Monetary policy is a crucial tool used by the central bank to regulate the supply of money in the economy and influence macroeconomic variables such as inflation, output, and employment. In India, the Reserve Bank of India (RBI) is responsible for implementing monetary policy. The RBI has several instruments at its disposal to achieve its objectives.
Cash Reserve Ratio (CRR)
Cash Reserve Ratio (CRR) is the amount of funds that banks are required to maintain with the RBI as a percentage of their deposits. The RBI uses this instrument to regulate the money supply in the economy. An increase in the CRR reduces the amount of money available with banks for lending, leading to a decrease in the money supply. On the other hand, a decrease in the CRR increases the amount of money available with banks for lending, leading to an increase in the money supply. As of March 2023, the CRR in India stands at 3%.
Statutory Liquidity Ratio (SLR)
Statutory Liquidity Ratio (SLR) is the percentage of deposits that banks are required to maintain with themselves in the form of liquid assets such as government securities, cash, and gold. The RBI uses this instrument to ensure that banks have enough assets to meet their obligations. An increase in the SLR reduces the amount of money available with banks for lending, leading to a decrease in the money supply. On the other hand, a decrease in the SLR increases the amount of money available with banks for lending, leading to an increase in the money supply. As of March 2023, the SLR in India stands at 18%.
Bank Rate
Bank Rate is the rate at which the RBI lends money to commercial banks. The RBI uses this instrument to influence the cost of borrowing for banks. An increase in the Bank Rate increases the cost of borrowing for banks, leading to a decrease in borrowing and lending activity in the economy, and a decrease in the money supply. On the other hand, a decrease in the Bank Rate decreases the cost of borrowing for banks, leading to an increase in borrowing and lending activity in the economy, and an increase in the money supply. As of March 2023, the Bank Rate in India stands at 4.25%.
Repo Rate
Repo Rate is the rate at which the RBI lends money to banks for a short period of time by buying government securities from them. This instrument is used by the RBI to regulate short-term liquidity in the market. An increase in the Repo Rate increases the cost of borrowing for banks, leading to a decrease in borrowing and lending activity in the economy, and a decrease in the money supply. On the other hand, a decrease in the Repo Rate decreases the cost of borrowing for banks, leading to an increase in borrowing and lending activity in the economy, and an increase in the money supply. As of March 2023, the Repo Rate in India stands at 4.25%.
Reverse Repo Rate
Reverse Repo Rate is the rate at which the RBI borrows money from banks by selling government securities to them. This instrument is used by the RBI to absorb excess liquidity in the market. An increase in the Reverse Repo Rate increases the returns on lending to the RBI, leading to a decrease in lending activity in the economy and a decrease in the money supply. On the other hand, a decrease in the Reverse Repo Rate decreases the returns on lending to the RBI, leading to an increase in lending activity in the economy, and an increase in the money supply. As of March 2023, the Reverse Repo Rate in India stands at 3.75%.
Marginal Standing Facility (MSF) Rate
Marginal Standing Facility (MSF) Rate is the rate at which the RBI lends money to banks overnight in case of a shortfall of funds, against the collateral of government securities. This instrument is used to address emergency situations where banks face a sudden shortage of funds. The MSF rate is usually set 100 basis points above the Repo Rate, which provides banks with an incentive to borrow from the interbank market rather than relying on the MSF. As of March 2023, the MSF Rate in India stands at 4.25%.
Open Market Operations (OMOs)
Open Market Operations (OMOs) refer to the buying and selling of government securities by the RBI in the open market. OMOs are used by the RBI to regulate the money supply in the economy. When the RBI buys government securities from banks, it injects money into the economy, increasing the money supply. On the other hand, when the RBI sells government securities to banks, it absorbs money from the economy, decreasing the money supply. As of March 2023, the RBI conducts OMOs through multiple auctions every week.
Liquidity Adjustment Facility (LAF)
Liquidity Adjustment Facility (LAF) is a tool used by the RBI to manage short-term liquidity in the market. Under LAF, banks can borrow money from the RBI by pledging government securities as collateral. The LAF has two components: repo and reverse repo. Banks can borrow money from the RBI under the repo window, while the RBI can borrow money from banks under the reverse repo window. The LAF rate is the weighted average of the repo and reverse repo rates. As of March 2023, the LAF rate in India stands at 4.25%.
Standing Deposit Facility (SDF)
Standing Deposit Facility (SDF) is a tool introduced by the RBI in 2019 to absorb excess liquidity in the market. Under SDF, banks can park their excess funds with the RBI at a fixed rate of interest. The SDF rate is usually 25 basis points lower than the Reverse Repo Rate. This instrument provides banks with an alternative option to park their excess funds with the RBI instead of participating in the reverse repo window. As of March 2023, the SDF rate in India stands at 3.50%.
Market Stabilization Scheme (MSS)
Market Stabilization Scheme (MSS) is an instrument used by the RBI to manage excess liquidity in the market. Under MSS, the RBI issues securities to absorb excess liquidity from the market. The proceeds from the sale of these securities are kept in a separate account with the RBI and are not available for lending to banks. The MSS is usually used to absorb excess liquidity that is not absorbed by other instruments such as the reverse repo and SDF. As of March 2023, the MSS limit in India stands at INR 8 lakh crore.