Integrated Guidance Programme of
General Studies for IAS (Pre)
Subject – Economic and Social Development
Chapter – Monetary & Credit Policy
Monetary Policy and its objectives
The use by the Central Bank of interest rate and other
instruments to influence• money supply to achieve certain macro economic goals
is known as monetary policy. Credit policy is a part of monetary policy as it
deals with how much and at what rate credit is advanced by the banks. Objectives
of monetary policy are:
accelerating growth of economy
exchange rate stabilization
balancing savings and investment
Generating employment and
What is Bank Rate
Bank Rate is the rate at which RBI lends long term to
commercial banks. It is a tool which RBI uses for managing money supply and
What do you mean by SLR
It is the portion of time (fixed deposits) and demand
liabilities (savings bank and current accounts) of banks that they should keep.
in the form of designated liquid assets like government securities and other
RBI-approved securities like, public sector bonds current account balances with
other banks and gold SLR is aims at ensuring that the need for government funds
is partly but surely met by the banks.
What is CRR
CRR is a monetary tool to regulate money supply. It is the
portion of the bank deposits that a bank should keep with the RBI in cash form.
CRR deposits earn no interest.
Open Market Operations of RBI
OMOs of the RBI can be described as purchase and sale of
government securities in the Open market (open market essentially means
banks and financial institutions) by the RBI in order to influence the
volume of money and credit in the economy.
A purchase of government securities injects money into
the market and thus expands credit; sales have the opposite effect- absorb
excess liquidity and shrink credit.
Ready Forward Contracts (Repos)
It is a transaction in which two parties agree to sell
and repurchase the same security. Under such an agreement the seller sells
specified securities with an agreement to repurchase the same at a mutually
decided future date and a price. Similarly, the buyer purchases the
securities with an agreement to resell the same to the seller on an agreed
date in future at a predetermined price.
In India, RBI lends on a short term basis to banks on the
security of the government paper (repo). Banks undertake to repurchase the
security at a later date- over night or few days. RBI charges a repo rate
for the money it lends
Reverse repo is when RBI borrows from the market (absorbs
excess liquidity) with the sale of securities and repurchases them the next
day or after a few days. The rate at which it borrows is called reverse repo
rate as it is the reverse of the repo operation.
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What is Selective Credit Controls
Certain businesses can be given more and certain others may
get less credit from banks on the orders of the RBI. Thus, selective credit
controls can be imposed for meeting various goals like discouraging hoarding and
black-marketing of certain essential commodities by traders etc by giving them
A persuasion measure used by Central bank to influence and
pressure, but not force, banks into adhering to policy.
What do you mean by LAF (Liquidity Adjustment Facility)
Liquidity’ Adjustment Facility (LAF) was introduced by RBI in
2000.Under Laf, banks borrow from RBI and lend to RBI and repo and reverse repo
rates based on government securities which are held above the 24% limit of SLR.
Funds under LAF are used by the banks for their day-to-day mismatches in
liquidity. It is different from OMOs as OMOs involve outright purchase/sale of
security while Laf is for lending/borrowing.
What do you understand by MSF
Reserve Bank of India’s (RBI) introduced marginal standing
facility (MSF) in May 2011. Under the MSF, banks can borrow overnight up to 1%
of net demand and time liabilities (NDTL). The MSF is set 100 basis points above
the repo rate — the rate at which banks borrow from RBI.
What do you mean by Base Rate
The Reserve Bank introduced base rate on Deepak Mohanty committee
recommendations in 2010. It is the rate below which banks can not lend.
Reserve Bank of India
The central bank of the country is the Reserve Bank of
India (RBI). It was established in 1935 with a share capital of Rs. 5 crores
on the basis of the recommendations of the Hilton Young Commission.
Reserve Bank of India was nationalised in the year 1949. The
general superintendence and direction of the Bank is entrusted to Central Board
of Directors of 20 members, the Governor and four Deputy Governors, one
Government official from the Ministry of Finance, ten nominated Directors by the
Government to give representation to important elements in the economic life of
the country, and four nominated Directors by the Central Government to represent
the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New
Functions of RBI
- Under Section 22 of the Reserve Bank of India Act, the Bank has the sole
right to issue bank notes of all denominations. The distribution of one
rupee notes and coins and small coins all over the country is undertaken by
the Reserve Bank as agent of the Government.
- RBI should maintain gold & foreign exchange reserves of Rs. 200 Cr, of
which Rs. 115 Cr. should be in gold.
Banker to Government
The second important function of the Reserve Bank of India is to act as
Government banker, agent and adviser. The Reserve Bank is agent of Central
Government and of all State Governments in India. The Reserve Bank has the
obligation to transact Government business, to receive and to make payments on
behalf of the Government and to carry out their other banking operations.
Controller of Credit
The Reserve Bank of India is the controller of credit i.e. it has the power
to influence the volume of credit created by banks in India.
Custodian of Foreign Reserves
The Reserve Bank of India has the responsibility to act as the custodian of
India’s reserve of international currencies. It takes up operations in the forex
market to stabilize the- exchange rate of rupee and ensure that there is no
speculation and there is order.
In addition to its traditional central banking functions, the Reserve bank
has certain non- monetary functions of the nature of supervision of banks and
promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking
Regulation Act, 1949 have given the RBI wide powers of supervision and control
over commercial and co-operative banks, relating to licensing and
establishments, branch expansion, setting reserve ratios etc.
Since Independence, the range of the Reserve-Bank’s functions has steadily
widened. The Bank now performs a variety of developmental and promotional
functions. The Reserve Bank was asked to promote banking habit, extend banking
facilities to rural and semi- urban areas, and establish and promote new
specialised financing agencies.
- This refers to the total volume of money circulating in the economy.
Money supply can be estimated as narrow or broad money.
- M1 equals the sum of currency with the public and demand deposits with
the banks. It is the narrow money.
- M3 or the broad money concept, as it is also known includes time
deposits (fixed deposits), savings deposits with post office saving banks
and all the components of M1
Credit Crunch/Liquidity Crunch/ Liquidity Crisis
Credit/Liquidity crunch refers to a state in which there is a short supply of
money to lend to businesses and consumers and interest rates are high. It may
happen when the government borrows heavily and there is crowding out of the
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