THE MONETARY MONARCH - RBI 2

Monetary policy includes LAF, MSF, CRR and SLR. These tend to be the most important terms and tools used by the RBI to control money flow in the market.  Liquidity Adjustment Facility includes 1) Bank rate 2) Repo rate 3) Reverse Repo rate. In layman’s terms, Bank rate is the rate of interest at which the RBI lends to banks. It is just like lending public with or without any security. For example, when banks are out of funds, and want to borrow from RBI, which is considered the lender of last resort, let us say an amount of RS 100 at the interest of 5%. This interest rate is called the bank rate. It is a long term borrowing option for the banks with a pre decided maturity date. It was the most often used platform by the banks but recently went under operation when its prominence was taken over by the Repo rate.

Repo is the repurchase agreement. It means that banks place the government securities as collateral with the RBI and borrow money for a short period of time (seven days) at a pre decided interest rate which is called repo rate. The banks are expected to pay back the amount including the interest before maturity date and take back their securities. Reverse Repo rate is just opposite to the Repo rate. The rate at which RBI borrows from the banks and pledges its securities as collateral in order to grab the excess money flow and impart stability into the markets. There is no limit for the amount borrowed in LAF.

Cash reserve Ratio is a compulsory tool used by RBI to curb or release the money supply in the economy for stabilization. There is an obligation for every bank to pledge or keep aside a percentage of its total deposits of the customers in cash with the RBI for security in case if the bank dissolves, all of a sudden. Standard liquidity Ratio is similar to the CRR where a percentage of total deposits are kept aside in liquid assets like government securities, bonds etc with RBI.

MSF (Marginal Standing Facility) is another platform for the banks to borrow money. Usually, this medium is used only when there is an urgent need and there is no collateral available with the banks as of then immediately. This was introduced in 2011 for the emergency purposes. It is a facility where the banks can use their Liquid assets pledged as SLR with the RBI, to borrow up to 2% of their Net demand and time liabilities. They can be borrowed overnight and are considered long term borrowings unlike the LAF (Repo and Reverse repo are short term but Bank rate is long term).

Now, as the jargon is set clear in minds, let us move on to the practicality of these terms. If there is money flow increasing in the market, then the RBI in order to curtail inflation, has to cut down the money flow. But how is that possible? By using all the tools discussed above, primarily. There are many other tools under fiscal policy which also aid in curtailing inflation/deflation. When there is inflation (more money chasing less goods), immediately RBI increases CRR, SLR, Repo rate and bank rate altogether or one at a time according to the situation. Increasing these rates would attract more money from the banks as interests or reserves thus restricting the banks from using much money for lending. This makes banks increase their interest rates making people stop investing and taking loans. Thus, the money flow in the market reduces. Vice versa is the case with deflation dealt. This is not it. There are many complexities involved but everything in detail will be dealt in the inflation topic.