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MONETARY AND CREDIT POLICY
What is Monetary Policy l Also known as RBI's money management policy. Related to the demand and supply of money economy? How much should be the viability of money? I How much should be supply of money in the I How much should be ratio of interest?
Definition *Monetary policy is the process of managing a nation's money supply to achieve specific goals- such as constraining inflation, achieving full employment etc The use by the central bank of interest rate and other instruments to influence money supply to achieve certain macroeconomic goals is known as monetary policy. Credit policy is a part of Monetary policy as it deals with how much and at what rate credit is advanced by the bank
Objectives *Rapid Economic growth *Price stability *Exchange rate stability Balance of payment (BOP) equilibrium eFull employment *Neutrality of Money .Egual income distribution
Instruments of Monetary Polic Quanti ative Measures: Repo rate Reserve repo rate Marginal Standing facility (MSF rate) Bank Rate Cash Reserve ratio (CRR) Statutory liquidity ratio (SLR) Open market operations (OMO) e Marginal cost of funds based lending rate (MCLR)
Repo rate Repo rate (rate of purchase) refers to the interest rate at which the RBI provides short-term liquidity to banks against the collateral of government securities.
Reserve repo rate Reverse repo rate refers to the rate at which RBI absorbs Iiquidity from banks against the collateral of government securities.
Marginal Standing facility (MSF rate) MSF refers to the facility under which banks can borrow additional amount from RBI up to a limit at a penal rate of interest. It is called "penal rate"
Bank Rate Bank rate refers to the rate at which RBI provides long-term borrowings to its clients
Cash Reserve ratio (CRR) CRR refers to the percentage of total deposits of a bank to be kept with RBI in the form of cash
Statutory liquidity ratio (SLR) SLR refers to the percentage of total deposits of a bank to be kept with itself in the form of liquid asset such as cash, gold and select government securities.
Open market operations (OMO) OMO refers to sale and purchase of government securities by RBI in the open market with the aim of influencing liquidity in the economy.
Instruments of Monetary Policy, Quantitative Measures: Margin requirements *Consumer credit regulation Guidelines Rationing of credit Moral suasiorn Moral suas Direct Actiorn
Guidelines RBI issues oral, written statements, appeals, guidelines and warnings to the bank.
Moral suasiorn Psychological means and informal means of selective credit control.
Direct Action This step is taken by the RBI against banks that don't fulfill conditions and requirements
Monetary policy transmission (MCLR) Marginal cost of funds based Lending (MCLR) system introduced in 2016 for improving the monetary transmission It is a system which is closely based on market rates, allowing quicker transmission of monetary policy
MCLR eMCLR is a internal benchmark lending rates. Based upon this MCLR, interest rate for different type of customers should be fixed in accordance with their riskiness. eMCLR should be revised monthly by considering some new factors including the repo rate and other borrowing rates. As per the new guidelines, bank have to set 5 benchmark rates for different tenure ranging from overnight rates to one year. The interest rate given by a bank for deposits and the rep<o rate are the decisive factors in the calculation of MCLR
Components of MCLR *Marginal cost of FUNDS: Marginal cost that is the novel element of MCLR. The marginal cost of funds will comprise of marginal cost of borrowings and return on net worth. According to the RBI, the marginal cost should be charged on the basis of following factors: o Interest rate given for various types of deposits- savings, current, term deposit, foreign currency deposit o Borrowing- Short term interest rate or the repo rate etc, long term rupee borrowing rate. o Return on net-worth: in accordance with capital adequacy norms.
