Bank Rate:
Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. RBI Can increase or Decrease the Bank Rate to influence the market rate. Usually, an increase in bank rate results in commercial banks increasing their lending rates and vice versa. Changes in bank rate affect credit creation by banks through altering the cost of credit.
Cash Reserve Ratio (CRR):
All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 4 per cent.
Statutory Liquidity Ratio (SLR):
Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securities. These are collectively known as SLR securities.
Repo:
A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities. Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest.
Open Market Operations :
An important instrument of credit control, the Reserve Bank of India purchases and sells securities in open market operations. In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities.
Money Supply :
M1, which equals the sum of currency with the public, demand deposits with the public and other deposits with the public. Simply put M1 includes all coins and notes in circulation, and personal current accounts.
M2, is a measure of money, supply, including M1, plus personal deposit accounts - plus government deposits and deposits in currencies other than rupee.
M3 or the broad money concept, as it is also known, is quite popular. M3 includes net time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1
Inflation:
Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much money and too few goods. Thus, due to scarcity of goods and the presence of many buyers, the prices are pushed up. The converse of inflation, that is, deflation, is the persistent falling of prices. RBI can reduce the supply of money or increase interest rates to reduce inflation.
How RBI Regulates Money Supply
Excess availability of money with the public lends higher liquidity and increases the purchasing power, while goods and services available in the market remain constant. This adversely affects and pushes up the prices and sets in inflationary effect in the economy. In order to drain off excess money supply or purchasing power in the hands of the public RBI uses-
Open Market Operations (OMO)
Changes in Interest Rate
Changes in CRR to be maintained by commercial banks
Primary placement of Government Debt
By way of open market operations RBI buys/sells government bonds in the secondary market. When bonds are sold to the public, it results in corresponding contraction of availability of money with the public and vice versa when bonds are purchased.
Similarly when Cash Reserve to be maintained by banks is increased, it siphons off part of the available cash with the banks, removes liquidity, drives interests up.
Primary deals in government bonds are a method to intervene directly in markets being followed by the RBI, while open market operations are carried out in the secondary market.
The increase or decrease of Bank rate as an instrument of monetary policy is no longer preferred as the interest rates are now market driven and RBI do not directly influence them. Interest rate announcements since 1998-99 were based on economic and market developments.
