CREDIT POLICY MEASURES

NIKHIL GARG
ABS

Monetary Policy
Monetary policyis the process by
which themonetary authorityof a
country controls thesupply of money
,
often targeting an inflation rateor
interest rateto ensure price stability
and general trust in the currency.

Types of Monetary Policy

an expansionary policy increases the total supply of
money in the economy more rapidly than usual, and
contractionary policy expands the money supply
more slowly than usual or even shrinks it.
Expansionary policy is traditionally used to try to
combatunemploymentin arecessionby lowering
interest ratesin the hope that easy credit will entice
businesses into expanding.
Contractionary policy is intended to slowinflationin
order to avoid the resulting distortions and
deterioration of asset values.
Monetary policy differs fromfiscal policy, which refers
totaxation,government spending,
and
associated borrowing

Objectives of Monetary
Policy
Rapid Economic Growth -
If the RBI opts for a cheap or easy
credit policy by reducing interest
rates, the investment level in the
economy can be encouraged. This
increased investment can speed up
economic growth. Faster economic
growth is possible if the monetary
policy succeeds in maintaining
income and price stability.

Price Stability
All the economics suffer from inflation and deflation.
It can also be called as Price Instability
. Both inflation are harmful to the economy.
Thus, the monetary policy having an objective of
price stability tries to keep the value of money
stable.
It helps in reducing the income and wealth
inequalities.
When the economy suffers from recession the
monetary policy should be an 'easy money policy'
but when there is inflationary situation there should
be a 'dear money policy'.

Exchange Rate Stability

Exchange rate is the price of a home
currency expressed in terms of any
foreign currency.
If this exchange rate is very volatile
leading to frequent ups and downs in
the exchange rate, the international
community might lose confidence in
our economy.

Generation Of
Employment
Monetary policy helps in employment
generation by influencing the rate of
investment
and
allocation
of
investment among various economic
activities
of
different
labour
Intensities.

Redistribution Of income And

Wealth
monetary policy can make special
provisions for the neglect supply
such as agriculture, small-scale
industries, village industries, etc. and
provide them with cheaper credit for
longer term. This can prove fruitful
for these sectors to come up.

Balance of Payments (BOP)

Equilibrium
The BOP has two aspects i.e. the
'BOP Surplus' and the 'BOP Deficit'.
The former reflects an excess money
supply in the domestic economy,
while the later stands for stringency
of money.
The Reserve Bank of India through its
monetary policy tries to maintain
equilibrium in the balance of
payments

MONETARY & CREDIT

SUPPLY
One of the primary functions of RBI is to
control the supply of money in the
economy and also the cost of credit.
Meaning, how much money is available for
the industry or the economy and
what is the price that the economy has to
pay to borrow that money.
Availability of money is nothing but
liquidity and cost of borrowing is interest
rates.

To control inflation and the growth,

RBI uses certain tools like
CASH RESERVE RATIO,
STATUTORY LIQUIDITY RATIO,
REPO RATE, R
EVERSE REPO RATE etc.,

REPO RATE
Repo rateis therateat which the
central bank of a country (Reserve
Bank of India in case of India) lends
money to commercial banks in the
event of any shortfall of funds.
Repo rateis used by monetary
authorities to control inflation.
Repo
rate
is
short
form
of
Repurchase Rate

 RBI lends money to commercial

banks
against
the
pledge
of
government securities whenever the
banks are in need of funds to meet
their day-to-day obligations.
Banks enter into an agreement with
the RBI to repurchase the same
pledged government securities at a
future date at a pre-determined
price.

 ExampleIf repo rate is 5% , and

bank takes loan of Rs 1000 from RBI ,
they will pay interest of Rs 50 to RBI.
So, higher the repo rate higher the
cost of short-term money and vice
verse.
Higher repo rate may slowdown the
growth of the economy. If the repo rate
is low then banks can charge lower
interest rates on the loans taken by us.

whenever the repo rate is cut, can we

expect that both the deposit rates and
lending rates of banks to come down to
some extent?

may or may not happen every time

The lending rate of banks goes down to the
existing bank borrowers only when the banks
reduce theirbase rates, as all lending rates
of banks are linked to the base rate of every
bank.
In the absence of a cut in the base rate, the
repo rate cut does not get automatically
transmitted to the individual bank customers.
Base Rateis the minimum rate below which
Banks are not permitted to lend

INFLATION
In the event of inflation, central
banks increase repo rate as this acts
as a disincentive for banks to borrow
from the central bank.
This ultimately reduces the money
supply in the economy and thus
helps in arresting inflation.

