MONEY AND BANKING 2 Flashcards
Demonetization under which act?
This was done as per the RBI Act 1934 which says that “on recommendation of the Central Board of RBI, the Central Government may, declare that any series of bank notes of any denomination shall cease to be legal tender”.
Impact of Demonetization in the short run
On liquidity
1.Demonetization led to liquidity (effective cash in circulation) crunch as the old Rs. 1000 and
Rs. 500 notes could not be used for transaction purpose and there was restriction on
withdrawal of new currency notes
2.In the banking system, demonetization led to increase in liquidity (here liquidity means
deposits with the banks) which has resulted in decreased market interest rates
On Money Supply
1.Economists define money supply as broad measures that encompasses both cash and bank
deposits, because these are very close substitutes. A key aspect of the Nov. 8 demonetization, however, is that the convertibility between cash and bank deposits was impeded. Cash could not be easily deposited into bank accounts, while withdrawals were subject to strict limits. So, we can say that demonetization led to reduction in money supply in the economy
On GDP
1.An aggregate demand shock, because demonetization reduced the supply of money and
affected private wealth (especially of those holding unaccounted money and owning real
estate)
2.An aggregate supply shock to the extent that cash was a necessary input for economic activity
(for example agricultural producers required cash to pay labour)
Currency Deposit Ratio (cdr)
= Currency held by Public/Deposits of public in banks
Reserve Deposit Ratio (rdr)
= Reserves of Banks/Deposits of public in banks, and can also be written as CRR (with RBI) + SLR (with themselves)
What is fractional reserve banking?
Banks are only required to hold a fraction of their deposit liabilities as reserves, while the rest can be lent out to borrowers or invested. Mechanism of creating money.
What does the value of the money multiplier depend upon?
currency-deposit ratio (cdr) based on public behaviour and reserves-deposit ratio (rdr) based on RBI guidelines
Monetary Policy means?
Monetary Policy is the process by which the monetary authority (RBI) of a country controls the creation and supply of money in the economy.
Types of Monetary policy?
Expansionary monetary policy increases the supply of money also called ‘Dovish’/ ‘Accommodative’/ ‘Easy Money Policy’. Whereas contractionary policy reduces the money supply aka ‘Hawkish’ or ‘Tight Money Policy’.
“Monetary Policy Framework” Agreement?
- Signed in Feb 2015 between the Government of India and RBI.
- Objective: Price stability with consideration for growth.
- Operated by RBI, the monetary policy framework.
- Inflation target set at 4% with a band of +/- 2%, decided by the Government of India in consultation with RBI as per the RBI Act 1934 (every 5 years)
- Inflation measured by “Consumer Price Index (CPI) – Combined” published by Ministry of Statistics and Programme Implementation (NSO).
- RBI fails to meet target if inflation exceeds 6% or falls below 2% for three consecutive quarters.
- If target is missed, RBI must submit a written report to Government of India explaining reasons, remedial actions, and estimated time for target achievement.
who decides target rate of inflation?
decided by the Government of India in consultation with RBI as per the RBI Act 1934 (every 5 years)
Who determines the repo rate?
1.The Government of India established the Monetary Policy Committee (MPC) in September 2016 to determine the Policy (Repo) Rate aimed at achieving the inflation target.
2.Comprising six members, three from RBI (including the Governor) and three appointed by the Government, each member holds one vote, with the Governor having a casting vote in case of ties.
3.MPC’s decisions are binding on RBI, with authority limited to setting the repo rate, excluding reverse repo, CRR, SLR, etc.
Does the RBI account for Currency market fluctuations, depreciation or appreciation of the rupee in the Monetary Policy Framework?
These are not a factor for consideration for the MPF. And for dealing with those situations, RBI has other instruments which are deployed as per the requirement.
monetary policy tools of RBI-
1.Liquidity Adjustement Facility-
1. overnight and term repo and reverse repo rate (fixed and variable)
2.Standing Deposit Facility
3.Marginal Standing Facility
xxxx
2.Bank rate
3.LAF corridor
4.Fractional Reserve Banking
5.Open Market Operations
6.Market stabilization schemes/sterlization
Liquidity Adjustment Facility (LAF)
The LAF refers to the RBI’s operations through which it injects/absorbs liquidity into/from the banking system. It consists of-
1.overnight as well as term repo/reverse repos (fixed as well as variable rates),
2.SDF
3.MSF
Does RBI manage liquidity only through LAF?
Apart from LAF, instruments of liquidity management include outright open market operations (OMOs), forex swaps and market stabilisation scheme (MSS).
Repo Rate
1.Aka policy rate, The interest rate at which RBI lends money to bank
2.up to a limit of 0.25% of their NDTL
3.for a short term, usually overnight.
4.Banks provide government securities as collateral to RBI when borrowing cash at the repo rate.
5.The repo rate is set by the RBI (MPC) discretion of RBI
What is NDTL
Net demand and time liabilities. It represents the total amount of money a bank owes to its customers (both on-demand and time deposits) minus the amount of money it holds in cash reserves with the Reserve Bank and other banks.
