Role played by central bank monetary and credit policy
Prof. D. C. Pai
control credit and vary the reserve requirement.
y Monetary policy and fiscal policy are two important
tools of macroeconomic policy.
y RBI is responsible for formulating and implementing
monetary policy. carry out open market operation.Monetary Policy
y The objectives are to maintain price stability and ensure
adequate flow of credit to the productive sectors of the economy. It can increase or decrease the supply of currency as well as interest rate.
volume of bank credit and
also cost of bank credit (via the bank rate) and thereby the overall money supply in the economy.
y Money supply change is technique of controlling
inflationary or deflationary situation in the economy.y RBI controls the money supply.
y RBI issues monetary and credit policies annually and also
Tools of monetary control
y RBI uses monetary policy by using one or more of the
following tools of monetary control these are:
y CRR (cash reserve ratio)
y It refers to the cash that all banks (scheduled & non scheduled) are
required to maintain with the RBI as a certain percentage of their demand and time liabilities (DTL).
y In order to meet these liabilities in time (that is to keep liquidity ).
. a bank
has to keep a regulatory cash reserve with the RBI.
y An increase in CRR will squeeze the liquidity in the banking system and
reduce their lending operations and the call rate will tend to increase.
.y If bank fails to maintain the prescribed CRR at prescribed intervals it has
to pay a penalty.
y SLR (statutory liquidity ratio)
y It refers to supplementary liquid reserve requirements of banks in
addition to CRR.
y A cut in the CRR enhances loan able funds with the bank and reduces
their on the call and term money market.
To increase banks investment in approved securities Ensure solvency of banks
. y SLR has three objectives:
To restrict expansion of banks credit. unencumbered approved securities and gold. current account balances with the SBI and other public sector banks.y SLR is maintained by all banks in the form of cash in hand (exclusive of
the minimum CRR).
y RBI can prescribe SLR from 0% to 40% of banks DTL.
y Thus RBI can affect the interest rates via changes in its bank rate .y Bank rate y Bank rate is the standard rate at which RBI is prepared to buy or rediscount bills of exchange or other eligible commercial paper from banks.
. if not to the same extent. y Change in the bank rate by RBI affects the interest rate on loans and
deposits in the banking system across the board in the same direction.
whenever the situation of the economy warrants it.
y It is the basic costs of rediscounting and refinance facility from RBI.
.y Open Market Operations (OMOs)
y This refers to sale or purchase of government securities (of central or
state governments or both) by RBI in the open market.
y This is with a view to increase or decrease the liquidity in the banking
system and thereby affect the loan able funds with the banks.
y RBI can also alter the interest rate structure through its pricing policy for
open market sale/ purchase.
y Selective Credit Control (SCC) y The RBI issues directives. oils incl. oil seeds. stipulating certain restrictions on bank advances against specified sensitive commodities.
y RBIs objective in issuing selective credit control (SCC) directives to
prevent speculative holding of essential commodities and the resultant rise in their prices. all imported oil seeds.
y Commodities ² pulses. paddy/rice and wheat. under section 21 and 35A of banking regulation act. vanspati. gur and khandsari. cotton and kapas.
y RBIs general guidelines on SCC are:
Banks should not allow customers dealing in SCC commodities any credit facilities that would directly or in directly defeat the purpose of SCC directives.
. Credit limits against each commodities covered by SCC directives should be segregated and SCC restrictions be applied to each of such segregated limits.