Monetary and credit policies

Question 1

Monetary Policies

Answer 1

Monetary Policies: The strategy of influencing movements of money supply and interest rates to affect output and inflation

Question 2

Liquidity Adjustment Facility (LAF)

Answer 2

LAF introduced in 2000

• Through this RBI adjusts liquidity in the market against the collateral of government securities
• Available on a short term basis
• All commercial banks (except Regional Rural banks) and Primary dealers
• While banks borrow under LAF, they do at repo rate, and vice versa
• Government securities that banks and primary Dealers use under LAF are the securities that they purchased over and above what they are mandated to purchase under the statutory liquidity ratio (SLR) requirement

Question 3

Ready Forward Contracts (Repos)

Answer 3

Repos are a transaction in which two parties agree to sell and repurchase the same security
- Repo/Reverse can be done only in securities approved by the RBI i.e. Treasury Bills, Central/state govt securities

Question 4

Marginal Standing Facility (MSF)

Answer 4

Introduced in 2011

- MSF to enable the commercial banks to borrow form RBI at a PENAL RATE when the amount allotted under LAF is exhausted

Question 5

Bank Rate

Answer 5

Bank rate is the rate at which RBI used to lend long term to commercial banks
- Also a penal rate alongside MSF

Question 6

Base rate

Answer 6

Introduced in 2011, used for monetary policy transmission

- Base rate: Below which banks should not lend to anyone except in rare cases approved by RBI

Question 7

Marginal Cost of Fund Based Lending rate (MCLR)

Answer 7

Introduced in 2016, used for monetary policy transmission

- MCLR is based on CURRENT cost of funds, while Base rate is based on OVERALL cost of funds

Question 8

Statutory Liquidity Ratio (SLR)

Answer 8

• Long term tool
• SLR is the portion of time (Fixed Deposits) and demand liabilities (savings and current account) of banks that they should keep in the form of RBI approved liquid assets like government securities (GoI bonds, GoI Treasury Bills, State Development Loans), gold, cash with THEMSELVES
• Under SLR requirements, Some government securities are classified as High Quality Liquid Assets (HQLA) for the purpose of computing Liquidity coverage Ratio (LCR)

Question 9

Liquidity Coverage Ratio (LCR)

Answer 9

• The LCR promotes short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high quality liquid assets (HQLAs) to survive an acute stress scenario lasting 30 days
• Under SLR requirements, Some government securities are classified as High Quality Liquid Assets (HQLA) for the purpose of computing Liquidity coverage Ratio (LCR)

Question 10

Cash Reserve Ratio (CRR)

Answer 10

• Section 42 of RBI Act 1934
• Medium to short term
• CRR is the portion of the bank deposits that a bank should keep with RBI in cash form
• It earns no interests

Question 11

Standing Deposit Facility

Answer 11

SDF allows banks with extra liquidity to deposit with the RBI for an interest which is reverse repo rate

Question 12

Open Market Operations (OMO)

Answer 12

OMO is outright purchase and sale of government securities in open market

Question 13

Market Stabilization Bonds

Answer 13

MSS to absorb excess liquidity from the market

for example- after demonetization, foreign investors inflow