Reverse Repo Rate

reverse reporate is the rate of
interest offered by RBI,
when banks deposit their surplus
funds with the RBI for short periods.
When banks have surplus funds but
have no lending (or) investment
options, they deposit such funds with
RBI. Banks earn interest on such
funds.

 In a reverse repo transaction, banks

purchase government securities form RBI
and lend money to the banking
regulator, thus earning interest.
Reverse repo rate is the rate at which
RBI borrows money from banks.
Banks are always happy to lend money
to RBI since their money is in safe hands
with a good interest.
repo rate is always higher than the
reverse repo rate.

 An increase in the reverse repo rate

will decrease the money supply and
vice-versa, other things remaining
constant.
An increase in reverse repo rate
means that commercial banks will
get more incentives to park their
funds with the RBI,
thereby decreasing the supply of
money in the market.

CASH RESERVE RATIO (CRR)

It is the ratio of Deposits which banks
have to keep with RBI.
Under CRR a certain percentage of
the total bank deposits has to be
kept in the current account with RBI.
Banks dont earn anything on that.

CRR Contd.
Banks will not have access to this
amount.
They cannot use this money for any
of their economic or commercial
activities.
Banks cant lend this portion of
money to corporate or individual
borrowers.

ExampleYou deposit say Rs 1000 in

your bank. Then Bank receives Rs
1000 and has to put some
percentage of it with RBI.
If the prevailing CRR is 6% then they
will have to deposit Rs 60 with RBI
and they are left with Rs 940.
Your bank can not use this Rs 60 for
its commercial activities like lending
or investment purpose. This Rs60 is
deposited in current account with
RBI.

The current CRR is 4%. If RBI cuts

CRR in its next monetary policy
review which is scheduled on 2nd,
December then it means banks will
be left with more money to lend or to
invest.
So, more money can be released into
the economy which may spur
economic growth.

What is Statutory Liquidity

Ratio (SLR)?
Banks have to invest certain percentage
of their deposits in specified financial
securities like Central Government or
State
Government
securities.
This
percentage is known as SLR.
This money is predominantly invested in
government securities which mean the
banks can earn some amount as interest
on these investments as against CRR
where they do not earn anything.

ExampleYou deposit say Rs 1000 in your bank.

Then Bank receives Rs 1000 and has to put
some percentage of it with RBI as SLR. If the
prevailing SLR is 20% then they will have to
invest Rs 200 in Government securities.

So to meet both CRR and SLR requirements, bank

have to earmark Rs 260 (Rs 60 + Rs 200).

What is Bank rate?

Bank Rate is the rate at which central bank of the
country (in India it is RBI) allows finance to
commercial banks without collateral.
Bank Rate is a tool, which central bank uses for shortterm purposes.
Any upward revision in Bank Rate by central bank is an
indication that banks should also increase deposit rates
as well as Base Rate / Benchmark Prime Lending Rate.
Thus any revision in the Bank rate indicates that it is
likely that interest rates on your deposits are likely to
either go up or go down, and it can also indicate an
increase or decrease in your EMI.

 Higher bank rate will translate to higher

lending rates by the banks. In order to
curb liquidity, the central bank can
resort to raising the bank rate and vice
versa.
Lower bank rates can help to expand
the
economy
by
lowering
the
cost of fundsfor borrowers, and higher
bank rates help to reign in the economy
when inflation is higher than desired.

MORAL PERSUASION
Under Moral Suasion, RBI issues
periodical letters to bank to exercise
control over credit in general or
advances
against
particular
commodities.
Periodic discussions are held with
authorities of commercial banks in
this respect.

Open market operations

It refers to buying and selling of
government securities in open market in
order to expand or contract the amount
of money in the banking system.
Purchases inject money into the
banking system while sale of securities
do the opposite.
This
policy
aims
at
preventing
unrestricted increase in liquidity.