Total liabilities= all the money the bank owes its customers
Net because some portion becomes an asset when kept with central banks.
Reverse Repo Rate
1.The interest rate at which RBI borrows money from banks
2.Presently, there’s no limit on the amount banks can deposit at the reverse repo rate, although RBI may impose a cap if necessary.
3.for a short term, typically overnight.
4.RBI deposits govt securities as collateral
5.Set by RBI, not under MPC
Standing Deposit Facility (SDF)
1,Introduced in April 2022 via an amendment in the RBI Act 1934. Banks keep money with the RBI
2.Deposit Any Amount at a rate of ‘repo rate – 0.25%’
3.for overnight (and potentially for longer periods in the future)
4.No Collateral Requirement
5.also enhances financial stability and at Discretion of Banks and it’s available on all days of the week, throughout the year
Marginal Standing Facility
1.introduced in 2011 Banks borrow money from RBI
2.extra at MSF rate (Repo Rate + 0.25%).
3.MSF offers overnight funding, repayable the next day
4.Banks can use up to 2% of their SLR securities as collateral for MSF borrowing.
5.Discretion of Banks, helps in financial stability
Bank Rate
1.once used as the standard rate for injecting liquidity, became dormant after the introduction of the Liquidity Adjustment Facility (LAF) by the Reserve Bank. Now, it’s primarily aligned with the Marginal Standing Facility (MSF) rate and used for calculating penalties on defaults in the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
2.The Bank Rate = MSF rate, which is typically higher than the repo rate.
What is the aim of term repo?
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.
Long Term Repo Operations (LTRO)
1.RBI lends money to banks
2.rate equal to or higher than the repo rate which is contingent upon the bank’s NDTL, and the interest rate may be determined through an auction process.
3.LTRO provides funds for a fixed long term
4.Collateral of government securities is required for LTRO, although it may not always be 100% of the borrowed amount.
5.RBI has the discretion to conduct LTRO as needed, and the interest rate may vary depending on market conditions and demand for funds from banks.
variable long-term reverse repo auctions
1.Banks lend money to RBI
2.rate equal or higher than reverse repo, or lower than repo through auction
3.long term
4.collateral needed, though not necessarily 100% of borrowed amount
5.RBI discretion
Targeted LTRO
1.RBI lends money to banks to specific sectors
2.rate equal to or higher than the repo rate which is contingent upon the bank’s NDTL, and the interest rate may be determined through an auction process.
3.LTRO provides funds for a fixed long term
4.Collateral of government securities is required for LTRO, although it may not always be 100% of the borrowed amount.
5.RBI has the discretion to conduct LTRO as needed, and the interest rate may vary depending on market conditions and demand for funds from banks.
The LAF Corridor
is like a framework used by the RBI to manage how much banks charge each other for short-term loans. Before the SDF, the MSF rate set the upper limit, the reverse repo rate set the lower limit, and the repo rate was in the middle. Now, the SDF rate sets the lowest possible interest rate, the MSF rate sets the highest, and the repo rate is in between, forming the LAF corridor.
The Weighted Average Call Money Rate
The weighted average call money rate is the average interest rate banks pay each other to borrow funds overnight in the call money market, calculated based on the volume borrowed at each rate. An important indicator of short-term liquidity conditions.
Reserve Requirements (Fractional Reserve Banking)
constituents
Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)
Cash Reserve Ratio (CRR)
1.The amount of cash that the scheduled commercial banks are required to maintain with RBI
2.cash
3.with respect to their NDTL
4.on a fortnightly basis
5.RBI Act, 1934 the Reserve Bank without any floor or ceiling rate
Statutory Liquidity Ratio (SLR)
1.The amount of reserves that the scheduled commercial banks are required to maintain with themselves. Excess CRR can also be treated as SLR.
2.in safe and liquid assets such as government securities, gold and cash
3.with respect to their NDTL
4.on a daily basis
5.Scheduled Commercial Banks are required to maintain SLR as per the Banking Regulation Act 1949. The ceiling on SLR is 40%
Importance of CRR and SLR
1.enable RBI to control the money multiplier
2.It ensures that banks have a safe cushion of assets to draw on when account holders want to be paid.
Who all are required to maintain CRR SLR? Acts and provisions?
All Commercial and Cooperative Banks (either scheduled or non-scheduled) are required to maintain CRR and SLR.
1.CRR—-For scheduled banks, the maintenance of CRR is governed through The Reserve Bank of India Act 1934 and for Non-Scheduled banks CRR is governed through Banking Regulation Act 1949.
2.Banking Regulation Act 1949 (Section 24) governs maintenance of SLR for all banks (scheduled and non-scheduled) commercial and cooperative.
Open Market Operations (OMO)
Sale or purchase of government securities by RBI in the open market (secondary market) to banks/financial institutions for absorption and injection of durable liquidity in the economy is called open market operations.
