What are the monetary policy tools in
the hands of the Reserve Bank of India?


Introduction


In
order to control the monetary system, the Reserve Bank of India uses seven
different tools. These tools are used to mitigate inflations. In this regard,
it is to mention that the Reserve Bank of India controls inflation by
controlling the liquid cash in the market and this is done through the
following tools:




Figure 1: Monetary Policy Tools of RBI


(Source: As created by the author)



1. Cash Reserve Ratio (CRR)


Every
commercial bank in India is required to deposit a small proportion of its total
deposit with the Reserve Bank of India. This proportion or percentage of the
total deposit that the commercial banks deposit with the RBI is called the Cash
Reserve Ratio.


Importance of Cash Reserve Ratio:


If
the RBI increases the CRR, the liquid cash in the hands of commercial banks
decreases. Thus, the commercial banks' lending capacity falls with the rise of
the CRR. When the economy faces the problem of inflation, the Reserve Bank of
India increases the Cash Reserve Ratio for lowering the lending capacity of the
commercial banks. Similarly, when the economy faces a lack of liquid cash, the
RBI uses this tool to combat deflation. RBI decreases the CRR to help the
commercial banks to lend more money to the public. Therefore, this monetary
policy tool has effective outcomes over the economy and due to this reason, RBI
uses this tool to control the monetary system of the country.








2. Statutory Liquidity Ratio (SLR):


Every
commercial bank utilises the deposits by investing them in profitable investment
options including giving a loan to the public. However, the commercial banks
are required to deposit a small portion of the total deposit with the RBI as
CRR and another portion as liquid cash in hand. The portion of cash that the
commercial banks keep with them in form of cash is called the liquidity ratio.
This liquid money is used for meeting the demand of the depositors. Being the
regulator of scheduled banks, the RBI mandates the liquidity ratio, which is
required to be maintained by all commercial banks. This ratio is called the
Statutory Liquidity Ratio (SLR).


Importance of SLR:


If
the RBI enhances the SLR, the commercial banks need to keep a higher amount of
money in their hands. This means the lending capacity of the banks will fall
with the rise in SLR. This will result in fall in liquid cash in the hands of
the public. As a consequence of this, the demand for goods or services will
fall and therefore there will be a fall in the price of commodities in the
market. However, the RBI can use this tool in case of slow economic growth. The
RBI decreases the SLR to enhance the lending capacity of the commercial banks,
and by this, the RBI can combat against low production and demand.       


3. Bank Rate:


Reserve
Bank of India lends money to commercial banks in two different ways. The
advance can be made with or without any security. If the RBI lends money to
commercial banks without any security, then the rate at which the loan is
allowed to the commercial banks is called the Bank Rate.


Importance of Bank Rate:


If
the bank rate rises, the cost of taking a short-term loan from the RBI becomes
high, which affects the advancing ability of the commercial banks. On the other
hand, a fall in the bank rate facilitates the commercial banks to take the loan
from the RBI at a lower rate. 


4. Repo Rate:


In
case of any deficit, commercial banks take a short-term loan from the Reserve
Bank of India against some securities. The interest rate charged by the RBI is
called the Repo Rate.


Importance of Repo Rate:


The
rise in the Repo Rate implies an enhancement in the cost of short-term debt for
the commercial banks. Therefore, RBI can mitigate the short-term demand for
money by increasing the Repo Rate.    


5. Reverse Repo Rate


From
the name, it is clear that this is just the reverse of the Repo. This rate is
charged by the commercial banks for lending Reserve Bank of India. However, the
Reverse Repo Rate is determined by the Central Bank of the country (RBI).


Importance of the Reverse Repo Rate:


If
there is a surplus of the fund in the hands of commercial banks, they can be
able to lend more money to the people. This enhances the purchasing power of
the people of the country. In this context, if the RBI offers a higher rate for
lending funds from the commercial banks, the commercial banks' ability to give
a loan to the public decreases. By this way, the RBI can control the lending
power of the commercial banks.   


6. Open Market Operations:


The
open market operation is to be considered as one of the most crucial roles that
the Reserve Bank of India plays in the Indian economy. The Reserve Bank of
India buys and sells government securities. The primary objective of the open
market operation is to manage the liquidity in the market.


Importance of the Open Market
Operations:


When
the RBI buys security from the open market, the liquid market in the economy
rises. This results in an enhancement in the aggregate demand in the economy.
Thus, the purchase of the security from open market results in a price hike.
However, the RBI use this tool for attaining higher growth rate.     


7. Marginal Standing Funding:


In
case of an emergency, commercial banks can apply for funding to the RBI. Due to
this service of the RBI, it is called the lender
of last resort. In this regard, it is to be noted that the commercial banks
can get up to 1% of the total deposit and liability.









Conclusion


From
the above discussion, it is clear that the RBI has seven weapons to control the
monetary policy. In this context, it is to be noted that the increase in liquid
money helps in growth in the economy. However, the inflation factor is to be
considered as another outcome of such higher liquidity. Thus, the RBI is
required to maintain the balance between the growth and inflation while setting
monetary policy.















Reference

Reserve Bank of India Monetary Policy