Monetary policy is the process by which the RBI controls the supply of money and the cost of credit in the economy. Its main goal is to keep inflation in check while supporting growth. The tools of monetary policy, especially repo rate, CRR and SLR, are core banking exam topics.
Key Rates
- Repo rate - the rate at which the RBI lends short-term money to commercial banks. A higher repo rate makes loans costlier and reduces money supply.
- Reverse repo rate - the rate at which the RBI borrows from banks. It absorbs extra cash from the system.
- Bank rate - the rate at which the RBI lends long-term funds to banks without collateral.
- Marginal Standing Facility (MSF) - lets banks borrow overnight funds in emergencies, usually above the repo rate.
Reserve Ratios
- Cash Reserve Ratio (CRR) - the share of total deposits banks must keep with the RBI as cash. No interest is paid on it.
- Statutory Liquidity Ratio (SLR) - the share of deposits banks must keep in liquid assets like cash, gold and government securities.
- Raising CRR and SLR reduces the funds banks can lend.
Advertisement
How the Tools Work
- To fight inflation, the RBI follows a tight (dear) money policy - raising repo rate, CRR and SLR.
- To boost growth, it follows an easy (cheap) money policy - cutting these rates.
- The Monetary Policy Committee (MPC), set up in 2016, has six members and decides the repo rate.
- The MPC's main aim is to keep CPI inflation at 4 percent within a 2-6 percent band.
Quick Revision Points
- Monetary policy is controlled by the RBI.
- Repo rate = RBI lends to banks; reverse repo = RBI borrows from banks.
- CRR = cash kept with RBI; no interest.
- SLR = liquid assets kept by banks themselves.
- MSF = emergency overnight borrowing.
- Repo decided by the 6-member MPC (since 2016).
- Tight policy fights inflation; easy policy boosts growth.