MONEY AND BANKING PART 08
INSTRUMENTS OF MONETARY POLICY Monetary policy instruments are of 2 different types. GENERAL OR QUANTITATIVE METHODS 2. SELECTIVE OR QUALITATIVE METHODS
QUANTITATIVE METHOD The quantitative method or general method are the instruments which aim at controlling the total volume of credit in an economy. It includes: Bank Rate Open market operations Variable cash reserve ratio Statutory liquidity ratio 2. 4
BANK RATE The bank rate is an important instrument to control the volume of currency in the economy. It is the rate at which the central bank of a country rediscounts bills and grants advances to the commercial bank against approved government securities It is "the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act It affects the availability and cost of credit. If it changes, the credit available to commercial banks also changes.
If the RBI, increases the bank rate, the volume of borrowings will fall by the commercial banks. This is because the credit has now become costlier. The increase in cost of credit along with a fall in demand for credit, proves to be an anti inflationary method. This is also called 'dear monetary policy If the RBI, decreases the bank rate, the volume of borrowings will increase implies that credit is available at a cheaper rate.. This boosts the credit creation in the economy and is anti deflationary. This is also called 'cheap monetary policy by the commercial banks. This
OPEN MARKET OPERATIONS Open market operation refers to the purchase and sell of securities by the central bank to the commercial banks. It leads to expansion or contraction of the money supply in the market. It influences the cash reserves held by the commerical banks and thus, controls the credit
If the central bank sells securities and the commercial bank purchases them, it would lead to a fall in the cash reserves of the latter. This would restrict it's credit creation opportunities. Thus, a fall in the total volume of credit in the economy. This is an anti inflationary method If the central bank purchases securities and the commercial bank sells them, it would increase the cash reserves of the former. The credit creation would increase. This is an anti deflationary method
VARIABLE CRR Every commercial bank has to keep a certain fixed percentage of deposits with the central bank, by law which is called the Cash Reserve Ratio or CRR. The central bank has the power to vary this CRR. It influences the cash reserves held by the commercial banks and thus, controls the credit. It is kept between 3% to 15% by the RBI.
If the central bank increases CRR, it means the commercial banks have to deposit a larger portion of their deposits with the central banks. This lead to a fall in the credit creation. If the central bank decreases the CRR, a smaller portion is to be deposited in the central bank. This leads to an increase in the credit creation.
VARIABLE SLR The proportion of aggregate deposits which the commercial banks are required to keep with themselves in a liquid form is called Statutory Liquidity Ratio or SLR. The commercial banks generally make use of this money to purchase the government securities. It is used to siphon off the excess liquidity of the banking system, and to mobilise revenue for the government. It is set between 25% to 40% by the RBI