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 Monetary Policy

• Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments
under its control to achieve the goals specified in the Act.
• RBI is vested with the responsibility of conducting monetary policy under the Reserve Bank of India Act,
1934.
• The primary objective of monetary policy is to maintain price stability while keeping in mind the
objective of growth. Price stability is a necessary precondition to sustainable growth.
• The amended RBI Act also provides for the inflation target to be set by the Government of India, in
consultation with the Reserve Bank, once in every five years.
• Accordingly, the Central Government has notified 4 % Consumer Price Index (CPI) inflation as the
target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per
cent and the lower tolerance limit of 2 per cent.
• The Central Government notified the following as factors that constitute failure to achieve the inflation
target:
(a) the average inflation is more than the upper tolerance level of the inflation target for any three
consecutive quarters; or
(b) the average inflation is less than the lower tolerance level for any three consecutive quarters.

Monetary Policy Committee

Section 45ZB of the amended RBI Act, 1934 also provides for six-member monetary policy committee
(MPC) to be constituted by the CG. The members of the committee are:
1. Governor (RBI) – Chairperson, ex officio;
2. Deputy Governor (RBI), in charge of Monetary Policy – Member, ex officio;
3. Officer of RBI to be nominated by the Central Board (1) – Member, ex officio;
4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
5. Professor Pami Dua, Director, Delhi School of Economics – Member; and
6. Dr. Ravindra H. Dholakia, Professor, IIM – Member.
(Members at 4 to 6 above, will hold office for a period of four years).
• The MPC is required to meet at least four times in a year.
• The quorum for the meeting of the MPC is four members.
• Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a
second or casting vote.
• On the 14th day, the minutes of the proceedings of the MPC are to be published which will include
details of the resolution adopted; the vote of each member on the resolution.
• Once in every six months, RBI will publish Monetary Policy Report to explain: the sources of inflation;
and the forecast of inflation for 6-18 months ahead.
• The MPC determines the policy interest rate required to achieve the inflation target.

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Cash Reserve Ratio

• The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such
per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to
time in the Gazette of India.
• At present CRR is 4%.

Incremental CRR
• SCBs are required to maintain, in addition to the balances prescribed under RBI Act, an additional
average daily balance, the rate of which will be specified by the Reserve Bank.
• Such additional balance will be calculated with reference to the excess of the total of DTL of the bank.
• At present no incremental CRR is required to be maintained by the banks.

Statutory Liquidity Ratio (SLR)

• The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered
government securities, cash and gold.
• Changes in SLR often influence the availability of resources in the banking system for lending to the
private sector.
• At present SLR is 19.25%
Bank Rate
• Bank rate is a monetary policy tool of the RBI.
• It is the rate charged by the central bank for lending funds to commercial banks for long term.
• Long term here means more than 90 days.
• Bank rates influence lending rates of commercial banks. Higher bank rate will translate to higher
lending rates by the banks.
• In order to curb liquidity, the central bank can resort to raising the bank rate and vice versa.
• At present, Bank Rate is 6.50%
Repo Rate
• Repo rate is the rate at which the central bank of a country i.e. Reserve Bank of India lends money to
commercial banks in the event of any shortfall of funds for shorter duration.
• Short term here means upto 90 days.
• Repo rate is used by monetary authorities to control inflation.
• At present Repo Rate is 6.25%