How MCLR is different from Base rate It is very clear that the CRR costs and operating expenses are the common factors for both base rate and the MCLR The factor minimum rate of return is explicitly excluded under MCLR *Most important difference is the careful calculation of marginal cost under MCLR. On the other hand under base rate, The cost is calculated on an average basis by simply averaging the interest rate incurred for deposits. The requirement that MCLR should be revised monthly makes the MCLR very dynamic compared to the base rate
Monetary Policy Development since 1991 Since 1991 RBI's Monetary management has undergone some major changes let us explain: 1. Multiple Indicator Approach 2. Selective Methods being phased out 3. Reduction in reserve requirements 4. Deregulation of administered interest rate system 5. Delinking of Monetary policy from budget deficit
Monetary Policy Development since 1991 6. Liquidity adjustment facility (LAF) 7. Provision of microfinance 8. External Sector 9. Expectation as a Channel of Monetary Transmission 10. Marginal Standing facility (MSF)
Difference between LAF & MSF Liquidity Adjustment Facility (LAF) Marginal Standing Facility (MSF) Minimum bidding amount is 5 cr.Minimum bidding amount is 1cr. All clients of RBI are eligible to bid Only scheduled commercial banks can bid Bank can not sell government security to RBI that is part of Bank's SLR quota. Bank can sell the government security from its SLR quota to RBI Bank can borrow any amount of money as long as it has the securities to sell Bank can maximum borrow upto 2% of its NDTL Suppose repo rate is ,r%, MSF lending rate is always (r plus 1)90
MPA The obiective of monetary policy framework is to primarily main price stability, while keeping in mind the objective of growth. The central bank will be deemed to have missed its target if consumer inflation is at more than 6% or at less than 2% for three consecutive quarters starting in the 2015-16 fiscal year. If the central bank misses the inflation target, it will send a report to the government citing reasons and remedial actions Central Bank will also need to give an estimated time period within which it expects to return to the target level
Monetary Policy Committee (MPC) MPC is the body of RBI, headed by the Governor, responsible for taking the important Monetary policy decision about setting the repo rate MPC replaces the previous arrangement of Technical advisory committee First meeting of MPC was held on October 4, 2016 after the government made the amendment of the RBI act in June 27, 2016
Limitations of Monetary Policy Some of the important limitations of monetary policy: There exist a non-monetized sector Excess Non-Banking Financial Institutions (NBFI) Existence of Unorganized financial markets - Higher liquidity hinders monetary Policy Money Not appearing in an economy Time lag affects success of Monetary Policy V Monetary and fiscal policy lacks coordination Lack of control on inflation.
Reserve Bank of India (RBI)
Central Bank Acco to Samuelson "It's a Bank of Banker'" *Acco to Sayers "Central bank is the Government's Bank" Acco to Vera Smith " Bank which has monopoly over the note issue"
Brief History Since nationalization in 1949, the RBI is fullv owned by GOI Its first governor was Sir oOsborne a. Smith (1st april 1935- 30th June 1949) *The first Indian governor was "Sir hintamanD Deshmukh" (11th August 1943 to 30th June 1949) On 27th june 2006, the Union Governor of India reconstituted the central board of directors of RBI with 13 members, including Azim Premji and Kumar Mangalam Birla.
Regulator and Supervisor of the Financial System * Prescribes broad parameters of banking operations with which the country's banking and financial system functions * Objective: maintain public confidence in the system, protect depositors interest and provide cost effective banking services to the public
Issuer of Currencv * Issues and exchange or destroys currency and coins not fit for circulation * Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality
bjectives and reasons for establishment of RB]I To maintain monetary and credit system of the country To stabilize internal and external value of rupee eFor balanced and systematic development of banking in the countrv *For the development of organized money market in the country eFor proper arrangement of agriculture finance For proper arrangement of industrial finance eFor proper management of public debt To establish monetary relation with other countries of the world and international financial institutions For centralization of cash reserves of commercial banks eTo maintain balance between demand and supply of currency
Conclusion Central Bank plays important role in achieving economic growth of a developing country. It promotes economic growth with stability * It helps in attaining full employment balance of payment disequilibrium and in stabilizing exchange rates. RBI has an autonomous body promoted by the GOI and is headquartered at Mumbai RBI IS the primary regulator for banking and non- banking financial institutions. The RBI operates number of government mints that produce currency and coins