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Module VI Monetary and Fiscal Policy
• Monetary Policy operates on monetary magnitudes or variables such as money supply. interest rates and availability of credit. it affects total demand in the economy. .Amity School of Business What is Monetary Policy? • The term monetary policy refers to actions taken by central banks to affect monetary magnitudes or other financial conditions. and thus credit. • Monetary Policy ultimately operates through its influence on expenditure flows in the economy. • In other words affects liquidity and by affecting liquidity.
Amity School of Business INSTRUMENTS OF CREDIT CONTROL • Quantitative Measures • Qualitative Measures .
Quantitative Measures • Legal Reserve Ratio • Bank Rate Policy • Open Market Operations Amity School of Business .
Amity School of Business Open Market Operations (OMOs) • OMOs involve buying (outright or temporary) and selling of govt securities by the central bank. . from or to the public and banks. • RBI when purchases securities. which in turn credits the seller’s deposit account in that bank. pays the amount of money by crediting the reserve deposit account of the seller’s bank.
. This leads to a general tightening in economy. • Whereas decrease in bank rate has the opposite effect and leads to general easing of credit in the economy. • An increase in bank rate makes it more expensive for commercial banks to borrow .Bank Rate Amity School of Business • Standard rate at which bank is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase • The rate of interest charged by central bank on their loans to commercial banks is called bank rate(Discount rate). This exerts pressure to bring about the rise in interest rates (lending rates) charged by commercial banks on their lending to public.
These reserves are designed to satisfy withdrawal demands. .Amity School of Business RESERVE REQUIREMENTS • The reserve requirement (or required reserve ratio) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. and would normally be in the form of fiat currency stored in a bank vault(vault cash). or with a central bank.
Amity School of Business RESERVE REQUIREMENTS • Thus central bank makes it legally obligatory for commercial banks to keep a certain minimum percentage of deposits in reserve. • These are of 2 types:• Cash reserves • Liquidity reserves .
CRR Amity School of Business • Banks are required to maintain a certain percentage of their deposits in the form of reserves or balances with the RBI • It is called Cash Reserve Ratio or CRR • Since reserves are high-powered money or base money. RBI can reduce or add to the bank’s required reserves and thus affect bank’s ability to lend. . by varying CRR.
Amity School of Business STATUTORY LIQUIDITY RATIO • Statutory Liquidity Ratio (SLR) is a term used in the regulation of banking in India. • Unencumbered approved securities (G Secs or Gilts come under this) valued at a price as specified by the RBI from time to time. . It is the amount which a bank has to maintain in the form: • Cash • Gold valued at a price not exceeding the current market price.
• To ensure solvency of banks. This percentage is fixed by the Reserve Bank of India. The maximum and minimum limits for the SLR are 40% and 25% respectively.Amity School of Business STATUTORY LIQUIDITY RATIO • The quantum is specified as some percentage of the total demand and time liabilities of a bank. • The objectives of SLR are: • To restrict the expansion of bank credit. . • To augment the investment of the banks in Government securities. A reduction of SLR rates looks eminent to support the credit growth in India.
Amity School of Business QUALITATIVE MEASURES • Credit rationing • Moral suasion • Changing lending margin • Direct controls .
Amity School of Business CREDIT RATIONING • More popular techniques in developing countries because financial infrastructure is not fully developed. • A credit ceiling is allotted to each sector and to each bank • Because of its non interest nature. • Issue of Penalty . suitable for controlling Islamic banks.
• It implies the central bank exerting pressure on banks by using oral and written appeals to expand or restrict credit in line with its credit policy.Amity School of Business MORAL SUASION • Informal contacts. meetings. to explain position of central bank on various issues. . consultations.
Amity School of Business CHANGING LENDING MARGIN • The difference between the value of mortgaged property and the amount advanced as loan is lending margin. • The central bank is empowered to change the lending margin with a view to change the credit with the banks. .
. the central bank imposes direct controls with a clear directive to banks to carry out their lending activity in a specified manner.DIRECT CONTROLS Amity School of Business • When all other methods prove ineffective.