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Reverse Repo Rate
• Reverse repo rate is the rate at which the central bank of a country i.e. Reserve Bank of India borrows
money from commercial banks within the country.
• It is a monetary policy instrument which can be used to control the money supply in the country.
• At present Reverse Repo Rate is 6.00%
Liquidity Adjustment Facility (LAF)
• Repo and Reverse Repo are all together called as LAF.
• The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has
increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of
tenors.
• The aim of term repo is to help develop the inter-bank term money market, which in turn can set
market-based benchmarks for pricing of loans and deposits, and hence improve transmission of
monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as
necessitated under the market conditions.
Marginal Standing Facility
• A facility under which scheduled commercial banks can borrow additional amount of overnight money
from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a
penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking
system.
• Minimum amount of loan under – Rs. 1 crore and in the multiple of Rs. 1 crore.
• Maximum amount of loan – 2% of NDTL
• At present it is 6.50%
Open Market Operations
• These include both, outright purchase and sale of government securities, for injection and absorption
of durable liquidity, respectively.
Market Stabilization Scheme (MSS)
• The MSS was introduced in April 2004.
• It is a monetary policy intervention by the RBI to withdraw excess liquidity by selling government
securities in the economy.
• The money obtained under MSS should be kept with the RBI. It should not be transferred to the
government because, if it is transferred to government will spend the money in the economy thereby
adding to liquidity.
• The issued securities are government bonds and they are called as Market Stabilization Bonds. These
securities are owned by the government though they are issued by the RBI. The government is the
owner of the securities.
Qualitative Instrument - Moral Suasion
• Moral Suasion refers to a request by the RBI to the commercial banks to take certain measures as per
the trend of the economy.
• For example, RBI may ask banks to not to give out certain loans.
Margin Requirement/Loan to value Ratio
• The margin refers to the "proportion of the loan amount which is not financed by the bank “
or
• In other words, it is that part of a loan which a borrower has to raise in order to get finance for his
purpose.
• A change in a margin implies a change in the loan size.

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Direct Action
• Under this method the RBI can impose an action against a bank.
• If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills
and securities.
• RBI may also refuse credit supply to those banks whose borrowings are in excess to their capital.
• It can even put a ban on a particular bank if it does not follow its directives and work against the
objectives of the monetary policy.
• The Reserve Bank issues licences and also undertakes the elimination of licences, to banks and other
institutions to act as Authorised Dealers in the foreign exchange market.
• Reserve Bank has also provided the exchange facility for liberalized travel abroad.

Priority Sector Lending

• Central Bank fixes credit amount to be granted.
• Credit is rationed by limiting the amount available for each commercial bank.
• PSL was launched in 1972 by RBI.
• It is a scheme which aims to give loans to the important sectors of the economy in such a way to
ensure maximum credit flow to the last man in the last village of the country through a strong banking
network.
• Priority Sector includes the following categories:
• (i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education
(v) Housing
(vi) Social Infrastructure
(vii) Renewable Energy
(viii) Others

Agriculture
Agriculture includes
Farm Credit - It includes short-term crop loans and medium/long-term credit to farmers
Agriculture Infrastructure - It includes loan for the development of Infrastructure related to agriculture.
Ancillary Activities - It includes other activities related to agriculture.

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Small and Marginal Farmers
• Marginal Farmers - Farmers with land holding upto 1 hectare.
• Small Farmers - Farmers with land holding more than 1 hectare and upto 2 hectares.

Education
• Loans to individuals for educational purposes including vocational courses upto Rs. 10 lakh. (In
India) and Rs. 20 lakh (Outside India).
Housing

Social Infrastructure
• Limit of Rs. 5 crore per borrower for building social infrastructure in Tier II to Tier VI centres are
eligible for classification under priority sector.

Renewable Energy
• Limit of Rs. 15 crore for purposes like solar based or biomass based power generators, wind mills,
etc. and for non-conventional energy based public utilities viz. street lighting systems, and remote
village electrification. For individual - limit is Rs. 10 lakh per borrower.
Micro, Small and Medium Enterprises

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Priority Sector Lending Certificate (PSLC)

• PSLC are tradable certificates issued against priority sector loans of banks so as to enable banks to
achieve their specified target and sub-targets for priority sector lending through purchase of these
instruments in the event of a shortfall.
• These certificates are issued by banks that have overreached their priority sector lending targets.
• Buyers of PSLCs are usually those banks who could not meet their priority sector lending targets.
• The price of PSLCs will be determined on the basis of demand and supply that will be reflected in the
auction under the RBI’s e-Kuber trading platform.
• Valid only for 1 year.
• There are only four eligible categories of PSLCs i.e.
❖ PSLC General
❖ PSLC Small and Marginal Farmer,
❖ PSLC Agriculture
❖ PSLC Micro Enterprises.

Penalty - Priority Sector Lending

Domestic Bank Foreign banks with 20 branches and above

• Deficiency if any, will be transferred to RIDF which is managed by NABARD.
Foreign banks with less than 20 branches
• Deficiency if any, will be transferred to SEDF which is managed by SIDBI.

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