• UGI USER
  • Oct 06, 2023
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Q. Highlighting the instruments of monetary policy available with RBI, discuss how it not only acts as a banker to the commercial banks but also to the government.

 

Approach

● Briefly define monetary policy.

● Mention the instruments of monetary policy available with the RBI.

● Discuss how the RBI not only acts as a banker to the commercial banks but also to the government.

● Conclude accordingly.

Answer

Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control. As the Central Bank, the RBI implements monetary policy through following tools:

Qualitative tools

  • Legal reserve ratio: Commercial banks are required to keep a certain amount of cash reserves known as SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio) with the RBI.
  • Repo and reverse repo rate: Repo and the reverse repo are the rates at which commercial banks borrow (or sell) money by selling (or borrowing) their securities to the RBI to maintain day-to-day liquidity, respectively.
  • Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • Market Stabilization Scheme (MSS): Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through the sale of short-dated government securities and treasury bills.

Qualitative tools

These are also known as selective instruments of the RBI’s monetary policy.

  • Rationing of credit: RBI limits the credit amount to be granted for particular sectors and commercial banks.
  • Change in Marginal Requirement: Changing the margin requirement leads to a change in the loan size. This instrument is used to encourage the credit supply for the necessary sectors and avoid it for the unnecessary sectors.
  • Moral suasion: Moral suasion refers to the suggestions to commercial banks from the RBI that helps in restraining credits in the inflationary period. RBI applies pressure on the Indian banking system without taking any strict action. Other than maintaining the money supply in the market through the above tools, RBI acts as a banker to the government as well as other commercial banks.
  • Banker to commercial banks: Reserve Bank is the only institution that can issue currency. When commercial banks need more funds in order to be able to create more credit, they may go to market for such funds or go to the Central Bank. The Central Bank provides the funds through various instruments such as Liquidity Adjustment Facility and Marginal Standing Facility.

Banker to the government 

  • Under the RBI Act, 1934, RBI acts as the banker and debt manager to the Central.
  • Government as well as all state governments except Sikkim.
  • It is entrusted with the management of remittance, exchange, and banking transactions in India including floating of loans and managing them, and providing Ways and Means Advances to the Governments.

Thus, RBI plays a key role in managing and monitoring the monetary policies affecting commercial and personal finance, as well as the banking system.