Tools of Monetary Policy (Finance)

MONETARY POLICY TOOLS

• Cash reserve ratio (CRR) : It is the amount of money which every scheduled commercial bank including the RRB's have to keep with RBI in the form of cash.  The current bi-monthly monetary policy has kept it at 4%. For instance XYZ bank has a capital worth Rs. 100, it has to keep min. 4 Rs. with the apex bank as a mandatory deposit, which attracts NIL interest. Although it acts as a security also but the main reason behind the deposit is to control the money supply in the economy. If the regulator finds that the excess cash in the economy is giving rise to inflationary measures , the RBI will simply increase the CRR rate , which will ultimately suck up all the excess cash from the market and vice versa.                      Now how is the cash kept with RBI???                                                                         It is not that a bank has physically bring it up to the RBI. Every commercial bank maintains a current a/c with the RBI authorities for bills clearing and other purposes, further banks also maintain currency chests to store excess cash with them. The money kept in chest as well as in the current a/c is added up to meet the CRR percentage. The reporting is to be done on fortnightly basis, but banks have to maintain the deposit on daily average basis. For that purpose RBI has given an outer limit incase of any breach i.e. the deposit cannot be less than 95% of the prescribed ratio (which is 4%) on average daily basis. Any further breaches (beyond 95%) would attract penal charges.  

• Statutory liquidity ratio (SLR) : It is the amount which all the Scheduled commercial banks need to maintain in the form of cash, gold and govt. securities. It controls the expansion of banks credit and also encourages bank to invest in govt. securities. As compared to CRR , which is in purely cash form, SLR has other investment vehicles as mentioned above.  It is determined as percentage of total demand and time liabilities. The current rate prescribed by the regulator is 18.25%.

• Repo rate (repurchase agreement) : In a layman language it can be defined as the amount at which RBI lends money to other scheduled commercial banks. But actually repo is a collateralized lending in which banks borrow money from the reserve bank to meet the short term needs by selling some securities , usually bonds with a prior repurchase agreement. RBI charges some interest for the same, which is termed as repo rate. The current repo rate is 7.25%.

• Reverse repo : It is all together opposite from the above, when banks repurchase the above mentioned securities from the apex bank and give the money back, it is termed as reverse repo,now in this case the interest rate charged by the commercial bank is termed as reverse repo rate. Again in layman's language it would be termed as interest charged by commercial banks while lending money to the RBI.It is always less then Repo rate, currently it is 6.25%.