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19.01.2020



AAKASHAYA PATRA SEVEN STAR SMART EDUCATION SERIES PART – 32

EFFECTS OF MONETARY POLICY


Banks, are a key constituent of the economy. They are a key vehicle through  which RBI implements its monetary policy and exchange rate policy. The following are key  concepts to understand in this regard:

1.Cash Reserve Ratio (CRR)

Scheduled Commercial Banks are required to maintain with RBI, an average cash balance, the  amount of which shall not be less than 6% of the total of the Net Demand and Time Liabilities  (NDTL) in India.
Demand Liabilities include all liabilities which are payable on demand and they include current  deposits, demand liabilities portion of savings bank deposits, margins held against letters  of credit/ guarantees, balances in overdue fixed deposits, cash certificates and cumulative/  recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand  Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits  held as security for advances which are payable on demand.

Time Liabilities are those which are payable otherwise than on demand and they include fixed  deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings  bank deposits, staff security deposits, margin held against letters of credit if not payable on  demand, deposits held as securities for advances which are not payable on demand, India  Millennium Deposits and Gold Deposits.
The CRR is calculated on the basis of average of the daily balance maintained with RBI during  the reporting fortnight. Scheduled Commercial Banks are required to maintain minimum CRR  balances up to 70 per cent of the total CRR requirement on all days of the fortnight.
If RBI wants to tighten the monetary policy, it will raise the CRR. Lowering the CRR releases  more liquidity into the market. Changes in CRR tend to have an immediate impact on the  market.

2.Statutory Liquidity Ratio (SLR)

All Scheduled Commercial Banks, in addition to CRR, are required to maintain in India,
a)      in cash, or
b)      in gold valued at a price not exceeding the current market price, or
in unencumbered approved securities valued at a price as specified by the RBI from time  to time, an amount which shall not, at the close of the business on any day, be less than 24 per cent  of the total of its demand and time liabilities in India as on the last Friday of the second  preceding fortnight.
If RBI wants to tighten the monetary policy, it will raise the SLR. Such a measure would not  be effective, if banks’ holding of SLR is higher than the statutory SLR rate.
Lowering the SLR means that banks can sell some of their SLR securities to raise funds. It  therefore tends to soften interest rates.

3 Repo and Reverse Repo

Banks facing a shortage of funds can borrow from RBI through a repo transaction. The  transaction, backed by approved securities, has two legs:
  • In the first leg, the bank sells the required value of approved securities to RBI. RBI will  release funds to the bank against this transaction.
  • In the second leg, the bank buys back the same securities. The price for buying them  back (higher than the price for the first leg) is pre-decided, when the repo transaction is  agreed upon.

The difference between the prices for the two legs thus, is the borrowing cost for the borrowing  bank.
A repo transaction is meant to meet only the short term (single day to a few days) requirements  of banks.
A reverse repo is the opposite of a repo.

RBI announces the repo rate and reverse repo rate. They tend to remain steady for several  weeks, until RBI chooses to change it. The current repo rate is 6.5% p.a.; reverse repo  rate is 5.5%. The reverse repo rate will always be lower than the repo rate. If RBI wants to signal tight monetary policy, it will increase the repo rate. If the overall  liquidity position is tight, banks will increase their deposit rates or lending rates, since the  borrowing cost from RBI is up.A reduction in reverse repo rate makes it less interesting for banks to park their funds with  RBI. This measure is adopted when there is too much liquidity in the market, as reflected in  the inter-bank call money market or short term funds.In general, the call money rate (which is determined by the market, not RBI) is expected to  be between the repo rate and reverse repo rate.

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