gives clear directives to banks to carry out
their lending activity in a specified manner.
This method is adopted when a commercial bank does
not co-operate the central bank in achieving its desirable
objectives.
• Central banks may charge a penal rate of interest over
and above the bank rate upon the defaulting banks
• Central bank may refuse to rediscount the bills of
those banks which are not following its directives;
• Central bank may refuse to grant further
accommodation to those banks whose borrowings are
in excess of their capital and reserves.
 Monetary policy to control
recession
Monetary Policy to Control Recession Problem:
Inflation Measures:
1) Central Banks sells securities through OMO
2) Increases Bank Rate
3) Raises CRR

Money Supply Increases

Interest Rate falls

Investment increases

Aggregate Demand increases

Price Level increases

Monetary policy to control inflation
problem
Monetary Policy to Control Inflation Problem:
Measures:
1) Central Banks sells securities through OMO
2) Increases Bank Rate
3) Raises CRR

Money Supply Decreases

Interest Rate Rises

Investment Declines

Aggregate Demand Declines

Price Level Falls

The various instruments of monetary policy include variations in
bank rates, other interest rates, selective credit controls, supply
of currency, variations in reserve requirements and open market
operations.

INDICATOR CURENT RATE

CRR 4%
SLR 18.50%
REPO RATE 5.15%
REVERSE REPO RATE 4.90%
MARGINAL STANDING 5.40%
FACILITY RATE
BANK RATE 5.40%
THANKYOU!!