MONPOLICY: QUANTITATIVE TOOLS

Question 1

What are Quantitative Tools (or General/Indirect Tools) of monetary policy?

Answer 1

Quantitative tools are used by central banks to influence the overall money supply and credit conditions in the economy.
They have a broad impact, rather than targeting specific sectors.
Key Examples:
Statutory Reserve Requirements (CRR and SLR)
Open Market Operations (buying/selling government bonds)
Changes to policy interest rates (like Repo Rate)

Question 2

What are Statutory Reserve Requirements? How do they work to fight inflation or deflation? *

Answer 2

Statutory Reserve Requirements mandate banks to hold a portion of their deposits as reserves. This includes the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
Fighting Inflation: Central banks INCREASE CRR/SLR, reducing money available for lending, slowing down economic activity.
Fighting Deflation: Central banks DECREASE CRR/SLR, boosting funds available for lending, stimulating the economy.

Question 3

Define Cash Reserve Ratio (CRR) and explain its purpose.*

Answer 3

CRR: The percentage of a bank’s Net Demand and Time Liabilities (NDTL) that must be held as cash reserves with the central bank.
Purpose:
Primarily a tool to control liquidity (available money) in the banking system.
Increasing CRR removes money from circulation, decreasing lending capacity.
Decreasing CRR injects money into the system, increasing lending capacity.

Question 4

Define Statutory Liquidity Ratio (SLR) and explain its purpose.*

Answer 4

SLR: The percentage of a bank’s Net Demand and Time Liabilities (NDTL) that must be held in liquid assets (cash, gold, or government bonds).
Purpose:
Ensures banks have enough funds to meet short-term withdrawals and obligations.
Encourages banks to invest in government-approved securities.

Question 5

List the key similarities between CRR and SLR.

Answer 5

Both are percentages of a bank’s liabilities.
Both impact available funds for lending.
Both are tools for central banks to manage the economy.

Question 6

What’s the KEY difference between CRR and SLR?

Answer 6

Asset Type:
CRR: Reserves held as CASH with the central bank.
SLR: Reserves held as a mix of cash, gold, OR government bonds.

Question 7

Briefly explain how CRR and SLR ensure monetary stability in a country.*

Answer 7

CRR: Helps control the money multiplier effect (how much banks can lend based on deposits).
SLR: Provides a buffer during emergencies like bank runs, ensuring banks can meet depositor withdrawals.
Note: Though they can help manage inflation, central banks primarily use interest rates like the Repo Rate to directly fight inflation.

Question 8

Explain the concept of Net Demand and Time Liabilities (NDTL). Why is it important for CRR and SLR calculation?

Answer 8

NDTL refers to a bank’s total demand and time deposits.

Demand Deposits: Funds withdrawable by customers at any time (checking accounts, savings accounts).
Time Deposits: Funds held for a fixed period (certificates of deposit, etc.).
Importance: CRR and SLR are calculated as percentages of NDTL. This determines the amount of reserves banks must maintain relative to their deposit base.

Question 9

What is a Bank Run? How do CRR and SLR help protect against their impact?

Answer 9

Bank Run: A situation where a large number of depositors withdraw funds from a bank simultaneously, often driven by panic or loss of confidence.

Protection:

CRR: Ensures banks have some cash on hand to meet immediate withdrawal demands.
SLR: Liquid assets held under SLR can be quickly converted to cash, further increasing a bank’s ability to handle a run.

Question 10

What are the potential consequences for a bank if it fails to maintain the required CRR and SLR?

Answer 10

Failing to maintain CRR/SLR results in penalties imposed by the central bank.
Penalty interest rates are often linked to the Bank Rate, making non-compliance costly for banks.
Repeated failure to meet reserve requirements can damage a bank’s reputation and lead to further regulatory action.

Question 11

Discuss the limitations of CRR and SLR as tools for controlling inflation.

Answer 11

Limitations:
Indirect Influence: CRR/SLR primarily affect liquidity, impacting inflation indirectly. Central banks often rely more on interest rate changes.
Time Lag: Adjustments to CRR/SLR take time to fully impact lending behavior and the broader economy.
Other Factors: Inflation can be driven by supply-side issues or external factors that CRR/SLR cannot address.