Banking Awareness Question Day 17

Banking Awareness Question Day 17: Check Detail about Monetary Policy in India

Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act. The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of
India Act, 1934.

Objective of Monetary Policy:-

The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.

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Monetary Policy Framework:

The amended RBI Act explicitly provides the legislative mandate to the Reserve Bank to operate the monetary policy framework of the country.

The framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market rates at or around the repo rate. Repo rate changes transmit through the money market to the entire the financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.

Once the repo rate is announced, the operating framework designed by the Reserve Bank envisages liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the operating target – the weighted average call rate (WACR) – around the repo rate.

The operating framework is fine-tuned and revised depending on the evolving financial market and monetary conditions, while ensuring consistency with the monetary policy stance. The liquidity management framework was last revised significantly in April 2016.


Section 45ZB of the amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. Accordingly, the Central Government in September 2016 constituted the MPC as under:

  1. Governor of the Reserve Bank of India – Chairperson, ex officio;
  2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio;
  3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio;
  4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
  5. Professor Pami Dua, Director, Delhi School of Economics – Member; and
  6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad –Member.

(Members referred to at 4 to 6 above, will hold office for a period of four years or until
further orders, whichever is earlier.)

The MPC determines the policy interest rate required to achieve the inflation target. The first meeting of the MPC was held on October 3 and 4, 2016 in the run up to the Fourth Bi-monthly Monetary Policy Statement, 2016-17.

The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for arriving at the decision on the policy repo rate.

The Financial Markets Operations Department (FMOD) operationalises the monetary policy, mainly through day-to-day liquidity management operations. The Financial Markets Committee (FMC) meets daily to review the liquidity conditions so as to ensure that the operating target of the weighted average call money rate (WACR). Before the constitution of the MPC, a Technical Advisory Committee (TAC) on monetary policy with experts from monetary economics, central banking, financial markets and public finance advised the Reserve Bank on the stance of monetary policy. However, its role was only advisory in nature. With the formation of MPC, the TAC on Monetary Policy ceased to exist.

Measure of Monitory Policy:-

  1. Quantitative Measures
  2. Qualitative Measures
  3. Quantitative Tools

Bank Rate: Bank rate is the rate charged by the central bank for lending funds to
commercial banks.

Bank rates influence lending rates of commercial banks. 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.

Present Bank Rate is 6.75% in India.

Open market operations are conducted by the RBI by way of sale or purchase of government securities (g-secs) to adjust money supply conditions. The central bank sells g-secs to suck out liquidity from the system and buys back g-secs to infuse liquidity into the system. These operations are often conducted on a day-to-day basis in a manner that balances inflation while helping banks continue to lend.

Liquidity adjustment facility is a tool used in monetary policy that allows banks to borrow money through repurchase agreements. Liquidity adjustment facilities are used to aid banks in resolving any short-term cash shortages during periods of economic instability. It is done through repo rate and reverse repo rate.

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Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.

A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.

MSF came into effect from 2011. MSF scheme is provided by RBI by which the banks can borrow overnight upto 2 per cent of their net demand and time liabilities (NDTL) i.e. 2 per cent of the aggregate deposits and other liabilities of the banks.

This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through the sale of short-dated government securities and treasury bills. The cash so mobilized is held in a separate government account with the Reserve Bank.

Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.

Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking
system for lending to the private sector.

Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.

Quantitative Instrument

A Credit limit or a Credit ceiling is the maximum amount of credit that a financial
institution or other lender will extend to a debtor for a particular line of credit (sometimes called a credit line, line of credit, or a tradeline). For example, it is the most that a credit card company will allow a card holder to take out at once on a credit card. Moral suasion is the act of persuading a person or group to act in a certain way through rhetorical appeals, persuasion or implicit threats, as opposed to the use of outright coercion or force; it is commonly used in reference to central banks.

The Credit Authorisation Scheme (CAS) for bank advances was introduced by the Reserve Bank of India in 1965.Under the Scheme, all scheduled commercial banks have to obtain prior authorisation of the Reserve Bank before granting any fresh credit limit of Rs. 1 crore or more to any single borrower. This limit was, however, raised to Rs. 2 crores in 1975.The banks first scrutinise the proposals of the borrowers and then send them to the Reserve Bank for approval. The Reserve Bank goes through the proposal and if found suitable, then it may authorise the concerned bank to sanction the loans asked for. The CAS is beingre viewed by the Reserve Bank from time to time and is progressively liberalised.

Open and Transparent Monetary Policy Making

Under the amended RBI Act, the monetary policy making is as under:

The MPC is required to meet at least four times in a year.
The quorum for the meeting of the MPC is four members.
Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.
The resolution adopted by the MPC is published after conclusion of every meeting of the MPC in accordance with the provisions of Chapter III F of the Reserve Bank of India Act, 1934.

On the 14th day, the minutes of the proceedings of the MPC are published which include:
a. the resolution adopted by the MPC;
b. the vote of each member on the resolution, ascribed to such member; and
c. the statement of each member on the resolution adopted.

Once in every six months, the Reserve Bank is required to publish a document called the Monetary Policy Report to explain:
a. the sources of inflation; and
b. the forecast of inflation for 6-18 months ahead.

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